How to squeeze an income out of your cash

published 30 November 2005

It's been a dismal few years for anyone looking to earn income on their portfolio, says Harvey Jones in What Investment. The long equity bear market, low interest rates and the woes in the with-profits bond sector have left income seekers with few secure options. So where should you look now for the best income opportunities?

Cash

Savers can at last breathe a sigh of relief that interest rates are going up again, says Kate Burgess in the FT. Since the Bank of England raised rates by a quarter point in November, most banks and building societies have put up the interest paid on the £457bn in Britain's deposit accounts - or should do so shortly. The best accounts at the moment pay about 4.35% on instant access and up to 5.57% on a five-year fixed-term account. But make sure you do look around for these good rates. According to Leeds-based independent financial adviser Bates, one in three providers don't offer any customer - even non-taxpayers - an account that pays a positive real rate of return after allowing for tax and inflation. National Savings index-linked certificates may, therefore, be the best current option for many. To match National Savings' three-year index-linked certificate paying 0.95% after inflation and tax, higher-rate taxpayers need a deposit paying 1.58% after inflation, or at least 4.48% in nominal terms.

Equities

Dividend yields across the FTSE 350 average around 3.4% at the moment, says Jim Wood-Smith, chief analyst at stockbrokers Gerrard. This may not sound enough "to get the blood racing", but it's not bad, and some shares will, of course, return a lot more than that. The key is to remember that "dividends don't come out of nothing; they come out of cash flow". Lloyds TSB, for example, currently pays an attractive dividend of 7%, though an uncertain cash flow means it may not be sustainable. Other high yielders where the dividend is more secure, and which are recommended by Paul Kavanagh of broker Killick, include HSBC (4.7%), P&O (4.7%), which has a thriving international ports business, Legal and General (5%) and Shell (4.2%). In terms of general income, investors should stick to solid, blue-chip shares, says Invesco Perpetual fund manager Neil Woodford in the FT. Now is not the time to "flirt with riskier assets". Instead, revisit those high-quality companies, such as Glaxo, BT, and Diageo. Normally you have to pay a premium for quality; at the moment, "you don't have to" - current valuations are pretty reasonable.

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Bonds

Many investors still view bonds as a low-risk alternative to equities, says Harvey Jones. But some analysts warn that troubled stockmarkets have pushed bond prices to artificial highs and driven down yields. As interest rates rise, capital values could tumble fast. Adventurous investors might want to look at high-yield corporate (junk') bonds, or bond funds combining both junk and investment-grade assets, but these are not for those who need to avoid any capital losses.

Property

Some 77,000 private individuals bought investment properties in the first half of 2003 alone, says Harvey Jones, with a total of 335,000 rental properties - worth more than £30bn - now in private hands in the UK. And according to specialist buy-to-let lender Paragon Mortgages, rental yields have actually risen in the second half of the year, to an average of 7.6% per annum. If you still feel that becoming a landlord is currently too risky, you could invest in a property fund instead, such as Norwich Property (returning 60% over the last five years; 8% in the past 12 months), or Aberdeen Property Share (55% and 15%). But remember that most such funds invest mainly in commercial property, which may not move in the same way as residential, warns financial adviser Philippa Gee. Also, your own home already gives you significant exposure to this asset class. Some older savers might want to compensate for the long bear market in shares by borrowing against their home in an equity-release scheme, said Clare Gascoigne in the FT. Potentially, it's a "very useful tool for the income seeker". But it's a complex process, and borrowers should always take detailed, independent advice.