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COMMENTARY

Tempering income expectations in 2020

Even the higher risk, and potentially higher return, asset classes like shares don't offer very high returns. By Rupert Rucker

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It may be unrealistic to expect returns of 10.7 per cent per annum but it's still possible to achieve higher returns than those offered by savings accounts or government bonds. However, you and your money will have to work for them.

THE years since the 2008-09 global financial crisis have been difficult for income seekers and I think this is unlikely to change in 2020.

We live in a world where record low interest rates and years of asset purchases by central banks have led to ultra-low bond yields.

This means that the lower-risk investments and savings accounts that helped produce an income for previous generations simply do not offer high enough returns to grow our money. In developed markets in particular, rates of inflation are higher than deposit rates, meaning the value of cash savings is actually being eroded.

In 2019, many central banks, such as the US Federal Reserve (Fed), cut interest rates rather than raised them. This low interest rate environment looks set to persist in 2020 with the Schroder Economics Team forecasting one more interest rate cut from the Fed. Income seekers will not be able to rely on cash savings or low risk government bonds to provide the income they want.

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Investors' expectations are over-optimistic

In fact, investors want higher levels of income than any asset class can provide. The Schroders Global Investor Study 2019 found that average expectations of annual investment returns over the next five years now stand at 10.7 per cent - nearly one percentage point higher than at the same time the year before.

These expectations far outstrip the savings rates offered by banks. But even higher risk, and potentially higher return, asset classes like shares don't offer these kinds of returns.

Schroders' multi-asset team's latest forecasts for the next 10 years show emerging market equities are likely to provide the highest returns - but at 9 per cent, this is still below the average return investors say they expect.

The future won't be the same as the past

Investors and savers around the globe seem to be drawing on their memory of the 1970s, 1980s and 1990s, when interest rates looked very different from now.

Those were the days when my father could put money into an National Savings & Investment bond, backed by the British government, and gain a 8.75 per cent risk-free return. Savers in many countries could live off the income from their savings accounts.

These double-digit returns for savers have become stuck in our memories. However, they were the exception, not the rule. Across a broader sweep of history, base rates have stayed far closer to where we are today. Returns for savers were correspondingly lower too.

What can income investors do?

The picture described above is rather gloomy but it's important that investors don't despair. It may be that the worst thing would be to do nothing, and allow money to sit in a savings account where its value is being eaten away by inflation.

It may be unrealistic to expect returns of 10.7 per cent per annum but it's still possible to achieve higher returns than those offered by savings accounts or government bonds. However, you and your money will have to work for them. I offer three tips for investors seeking sustainable, higher income in 2020 and beyond.

Firstly, educate yourself about the market. Higher returns are available but they are likely to carry higher levels of risk. It's important for income seekers to be aware that they are risking capital when investing in asset classes like corporate bonds or shares. Investors need to understand the risks, and how comfortable they are with taking those risks.

A second related point, is that investing for a short time period is unlikely to bring the best returns. A time frame of at least five years is likely to be needed, particularly when investing in higher risk assets such as shares. This allows time to smooth out the peaks and troughs that are inherent in stock markets.

And thirdly, it's important to start as soon as possible. This allows your investment to grow through the power of compounding.

Can equity income provide a solution?

Looking more specifically into 2020, the dividend yield on most equity markets appears to be at attractive levels currently. Equity investments may be suitable for those seeking income who are prepared to take extra risk with their capital.

As the accompanying chart shows, current dividend yields look attractive both compared to recent history and, importantly, the alternatives available like cash deposit rates and bond yields. In particular, dividend yield levels are highest in Europe and Asia and at much higher levels than US markets.

Savers may need to consider many more sources of income than in the past, including equities. Dividends contribute a high percentage of the total returns from equity markets in Europe and Asia (the remainder coming from rising prices) so as we look into 2020 this could be a good opportunity to do some research.

  • The writer is Schroders Head of Income Solutions