Boost your income at low risk
Filed under: Investing
The past three years have been dreadful for Britain's savers, especially those who rely on their spare cash to generate income to support their everyday lives.
Between October 2008 and March 2009, the Bank of England slashed its base rate from 5% to 0.5% a year, where it has remained ever since. Thus, for more than three years, the base rate has been stuck at its lowest level in the Bank's 318-year history.
Your guide to banking
Need to know: Savings
Scared by shares?
One way to generate higher returns on your spare cash is to invest in high-yielding shares, which pay generous cash dividends to their shareholders, usually twice a year.
Your guide to banking
Need to know: Savings
For example, in a quick search of the blue-chip FTSE 100 index of elite British businesses, I found 22 companies offering dividend yields above 4.5% a year. On average, these 22 companies pay their shareholders a yearly income of nearly 6.2%. This is roughly twice as high as the interest paid by Best Buy savings accounts.
However, investing -- even buying into Britain's biggest, most successful firms -- involves a risk of loss. In the Noughties, the stock market taught us that share prices can plunge, rise and then plunge again, leaving investors nursing big losses. What's more, struggling companies can -- and do -- cut their cash dividends when times are hard.
Bag a bond
Is there some halfway house between cash and shares in which savers can earn a decent income, but at relatively low risk? For me, the answer lies in company IOUs known as corporate bonds.
Although few British savers and investors have significant holdings in corporate bonds, they are growing in popularity. This is largely due to the creation of ORB, the London Stock Exchange's Order Book for Retail Bonds, launched in February 2010.
Now well into its third year, ORB makes it easier and cheaper to invest in corporate bonds: the fixed-income investments offered by companies and other organisations. Thanks to its transparent, two-way, high-speed trading in over 150 bonds, ORB has attracted many new investors and companies to the UK bond market.
Today, private investors looking for a high-income home for, say, £1,000 or more can buy bonds speedily and simply via ORB. In short, ORB has made bonds almost as easy to trade as shares, which is great news for income-seekers.
Higher income, lower risk
Unlike shares, buying bonds does not incur stamp duty, which means investors don't have to pay a tax of 0.5% on the value of their purchases. Also, bonds which are at least five years away from maturity (being paid off by their issuer) can be bought inside tax-free stocks and shares ISAs and Self-Invested Personal Pension pensions (SIPPs).
Right now, I wouldn't touch the bonds on offer from most Western governments, as these pay pitiful coupons -- the regular cash payments made to bondholders. As I write, the UK government's 10-year Gilts yield just 1.94% a year, which is a terrible income.
On the other hand, I am a big fan of high-yielding corporate bonds, particularly the debt issued by some of Britain's biggest businesses. To show you what I mean, take a look at the table below:
Six high-yielding bonds
* GRY = gross redemption yield, the effective yield when a bond is held to maturity.
The first bond is issued by LBG Capital, which is a division of Lloyds Banking Group. If you were to buy, say, 10,000 of these bonds at the current price of 94p, they would cost you £9,400.
Based on their coupon of 9.334%, these bonds would pay you a fixed yearly income of £933.40 until they mature in February 2020.
Thus, your LBG bonds would earn a fixed income worth 9.93% a year on your £9,400 and then pay out £10,000 when they mature, for a capital gain of £600. Combining this income and capital gain, you get a gross redemption yield of almost 10.5%, which is a mighty impressive return.
An income of 8% a year
The other five bonds all have similar characteristics: they have a current price, a current yield, a gross redemption yield and a maturity date. Of these, three run until the final day of this century, so they are very long-dated bonds. Note that all six are issued by financial firms, including mega-bank HSBC, insurer Aviva and Nationwide, the UK's biggest building society.
What's remarkable about these bonds is their ongoing income, which averages 8% a year.
However, this is not a 100% risk-free income. There are two main risks:
1. Company goes bust or defaults
If a company goes bust or hits very serious trouble, it can't pay your coupon and the capital value of your bond will crash – probably to zero.
Back in 2006, I'd have said the risk of Lloyds defaulting was extremely small, but given what we've been through since then, that risk has increased a little.
Remember if things go wrong, you won't be able to get any compensation from the Financial Services Compensation Scheme (FSCS.)
2. Interest rates and inflation rises
Despite these risk factors, these bonds look good value to me, notably for income-seeking investors. There are more than 150 bonds listed on ORB to choose from, so do look at the full list on ORB.
In summary, savers looking for higher incomes, but who are afraid to lose money in shares, should take a good look at 'safer' corporate bonds. These can generate a higher income from your spare cash, but are less volatile than shares!
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