Generally speaking, Investors should have two targets from their portfolio:
- Capital growth
In the majority, a portfolio will be structured with the aim of achieving both of these targets, though often one is prioritised over the other, with that priority standing potentially rotating over the lifetime of a portfolio.
Capital growth will most commonly be the target over the larger part of a portfolio’s lifetime.
However, the end game of most investment portfolios is for the store of wealth they represent to be drawn down and spent, at least in part.
This will most often be the case when the holder reaches retirement and no longer has a regular income from employment, though could also be earlier in certain scenarios.
When the point comes, or is approaching, where the holder of an investment portfolio wishes to start drawing down a regular income from it, holdings will often be revised and adjusted to a greater ‘income’ generating character.
So, what are the choices available to investors to draw a monthly income from an investment portfolio?
While there are many different asset classes that investments may be made in, from real estate to business interests, we’ll focus here on passive investment classes that don’t require any input from the investor.
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Invest in Regular Income Funds
There is a class of funds specifically structured to meet the market for investors who want to generate a monthly income.
While most income funds pay cash out twice a year, monthly income funds, as the term would suggest, pay out monthly. The level of income paid out by this kind of fund is not fixed and still depends upon performance, so is not a guaranteed monthly income.
In most cases, the fund aims to provide 11 monthly payments of roughly equal value. The aim is generally for the twelfth month to provide a higher payment, though this will again vary based on performance.
The advantage of monthly income funds is that they provide regular income.
The disadvantage of monthly income funds is that they create pressure for the fund manager to invest in assets that also pay out income regularly, in order to maintain cash flow balance.
This can lead to short-termism in the investment approach, as well as the general difficulty of juggling conflicting priorities of optimising returns and being able to pay out monthly.
As a result, monthly income funds tend to have higher management fees than their peers that make less regular payments. They also, on average, tend to yield less over the whole year than other funds with less demanding income generation requirements.
Invest in a Portfolio of Funds/Equities
An approach likely to yield better overall results is construct a portfolio of income funds, and/or dividend paying equities with a view to balancing payment timings.
Different income funds that pay out once or twice a year do so at different points throughout the year. By creating a portfolio of income funds and equities that pay out during different months a similar result can be achieved to investing in one monthly income fund.
As already mentioned, funds not constrained by the requirement of making monthly payments also tend, on average, to provide better returns so the overall annual income generated by this approach should be higher.
If cash is not too tight, investors can also simply have all income and dividends generated from a portfolio paid into a holding account on their investment platform, or paid directly into their bank account.
The income may not be evenly spread month to month but as long as the investor sticks to a monthly income budget, it will can even out over the course of the year.
Another option for a guaranteed monthly income would be to use an investment portfolio to buy an annuity.
Annuities are insurance products which come in different formats but most commonly guarantee a fixed, regular income.
Many annuity products will allow this income to be paid monthly if the preference of the holder. Annuities either pay out the guaranteed income for life, the usual format, or for a fixed number of years e.g. 20.
The downside to annuities is that their guaranteed income character means they are expensive. A considerably smaller income would be expected over 20 years compared to that generated by an investment portfolio.
However, if there is a market downturn or crash the holder will still be guaranteed their monthly payments. But as always with investments, this security comes at a cost.
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Invest in Fixed-Rate Income Bonds
Bonds are a further option.
There are a small number of fixed-rate income bonds that pay their coupon monthly, and many more that do so quarterly.
A similar approach can be taken as with a portfolio of funds to choose fixed income bonds whose payments come on different months to spread income over the course of a year.
The risk here is the company issuing the bond doesn’t have the funds to meet their obligations, or goes under.
As a general rule, the higher the coupon the higher the risk.
However, retail bonds could be a ‘higher risk’ allocation worth considering helping boost income for those who can afford to take it.