Investment Income Options
Taking income from investments:
There are two distinct methods of taking income from an investment.
One method is to invest the capital and allow for the income to be taken via stripping out a percentage of the capital on a year-by-year basis. This can be achieved through offshore bonds or indeed onshore bonds by taking a set percentage of the overall value of the fund. Currently you can take 5% per year without any immediate liability to tax for 20 years from such an investment.
The advantage of taking income in such a way is that the underlying funds can be invested freely without regard to the need for income producing instruments.
The disadvantage is that the underlying capital will fluctuate in value and you may well see capital reduction. Additionally the capital will be put further under pressure by the encashment of more and more units, whilst the fund has dropped. In such an instance we would always advise that a client doesn't strip out the income in the first year and allows the capital to appreciate.
The second option is to buy income-producing assets such as gilts, corporate bonds, cash, and property.
The advantage is that you can calculate what the expected yield is, and strip that out. This is true income if it is taken without pressure on capital and is calculable (although approximate) in advance.
The downside is, funny enough, a risk to capital, but in a different way. By investing in simply one sector, you are not fully diversified should interest rates rise or companies struggle, capital could be put under pressure in a different way and we could see a reduction in capital value. For instance, companies could default on their coupon or even on capital repayment. Unlike equities, you cannot fall back on the dividend yield and indeed the fact that rising interest rates do have a beneficial effect on certain market sectors. Diversification would achieve this, but the underlying capital would fluctuate much more and we cannot predict whether the capital would perform better or worse. In short when building an income-producing portfolio with income producing instruments you are reasonably clear on what you will receive (although capital will still fluctuate) whereas with taking income from growth funds you are not. This is true in both the positive - rising income and capital and the negative – falling income and capital.
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