One of the first things you need to understand as you build and continue to manage your investment portfolio is the importance and relevance of income generation.
BY PETER JACOB
Income is important as it affects what investments and structures can or should be included in your portfolio.
Firstly though, let’s examine two reasons as to why you may need income.
Living expenses
The typical busy executive isn’t normally trying to obtain an income stream from their investment portfolio for day-to-day expenses. However, this may be a consideration now or at some time in the near future – typically in retirement.
If this is the case then the types of investments you can take on need to have a very reliable income stream. Putting food on the table isn’t negotiable!
However, busy business owners may also want to take some “money off the table” to pay for holidays, school fees, new cars etc. from time to time.
Debt repayments
This is the most likely reason an executive will require income. Investments typically require payments on a regular basis or at least annually.
Funding these repayments is normally through a regular and reliable investment income stream. Property investment, which is often funded using a high level of debt, is one asset class that’s often dependent on a secure income stream.
Debt repayment adds a significant risk to the overall portfolio. Not least of which is the fact that if you’re put in a position where you’re forced to sell the investment to repay debt it will almost certainly be at the worst point in the cycle.
Debt repayment requirements alter your portfolio as they become an immediate requirement when selecting assets.
Implications
Tax
Tax can have a significant impact on investment selection as income is generally taxed when it’s received. Therefore those who are trying to minimise tax in any given year are likely to be attracted to investments that pay little or no income in the immediate future. Hence the popularity of negatively geared investments, whether they be shares or property. Those looking to maximise income will seek investments that are predominantly income focused rather than capital or growth focused.
Of course all tax discussions and advice should be held with your accountant.
Portfolio size
The size of a portfolio matters when it comes to investment income. Large portfolios tend to require less income in an absolute sense because these portfolios are typically lowly geared so aren’t as demanding in terms of immediate income generation.
Property types and their income characteristics
Commercial
Direct commercial property is growth oriented but has a strong stable income flow. This does vary, however, depending on the subsector-income-focused industrial to capital-growth-focused office property.
Residential
The ever popular residential property is essentially a growth asset. The income returns net of expenses can be extremely low. Not a good option for those needing good income generation.
Conclusion
As you can see, if you have a strong need for income generation in your portfolio for living expenses or debt repayment you need to consider and view different asset classes differently, some being effectively not available to you.
The best outcome is to keep the portfolio conservatively geared and large enough so that high percentage income returns aren’t so high as to restrict you from investing in multiple asset classes and structures.
Peter Jacob is the managing director of Alphington Private Investor Services Pty Ltd in Melbourne.
I have always heard the saying “cashflow is the oil that lubricates the capital growth engine.” In other words we need to get cashflow from somewhere, whether that is through our every day jobs or from an income producing asset such as commercial property.
Comment by Sean — February 11, 2011 @ 11:54 am