Oran Hall | Investment income streams

Getting a stream of income from investment instruments is, without doubt, highly desirable.

This is particularly true for individuals who need additional income to supplement their pensions or financial resources to realise other important goals.

We will examine the income generated by the investment vehicles most commonly used in the Jamaican market – dividends from ordinary shares and preference shares, rent from real estate, and interest from short-term and long-term debt instruments such as Bank of Jamaica certificates of deposit and corporate and government bonds.

Companies that make profits consistently generally pay dividends, but they are not required by law to do so.

There is, therefore, no guarantee that a company will pay a dividend, even if it is making profits. There is a benefit to the company that retains a significant portion of its profits – it reduces the need to borrow and thereby pay interest – but when companies do not pay dividends, they lose some of their lustre.

Dividends do not represent a frequent flow of investment income. Many companies pay one dividend for the year, but others pay up to four. This does not generate a regular cash flow to the shareholder, but the cash flow may be meaningful to them.

A friend shared with me recently that she has been buying shares since the 1980s but that she has not sold them. She gushed when she spoke about the level of returns from dividends. She mentioned that the dividends she receives for some stocks exceed the price she paid for them.

At the same time, investors who bought shares more recently are not able to speak so adoringly of dividend returns. Perhaps they may be able to do so many years from now if profits rise to the level that allow for very significant dividend payments.

Preference shares also pay dividends. Generally, they are paid at a fixed percentage rate of the face value of the shares, so regardless of their price, the dividends are the same. For example, if the dividend rate is five per cent, the dividend paid on each share is five cents whether the price is $1, or 90 cents, or $1.10.

Preference share prices, like bond prices, move in the opposite direction to interest rates, but, in the case of convertible preference shares, the price of the ordinary shares to which the preference shares are convertible also have some bearing on the price of the preference shares.

A company is not required by law to pay dividends, but in the case of cumulative preference shares, dividends not paid in one period accumulate to be paid in the future. Preference dividends tend to be paid twice per year, although some companies pay more frequently.

Rental income from real estate is based on a contract between the owner of the property and its user. Being generally paid monthly, rent provides a steady flow of income, and owners have legal remedies to address its non-payment.

Bonds and debentures, as debt instruments, pay interest to investors – twice per year in most cases. Generally, the rate of interest is fixed in relation to the face value, so a 10 per cent bond always pays $10 annual interest, whether its price is $100, or $80, or $115. In some cases, however, the interest is variable, so the rate is determined by the rate on a specific security plus a specified number of percentage points. For example, the rate at which interest is paid could be the average yield on the six-month Treasury bill issued at the beginning of the period to which interest applies plus three percentage points.

The issuers of bonds and debentures are required to honour their contracts with the holders of the securities and pay interest at the specified rate at the specified time. Failure to do so can do serious harm to the reputation of the issuer, and bond holders can exercise their legal right to collect the money due to them.

Shorter-term instruments, such as repurchase agreements and Bank of Jamaica certificates of deposit, may provide a more regular stream of income depending on their term. For instance, the interest on a 30-day instrument is paid when the instrument matures 30 days after being issued. On the other hand, interest on a 270-day instrument is paid 270 days after it is issued.

Treasury bills have short maturities, generally up to 365 days, but they do not pay interest. They are issued at a discount and mature at face value, that is, 100 per cent of their face value. The income they generate is the difference between the value at maturity or at the time they are sold and the cost.

Except in the uncommon case of distribution funds, unit trusts generally do not distribute cash to unit holders, rather re-investing the income they earn in the form of interest, rent and dividends, for example, in the fund, thereby boosting its value and unit price.

The regularity and certainty of investment income varies, and the question of the ability of an investor to live off investment income rests largely on the scale of the investments and the rates of return. What is adequate at one time may prove inadequate at another owing to changing needs and the corrosive power of inflation.

Oran A. Hall, principal author of ‘ The Handbook of Personal Financial Planning’, offers personal financial planning advice and counsel.finviser.jm@gmail.com