Is sustainable income or steady capital your goal in a low interest rate environment?

Retirees concerned about the impact of another cut to the official cash rate need to clearly identify their investment goals to help clarify whether capital stability or income sustainability is of greater importance, according to AMP Capital.

The Reserve Bank has today cut the official cash rate by 25 basis points to 2.0 per cent. This is significantly below the corresponding rate of 7.25 per cent in August 2008 and the rate of 4.75 per cent in November 2011 when the current cycle of policy easing commenced.

Cash investments such as term deposits have been regarded as a safe option for cautious investors due to the stability of their capital value and, at least historically, the delivery of an adequate level of income. However, official cash rates are now at historically low levels and the income from term deposits has fallen to levels marginally above the underlying rate of inflation.

By contrast, a well-managed portfolio of select corporate bonds, equities, property and infrastructure can deliver an attractive and predictable income stream that is stable and can be expected to rise over time. In order to achieve a sustainable income stream, however, investors do need to accept some short-term volatility in the capital value of their portfolio. There are many companies with dividends that are stable or rising but with share prices that nonetheless move through a 25 per cent range over a year.

Jeff Rogers, the Chief Investment Officer of ipac funds in AMP Capital’s Multi-Asset Group, said: “A strategy based on term deposits is exposed to high income variability over time but benefits from low capital volatility.  It is good for people with a specific short-term spending goal because you know your initial investment is safe.  But it is a risky strategy for meeting the goal of achieving a sustainable income stream over an extended period.  The fluctuations in cash rates are just too large.  Importantly, while interest rates will undoubtedly rise again in the future, retirees need to recognise that the average level of cash rates in the years ahead is most likely to be lower than our experience during the past 30 years.

"A diversified portfolio of bonds, shares and real assets can be managed to meet the goal of a predictable and sustainable income stream that rises progressively over time although it will exhibit capital volatility as the price of the securities goes up and down.  This stability of income can be achieved through the selection of investments with specific characteristics: high-quality corporate bonds with fixed coupons, shares of quality companies whose management is committed to delivering rising dividends to its owners, property assets with long-term rental agreements and infrastructure assets with inflation–linked contractual cash flows."

"The most important thing is for people to be clear on what they’re trying to achieve and then identify an investment strategy best tuned to meet that goal.  A financial adviser can help retirees identify and articulate their goals, recommend a strategy that is right for them and their circumstances, and help deal with the challenges and uncertainties on the journey."