Assets for a Growing Income

Posted: September 09, 2009

For many investors the key reason they invest is to generate an income - either an income they need to rely on now or an income they will need to rely on in the future.

Term deposits

An obvious place to start for investors that need an income is term deposits. The interest rate is guaranteed and the capital is secure. However when you roll over your investment at the end of the term, you cannot be sure what the new interest rate will be. The graph below shows the average one year term deposit rate offered by the big four banks in June each year ranged from 3.75% to 8% pa since 2000.

While this style of investment may offer capital security the level of income can be extremely volatile over the long term.

Residential property

Back in 2000 the median price for a Sydney property was $300,000 and the rental yield would have been around 4% pa (or $230 per week). In 2009 the median house price in Sydney has jumped to nearly $550,000. However from an income perspective the key message is an increase in rental income to around $450 per week. This represents a 7.8% pa return on the original $300,000 invested.

Rental income is driven by supply and demand and there is no certainty that rents will increase each year. At times the property may have no tenants, so no income. The net return will also be affected by ongoing maintenance costs, fees and/or taxes. But unlike other assets you do have the opportunity to make capital improvements to your investment which may increase the rental income and the capital value.

Shares

You could also have used the same $300,000 to buy a portfolio of blue chip Australian shares (ANZ, BHP, CBA, NAB, NWS, TLS, WBC, WES, WOW & WPL). Today this portfolio would be valued at more than $600,000. The initial dividends in total would have provided a return of 4% pa - but with franking credits this increased to 6%. By 2009 the base dividend yield has increased to 9.6% pa based on the original $300,000 invested - add the franking credits and it represents a return of 13.7% pa.

Across the portfolio some dividends have increased more than others. There is even more variation in capital values. The key with shares is to have a diversified portfolio. Unlike property investment, there are no ongoing expenses and you have the option to make alterations to your portfolio over time in an attempt to improve returns.

Summary

This brief analysis demonstrates that each asset class is unique and offers different styles of income. Term deposits are ideally suited to short term investing. They are also used to decrease the capital volatility of a longer term portfolio. Property and shares should provide a substantially superior income over time. Residential property may suit investors who want to get involved in their investments. Shares may be appropriate for investors who are comfortable with a hands-off style of investing and who want greater diversification.

The key message for longer term investors is that the income stream from rent and dividends is likely to increase over time.