With interest rates rising, is now a good time to invest in income funds?
Thank you for your question.
Investors had a brutal year so far in the first half of 2022, as a result of the ongoing war in Ukraine and the Covid pandemic, consumer prices have reached their highest levels in decades and the US Federal Reserve hiking short-term interest rates to maintain inflation rates. Due to this many investors are trying to adjust their income to keep pace with inflation.
Just a brief explanation of income funds: An income fund is a type of mutual fund, exchange-traded fund or any type of fund that aims to provide income from investments.
The funds can hold bonds and equities. Income funds are mostly conservative but can be risky depending on the holding. Investors can easily invest in a diversified pool of securities that pay dividends or interest by using income funds. It’s vital to remember that the fund’s pricing is variable and subject to changes in the market.
The answer to your question is, with rising interest rates and considering your age, it is advisable to invest the bulk of your living annuities into conservative funds (income funds). However, since you like a growth close to inflation we suggest that you have some exposure to balanced and equities asset classes.
Being too conservative might not reach your investment goal of capital growth in line with inflation and you risk missing out on the appreciation you will get in the equity markets when they rebound.
Currently, the inflation rate is 6% and you are withdrawing 4% per annum, which means you need to achieve a real growth rate of above 8% per annum, making sure that you do not erode into the invested capital. Please also bear in mind that there are fees that are deducted from the growth of your investments.
Below is an example if you have 70% exposure to income funds and 30% to other funds.
|Funds||Allocation||1 year||3 years||5 years|
|Weighted average cost and return||100.00%||8.35%||8.30%||8.10%|
|Returns are as at 31 May 2022, past performances are not a guarantee of future returns|
*Please note we have used an average performance for each asset class based on a simulated model which however may not be indicative of future performance.
As seen in the above example, 30% exposure to other asset classes provides you with a return that is in line with inflation and provides you with long-term growth.
Inflation is one of the factors that the monetary authorities take into account when making a decision to change the interest rates. When inflation is high, the monetary authorities increase interest rates to discourage people and businesses from borrowing and spending too much money. This helps keep inflation on track.
When interest rates increase, investments such as high yield savings accounts, fixed deposits or any savings instruments look more attractive than equities. In this regard, investors tend to lock in profits made from equities by investing in high-interest rate investments. This equity sell-off will negatively impact the net asset value of the fund thus affecting the overall performance.
It is advisable to choose funds based on your own investment horizon and risk appetite. The idea should be to create a diversified portfolio that balances the asset allocation on your risk and return.