Q I am 72 years old and a Self-Funded retiree, In 2008 I was getting 6.8% interest on my 1 year term deposits. Now I am struggling to get above 3%. I moved away from shares because of the risk of losing capital. Where can I find investment income to fund living expenses on day to day basis? I do not want to erode my savings but face little alternative with interest rates being cut to record lows.
A During the Global Financial Crisis many self-funded retirees moved away from shares and reverted to the safe harbour of Savings accounts and Term deposits. As you point out Term Deposit rates at 6.8% provided a stable income stream and the comfort of the Government deposit guarantee scheme. But times have changed, with RBA cash rates now at a record low of 2%, the viability of Term Deposits as a mechanism of funding ongoing income support is in question.
In all investments there are risks; income risks and capital risks. Generally those prepared to accept greater risk are rewarded but you need to understand what risks you face and ensure you are receiving sufficient return (reward) for accepting those risks.
With portfolio management, you always trade off risk. In 2008 you moved from shares to Term deposits because your found the capital risks unacceptable. You now find the income risk unacceptable i.e the risk that the income on your portfolio is too low, too volatile or unable to meet your income needs.
To reduce investment risk both capital and income, you should always look to diversify your portfolio and avoid having all your eggs in one basket. Diversify by investment and asset class.
Alternative investments to consider to produce income may include debentures, corporate and government bonds, property trusts and high yield shares. The returns available should reflect the known risks of the investment and the length of time you are investing for.
Be wary and understand the underlying investment you are invested in. If a Term Deposit is paying 3% and a debenture or bond is paying 7%, logic states that the higher interest rate paid is because there is greater risk in the underlying investment.
Managed Funds provide the opportunity to invest into various asset classes relying on the expertise of the underlying portfolio manager to manage the risks. There are independent research houses that rate fund managers on the quality of their funds and their ability to deliver out performance relative to their respective benchmarks.
Even if you are capital risk averse, it is important that you have growth investments in your portfolio to ensure that the value and income of the portfolio keeps pace with inflation.
Avoid dipping into capital to supplement income. If the income generated from a portfolio is insufficient to meet your income needs, reducing the pool of funds available to generate the income will only make it worse in the longer term.
If you cannot accept any capital volatility, an alternative could be a Lifetime Annuity with payments linked to inflation. The only other alternative is either to reduce spending or accept that you will ultimately erode your capital and eventually become reliant on Age Pension support.
Identify your income needs, how long you are looking to invest for and your appetite for risk. Get an opinion from a Financial Planner and always base your decision on your personal circumstances.