DIY Investor Magazine
/
December 2015
16
The importance of growth in income is often neglected,
but for a retiree with potentially 20-30 years of
retirement ahead of them, growth in their income will be
vital. Assuming an annual inflation rate of 2% (the Bank
of England’s target rate), an income of £10,000 in 1990
would have needed to rise to over £17,000 today to
have the same purchasing power.
In practice, an income investor might buy a portfolio of
shares and bonds for £1000 paying an annual income
of £4. An investor in retirement needs that income to
grow in line with inflation. In other words, that investor
needs to get £4 in the first year, then, say, £4.25 the
next, and then £4.50 the next, to ensure that their
purchasing power is maintained over time. There are
also administrative considerations in how investors
structure their income. Many funds have income and
accumulation units. The income units pay out the
income generated by the fund, while for accumulation
units, this is simply added back into the fund.
Many platforms/online brokers will then also offer
investors the option of reinvesting their income units.
This can be useful if investors want to switch on and
switch off their income stream as and when they
need it. There may be cost implications involved in
reinvesting rather than using accumulation units,
AN INCOME OF £10,000 IN 1990 WOULD HAVE NEEDED
TO RISE TO OVER £17,000 TODAY TO HAVE THE SAME
PURCHASING POWER.
but this will depend on the individual platforms.
Nevertheless, investors should understand the
differences.
There will also be differences in the way fund managers
take their charges. Some will take charges out of the
fund’s capital and some out of the income generated.
For income investors, charges can act as a drag on
their income returns.
Funds also vary in the way they pay income. Some will
pay monthly, some quarterly, some semi-annually and
some annually. The right option will depend on investor
preference, but many looking to supplement income
generated elsewhere may like regularity of income.
There may also be an impact on performance from the
different options, depending on market conditions.
For all income investors, there will be tax considerations
if the money received from investments exceeds their
annual personal allowance (£10,600 for the 2015/16
tax year) and is held outside a Stocks and Shares
ISA**. Income investors could avoid this by sheltering
as much as possible within an ISA wrapper, where
all income received is tax-free. ISA allowances are
relatively generous at £15,240 for the 2015/16 tax year.
Investors looking to generate an income from their
investments have a range of factors to consider in
building a robust and reliable income-generative
portfolio. They need to consider the assets that they
would like to incorporate, how much risk they are
willing to take to achieve an income and importantly,
they should try to ensure that the income offers some
mitigation against the damaging impact of inflation.
