Investment income arrives from many sources: not all are safe

Volatility in global financial markets has made income more valuable for investors, but what are the best options?

Some investment experts say cash remains king right now .

Investors seeking good incomes have a turbulent time ahead of them amid global economic worries, Trump trade wars and the likelihood of more interest rate cuts.

Some investment experts say cash remains king right now as the financial and geopolitical volatility plays out, but other options have tempted many people in the chase for higher incomes.

Private credit has boomed in popularity but is being closely monitored by regulators amid fears it grew too quickly and products are now riskier than they should be.

Share dividends have become more attractive as stock prices tumble, but the downside of shares is big potential capital losses – as many investors have suffered in recent months.

Returns on deposits appear set to shrink as more economist pencil in more Reserve Bank interest rate cuts as a result of Donald Trump’s global tariffs and his likely international trade war.

Experts say fixed income, property trusts, exchange traded funds and some alternative assets might be a ticket to solid yields in the months ahead, despite volatility in financial markets. Their key message is for investors to diversify across different income sources.

Gaby Rosenberg, co-founder of fixed income app Blossom, said investors should not simply chase high yields.

“It’s tempting to go for the highest interest rate, but smart investors focus on risk-adjusted returns,” she said.

“That means understanding how much risk you’re taking for the return you’re earning.

“High yields often come with high risk – and if something’s paying way above market, there’s usually a reason. It could mean credit risk, illiquidity, or poor underlying fundamentals. If it looks too good to be true, it probably is.”

Always keep your money working and earning, Ms Rosenberg said.

“Cash sitting idle is income lost,” she said.

Blossom co-founder Gaby Rosenberg. Picture: Supplied

“Whether it’s reinvesting earnings, sweeping unused cash into short-term fixed income, or setting up auto-investments – compounding only works when your capital is consistently in motion.”

And when investing for income, always consider inflation and tax.

“Earning a solid 4 per cent might feel good – but if inflation is 3.5 per cent and you’re paying tax on your return, your real income might be close to zero. Always think in after-tax, after-inflation terms,” Ms Rosenberg said.

Here are the key options for income-focused investors right now.

SHARE DIVIDENDS

A traditional staple for millions of investors and super fund members, shares deliver handy dividend income but have a high chance of your investment going backwards in the short-term.

The past two months are a perfect example, where capital losses on many shares wiped out much more than the income delivered over the past year.

Baker Young managed portfolio analyst Toby Grimm said shares in Australian banks had become more attractive for income-focused investors following their recent falls.

Toll road giant Transurban, with a current yield near 4.7 per cent, was another solid income payer, Mr Grimm said.

“In Covid, cars kept driving,” he said.

“We would advocate diversification among income sources – you don’t want all your eggs in one basket.”

Shaw and Partners senior investment adviser Jed Richards said investors should be cautious of yield traps where companies paid out too much in dividends rather than try to grow their business.

“In Australia we have on average a 70 per cent payout ratio, because of our franking credit laws,” he said. “In America they only pay out 30 per cent and keep 70 per cent of the profit.

“So who gets the growth? We don’t because we pay out most of our profit in dividends. In America they pump it back into the business and therefore the business grows.”

PROPERTY

Investing in real estate can deliver decent income, especially for landlords who have owned a property for many years and enjoyed rent rises.

However, investors’ rental income must also fund other costs including loan repayments, insurance, repairs and maintenance, land tax and property management fees.

Real estate investment trusts, also known as listed property trusts, are an option that removes those extra costs, and can be bought in smaller parcels on the stock exchange.

“Australian property trusts have good dividend yields and often trade below asset backing,” Mr Richards said.

“One example is Abacus Storage King.” The company builds big sheds for people to store stuff inside, and Mr Richards said it was trading well below asset backing.

Mr Grimm said direct property investment “comes with baggage”, and he also suggested property trusts.

“You can pick whether you want a diversified property trust or pick an area, whether it’s residential, office or retail, with much smaller parcels than what you would buy if you bought direct property,” he said.

Shaw and Partners senior investment adviser Jed Richards. Picture: Supplied

BONDS

Aussies invest more money into property and shares than they do into bonds, which makes us different to many overseas investors, and we often don’t realise that one-third or more of our superannuation is invested in fixed income assets such as government and corporate bonds.

Bonds are debt owed by someone – historically governments but now many corporate providers too – who pays the bondholder a regular income for the loan duration.

Ms Rosenberg said high-quality bonds could offer a stable and predictable yield, low volatility, and regular distributions.

The way many are priced means that if interest rates start falling fast in response Donald Trump’s global trade war, investors will receive capital growth as well as income.

Ms Rosenberg said bonds could deliver some of the best risk-adjusted returns this year, but they did present challenges to investors.

“The most attractive bond opportunities are often unavailable to everyday investors due to high minimum investment sizes and limited retail access,” she said.

“This makes it difficult for smaller investors to build a well-diversified bond portfolio on their own.”

More exchange traded funds are offering investors exposure to bonds, and there are also managed funds focusing on this asset class.

Income Asset Management head of sales capital markets Jenna Hayes said there had been a “flight to safety” into government and corporate bonds.

“Investors are not necessarily moving into cash, but away from equities, and we are seeing greater flows into bonds,” she said.

“The returns on investment-grade bonds are yielding between 5.5 and 6.5 per cent, which is higher in some cases than the dividend yields of ASX 200 stocks.”

PRIVATE CREDIT

Until recently this was a relatively unknown income source. It’s lending bypasses banks and bonds and directly links borrowers with lenders, often packaged together by a company clipping the ticket on the way through.

Ms Hayes said private credit had grown quickly but this could have unintended consequences.

“When you experience rapid growth, the risks aren’t always going to be understood, especially as the asset class is far more complex than investors think,” she said.

“Some private credit funds are growing so quickly that in order to deploy their cash, they must say yes to deals they may have said no to in the past. There’s more risk than meets the eye here.”

Mr Grimm said private credit had been “hot of late” but did come with higher risk.

“It looks as though the return on offer is below what the risk deserves,” he said.

CASH

Mr Grimm said current high interest rates made cash in the bank a good income option.

“But you should shop around because there’s a huge difference in what you can get,” he said.

“Term deposits are more generous than they have been for a long time.

“Cash is king while this correction plays out.

Cash returns could come under threat this year from rate cuts, but Mr Richards said investors should not bank on that.

“Wait until it happens – people have been saying we are going to have rate cuts for years, and they haven’t come – we’ve just had one,” he said.

Cash remains popular for investors thanks to high interest rates. Picture: iStock

BYE BYE HYBRIDS

Bank hybrid shares – a mixture of debt and equity popular with mum and dad investors for many years – will gradually phase out by 2032 following a ruling by banking regulator APRA.

Mr Richards said APRA’s decision meant investors now had to buy riskier products to get the same 6.5-7.5 per cent return.

“We are still invested in bank hybrids, but as they expire new ones won’t be issued,” said Mr Richards, who was not happy with the APRA move.

He said exchange traded fund providers had been creating products to fill the gap, including one from BetaShares called QPON – Australian Bank Senior Floating Rate Bond.

ALTERNATIVES

Infrastructure stocks and funds can deliver solid incomes that often rise in line with inflation, and Mr Richards said he was also buying assets that were not correlated to global financial market moves. These included Duxton Water, which has the ASX code D20 and has had a 5 per cent share price increase since mid-February when global equites started to tumble.

“They’re a fund that buys water entitlements and leases them out to farmers,” he said.

LOW-YIELDING GROWTH SHARES

While investing in high-growth shares does not sound like an income strategy, if you pick the right ones the money tap can flow years.

Investment company DivGro’s co-founder, Jonathan Nurick, said his fund did not look for high-yield stocks: “we look for achieving very high yields over time starting with low yields that are growing very rapidly”.

One of his fund’s successful investments was US uniform supplier Cintas, which had grown its dividend by an average 18 per cent a year over the past 42 years.

Another was MasterCard, which generally yields around 0.5 per cent, but its dividend has grown 84 times over the last 19 years. “So your yield today is more than 50 per cent of your cost,” Mr Nurick said.

“The income starts from low and piles up, and the share price follows,” he said.

“The safest income is a growing income, and the faster it’s growing the safer it is.”

Originally published as Investment income arrives from many sources: not all are safe