Paul's Insights: Income funds - worth a look in these low rate days

The Reserve Bank’s decision to keep the official cash rate on hold at 0.25% for June comes as no surprise.  Our central bank has already made it clear that rates are likely to stay at record lows for some time – certainly until the economy picks up. That’s great news for anyone with debt, though not so good if you rely on interest-bearing investments for income.

Holding reasonable cash reserves always makes sense. Having a buffer of savings is especially useful to get through rough patches. But today’s low rates are a real source of concern for retirees and anyone else relying on cash assets for income.

The important thing is not to panic about the impact that low rates are having on your investment returns. Having navigated the unforgiving waters of Bass Strait many times, I know that panic is your worst enemy. It often leads to poor decisions. It’s much better to batten down the hatches and look for ways to ride out of the storm.

There are other investments beyond savings accounts and term deposits that can generate regular income with relatively low risk. In particular, I’m thinking of income funds.

These funds typically offer a handy mix of cash, interest-bearing assets like bonds, and shares in companies that provide a steady, reliable stream of dividends. As we’ve seen recently, dividends are by no means guaranteed. In response to the COVID-19 crisis some companies have dialed down or suspended dividend payments for 2020. But not every listed company has opted out of paying a dividend this year.

As our economy eases its way out of lockdown, listed companies will eventually resume their regular pattern of dividend payments. The challenge for investors, is knowing which shares are reliable dividend payers.

There is always the option of poring over individual company announcements to cherry pick those likely to pay dividends. A far easier option lies with a low-fee income fund. The hard work is done for you as the fund manager will have a readymade portfolio that blends dividend-paying shares with cash-based assets.

Adding these sorts of shares to your investment mix does mean taking on more risk. However, when you invest in an income fund, that risk is carefully managed. The reward for investors is the potential for good returns supported by a combination of long term capital growth plus dividends, which are very tax-friendly thanks to franking credits.

An income fund offers the additional benefit of spreading your money around. Diversifying this way helps you lower your overall portfolio risk while still having the opportunity to earn a higher income than if your money is sitting in a low rate bank account.

Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.