24.01 Liontrust Views Winter 2024 - Flipbook - Page 13
In constructing a portfolio to generate an income into the future,
it is beneficial to focus on delivering a risk profile to match your
own appetite and which is diversified across asset classes
as growth stocks. Start-up technology
companies are a good example of this.
Equities
Equities represent partshares in companies
listed on stock exchanges
and income can come from
the dividends they pay.
When companies are established they
might pay higher dividends to shareholders
rather than reinvest to support growth. Large
companies such as supermarket chains
are examples of this and their equities are
usually used in ‘equity income’ or ‘valuestyle’ funds, for example.
Companies can increase dividends
over time as they grow their earnings
and profits, which is also likely to lead to
a rise in the share price over time. Another
attraction are those companies that can
raise the prices for their goods and services
in line with the rate of inflation.
Some income investors, however, focus
on companies in the growth phase of their
business in the belief that they will be able
to grow their dividend over time as opposed
to companies paying out a high starting
level of income now that may struggle to
increase it in the future.
This potential for companies to grow both
their size and profits is why equities have
traditionally delivered the best investment
returns over the long term compared with
other asset classes. For example, data
comparing the performance of assets
adjusted for inflation shows that £1 left in
cash and UK government bonds 20 years
ago would have a purchasing power of 86p
and £1.01 respectively today, whereas £1
invested in the FTSE 100 index would be
worth over £2.20 in real terms.1 However,
equities are more volatile, so the higher
returns do entail a higher risk of losses.
Equity income funds might be seen as an
obvious option in which to invest for reliable
income and they are readily structured
to provide regular income. However, it
is also possible to draw an income from
capital gains within your portfolio instead.
This latter approach enables you to invest
in growth companies – instead of more
mature income stocks – while generating a
regular income.
Some companies and even industries
have traditionally paid higher dividends
than other companies – typically mature
businesses and sectors such as tobacco and
utilities. In the early stage of a company’s
development, for example, it is likely to
reinvest revenue to grow the business rather
than pay out dividends to shareholders.
Equities in such companies are known
1
Bonds – typically less risky
Bonds are IOUs issued by governments
and companies. They pay interest at a rate
usually fixed at launch and then repay the
principal after a set period, such as five
or 10 years (although some bonds are
‘perpetual’ and never repay it).
Bonds can therefore be a reliable source
of income. The level of interest paid
depends on the creditworthiness of the
debtor. For example, the UK government
or Sainsbury’s would typically pay a lower
rate of interest than a small company
because their relative financial strength
means the chances of them defaulting on
the debt are usually less.
Bonds are seen as less risky than equities
because creditors must be paid before any
dividends can go to shareholders and they
also have first call on a company’s assets in
the event of bankruptcy. The downside of
bonds, however, is that the income they pay
is usually fixed in nominal terms at issue,
for example £10 a year, so inflation will
erode its spending power over time unless
the bond is index- or inflation-linked, as with
some UK government bonds, for example.
A place for real estate
Anyone who has played monopoly knows
that owning property can provide attractive
income. Real estate, including commercial and
residential property as well as infrastructure
assets such as power plants and toll roads,
can produce steady income streams that are
also inflation-proofed if the leases under which
assets are rented are index-linked.
Investing in property via funds enables
investors to have a stake in a diversified
portfolio that is managed by property
investment professionals.
Real estate certainly has a place in a
diversified portfolio and it can be used to
generate income and capital growth.
Getting the right mix
In constructing a portfolio to generate an
income into the future, it is beneficial to
focus on delivering a risk profile to match
your own appetite and which is diversified
across asset classes to navigate future
economic and market cycles.
Source: Bloomberg, as at 31 July 2023, based on total returns from FTSE 100, UK gilts all maturities and three-month LIBOR
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