What to Invest In for Income?

It is an extremely difficult time for investors who want income with a high degree of safety.  Interest rates continue at virtually all time lows, and the Reserve Bank is unlikely to increase the official cash rate for some time.  Banks promote specials, but they certainly do not look attractive to investors who were typically receiving 7% plus for term deposits.

Finance companies, unless there is some surety of a continuing crown guarantee look like a minefield.  A few have managed to strengthen their balance sheets, and now have ratings, albeit most are too low.  Historical Standard & Pools one year default rates are over 10% for “B” rated companies.  With such high expected default rates, it is little wonder that the Crown is demanding its fair share of the silver to provide a guarantee. 

The cost of the guarantee is effectively being paid by the investor in the form of reduced interest rates.  Some companies are now offering tiered investments.  Some of these are in a pool with a crown guarantee, and others in the non guaranteed pool.  This is similar to what Capital & Merchant did before they collapsed.  History shows that the only difference was that the investors who did not have the insurance cover received a significantly higher interest rate.  At the end of the day (and it’s not yet finally over for these investors), everyone lost out big time and the insurance counted for nothing.  If for some reason you are considering investing in a finance company, we suggest that you thoroughly check the trust deed as well as the investment statement.  Particularly check who has priority over your potential investment.

For another group of investors, who wanted better than bank rates, they invested in what they considered to be a safe cash fund.  However the fund manager intermingled investors monies between two different funds.  The problem is that the Cash Fund monies got intermingled with a mortgage fund.  A matter of a few weeks later the funds got frozen.  Imagine if you needed what you considered your safe cash invested monies back.  Amazingly, they have not been taken to task for doing this by the enforcement authorities.  They didn’t even really get slapped on the wrist with a wet fish.  Did the trust deed allow this? Did the prospectus or investment statement allow this? The answer to this is, well there isn’t anything written down anywhere saying they couldn’t! Regulators and enforcement agencies just have to get real and provide some value for money.

Perhaps income seeking investors should take on some additional risk in order to increase their returns.  To do this, they really need to have an income focus, and not worry unduly about the capital value of their investment.  It is not an issue if they are not actually requiring the capital.  The capital value may have a chance to grow, or it may go down in value.  Single bonds could be used, or for safety’s sake a diversified mix of bonds, perhaps through a bond fund.  There are also high yielding shares which pay reasonably predictable dividends.  Again there are low cost options of providing a diversified approach to this.  Similarly listed property trusts offer reasonably attractive dividend yields.

Should you diversify out of the New Zealand market for this? Dividend yields are generally higher in New Zealand than for example Australia.  Interest rates are higher though in Australia.  But if there was any advantage in gross returns for Australia over New Zealand, the Australian tax man will negate it, as you cannot use Australian franking credits (effectively the same as imputation credits here in New Zealand).  The short answer to increasing your cash flow return from investments comes with the loss of capital stability.  Ask yourself is that a real issue, and in most cases it probably is not.  But before you do anything, take some good professional advice for your particular situation. 

This article is only general in nature and does not purport to take into account individuals needs and issues.