Income investing

Chickereeeee

I have long wanted to invest in more income-producing funds/ITs (even shares) but have long held the opinion that with historically low interest rates, these investments would be over-priced, (not to the same extent as bonds maybe). Come interest rate rises, their price would be hit harder than 'growth' investments. Hence I have minimised income investments (I have some), and would hope to swap more from growth to income as rate rise: even to normal levels.

I have been saying this for a good few years now.....

Does the logic hold?

Opinions welcomed.

C

ChesterDog

I think people tend to over-generalise and unwittingly exaggerate scenarios like the one you envisage.

When interest rates do eventually rise, it will not be with massive, cataclysm-inducing hikes, but with gradual and gentle increases over time.

Such an environment will clearly be somewhat less favourable to income-producing funds and they may look less attractive as a result, but I don't see there being a sea change overnight, and meanwhile - as you say yourself - the environment has not yet changed.

For me, this is all part of the problem with trying to time the market. Short-term, long-term, gut-feeling based, evidence-based... Markets often enough do not behave as expected as to make even the most reasoned forecast dubious in its reliability.

JohnRo

I've hedged my bets somewhat by trying to do both, as much as I can afford, with the plan being to transfer the growth, what little there is, towards compounded tax free equity income production over a period of as many years as I can afford before needing the income and or some of the capital.

That's my plan, although I've seen enough of the not-so-bright side of life to know it often has other ideas about the best laid plans.

Linton

I dont believe that an increase in interest rates will cause an across the board significant fall in dividend paying shares.

The reason is that the most popular dividend paying companies are major constituents of the FTSE100 and so are mainly held, not for their dividends, but rather for their fundamental economic characteristics. They are big successful companies that just happen to pay good dividends. Private investors seeking an income are a small market for such shares compared with the major funds investing in the UK generally.

Trying to guess the future value/growth balance is as futile as trying to time the market. You are better off fixing a % allocation from the outset and keeping to it.

Chickereeeee

ChesterDog wrote: »

I think people tend to over-generalise and unwittingly exaggerate scenarios like the one you envisage.

When interest rates do eventually rise, it will not be with massive, cataclysm-inducing hikes, but with gradual and gentle increases over time.

Such an environment will clearly be somewhat less favourable to income-producing funds and they may look less attractive as a result, but I don't see there being a sea change overnight, and meanwhile - as you say yourself - the environment has not yet changed.

For me, this is all part of the problem with trying to time the market. Short-term, long-term, gut-feeling based, evidence-based... Markets often enough do not behave as expected as to make even the most reasoned forecast dubious in its reliability.

Understood, but you can use the same argument about buying bonds (eg UK gilts), but I have a hard time convincing myself to put money into (almost) return-free risk.

C

ChesterDog

That's true. I prefer cash.

I feel that bond values (gilts, at least) are particularly sensitive to interest rates, without the underlying potentially-improving fundamentals of well-chosen equities these days.

Funny old world...

Thrugelmir

What do regard as growth investments? Companies that require cash, refinancing existing debt and/or capital to fund themselves will find it more expensive to do so when interest rates eventually rise.

jimjames

Chickereeeee wrote: »

I have long wanted to invest in more income-producing funds/ITs (even shares) but have long held the opinion that with historically low interest rates, these investments would be over-priced, (not to the same extent as bonds maybe). Come interest rate rises, their price would be hit harder than 'growth' investments. Hence I have minimised income investments (I have some), and would hope to swap more from growth to income as rate rise: even to normal levels.
C

Before 2007 shares always paid a much lower income than savings and bank accounts, you were sacrificing immediate income for the likely higher future income when the capital grows over time.

In 2008/9 that got turned on its head and shares now pay considerably more than savings. If anything that would indicate that prices of shares should rise if dividends stay the same. I don't see interest rates rising much if anything in the near to medium term so I can't see any reason why the current share price levels wouldn't be maintained.

Even if they do drop the income is unlikely to be reduced, many investment trusts have increased their income payments for over 40 years and some for nearly 50 so if you are after a good and rising income it would seem like a decent option to me.

Chickereeeee

jimjames wrote: »

Before 2007 shares always paid a much lower income than savings and bank accounts, you were sacrificing immediate income for the likely higher future income when the capital grows over time.

In 2008/9 that got turned on its head and shares now pay considerably more than savings. If anything that would indicate that prices of shares should rise if dividends stay the same. I don't see interest rates rising much if anything in the near to medium term so I can't see any reason why the current share price levels wouldn't be maintained.

Even if they do drop the income is unlikely to be reduced, many investment trusts have increased their income payments for over 40 years and some for nearly 50 so if you are after a good and rising income it would seem like a decent option to me.

Hmm it's tricky.. If you look at the 10 year chart for CTY (one of the ones with a long proud history of increasing dividends) say:

http://www.hl.co.uk/shares/shares-search-results/c/city-of-london-investment-trust-ord-25p/share-charts

...it shows a fairly close link to the FTSE 100 for the first 5 years. From 2008 it shows a large out-perform.

In 2004, CTY yield was about 4.6%, and the base rate was 4.25%
In 2015 CTY yields 3.91% and base rate is 0.5%

(I can't find a NAV for 2004, but there was about 10% discount in 2007)

C

JohnRo

These calcs are very crude, I'm not sure it's even relevant for what you're debating but using your yield figures above.

In 2004 CTY share price looks to be ~ 210p making a 9.65p dividend
In 2015 CTY share price looks to be ~ 390p making a 15.25p dividend

Since 2004 inflation has according to the CPI numbers I have, degraded purchasing power by about 23%, so I see both the CTY share price and the dividend payouts have very comfortably outpaced CPI inflation.

This is the sort of thing I'm hoping to capture in my income portfolio, though whether the last ten years have any bearing on matters going forward remains to be seen.

talexuser

My experience is that good income funds tend to be more consistent if you are reinvesting the dividends into units. Growth funds need more luck to choose one that outperforms, and are more subject to exchange rates that can hurt returns. At least that's my pennies worth subjective feeling investing over 20 years.