Searching for income returns better than bank term deposits has become the clarion cry from many investors ever since the world’s central banks took official interest rates where rates have never been before!  So it’s timely for me to look at alternative sources of income on the day we’ve held our annual first Switzer Income Conference, which has the unfortunate acronym of SIC!

When young people are impressed with something they’ll say it’s “sick”, which makes me think, appropriately, that our SIC to some would be described as “Sick!”

Enough already. Let me get to the point: income generation from stocks has been good for some time.

This was the summary of my Switzer Dividend Growth Fund (or SWTZ) to August this year.

An alternative fund did even better, with the Vanguard High Yield (VHY) fund bringing in a calendar year number that was higher but it’s income-return or yield was lower.

On a year-to-October basis, VHY returned 16.1% with a yield of  5.3%. That number is significant because over five years the overall return was 5.16%.

The past year saw everyone chasing stocks that paid good dividends as a substitute for ridiculously low term deposit rates. Also, after the May federal election, lots of investors chased dividend-yielding stocks because franking credits were taken off death row when Bill Shorten’s Labor Party failed to form government.

VHY’s very good overall result is because it has greater exposure to growth than SWTZ, while the latter has chased income at the expense of growth and has come up with a higher yield. That said, both ‘ETFs’ (or to be precise, exchange traded products or ETPs) have two problems compared to a term deposit.

First, they’re not government-backed up to the value of $250,000 and they can experience capital loss. And as VHY has grown faster on the upside, it probably will fall faster on the downside.

Other income-chasing products that are exposed to the ups and downs of the stock market are on show at our SIC and they include e-Invest and the listed invested company — Contango Income Generator (or CIE). BetaShares has its managed fund called the Australian Dividend Harvester (or HVST), while the likes of Perpetual have income-seeking products.

This potential for capital loss is the reason why many investors reduce their exposure to investment products linked to stocks that pay dividend income. They have looked at hybrids but their returns have shrunk, as interest rates have headed earthward. We still put our financial planning clients into hybrid products for diversification but it has meant that we’ve also looked slightly higher up the risk curve for other investments.

Companies such as Charter Hall and Centuria have delivered solid returns of 5% and better over time and investors have got on board their property plays. These companies offer diversification for income-seekers and there’s no direct correlation to stock market volatility, though these investments will always be most rigorously tested in a serious recession. That said, an important testing point for these sorts of investments should be the calibre of the tenants. Tenants that are good businesses that have survived previous recessions and government bodies add solidity to these investments.

Mortgage trusts are currently offering returns over 5% but, once again, these investments are not deposits at a bank and their returns tell you that they have more risk than term deposits at a local bank. And away from these more traditional sources of higher returns, companies such as Metric Partners, provide opportunities for investors to direct their savings towards corporate loans and a range of borrowers not usually available for retail investors.

These guys presented at our SIC and together with the other alternative investments on show give investors and D-I-Y fund managers access to a virtual smorgasbord of products to combine to give diversification. This should help in reducing the associated risk of going up the risk curve when you really want to be in a government-backed term deposit.

Your options are to play it totally safe or add risk to bolster returns. Personally I’m happy to be long dividend-paying stocks, knowing my capital can go up and down with the market.

I work off the idea that if my current yield from my portfolio is 6% plus franking, based on stocks I’ve bought over the years, then I’m probably operating off an average income return of 8%. However, in a bad market crash/recession, this could shrink to 3% plus franking so I have to have a buffer account that tops up my income for those years when the stock market doesn’t deliver.

This is a way that you can play dividend stocks alone. But in my financial planning business we shoot for diversification that often brings lower returns than stocks but they provide shock absorbers for when the market goes negatively crazy.

At this stage in the stock market cycle, you have to ask yourself the following questions:

• What would happen to my capital/returns in a crash?
• Am I sufficiently diversified in my portfolio, given my appetite for risk and my goals?
• In trying to avoid stock market volatility and in searching for 5% plus returns, that term deposits used to deliver, am I going too far up the risk curve?

Here’s my final point and I’m making it emphatically — if you don’t understand the investment you have put your money into, then either get to understand it or get out of it!

Remember, term deposits are less than 2% and anything that offers you more is more risky. Personally, I’d rather be in a stock that loses 30% of its share price in a crash and kept paying a reasonable dividend until its share price rebounded over time, than to be invested in a company/product that disappears in a crash!

But that’s me. You have to work out what works for you. Of course, I’d love to go to cash a few days before the inevitable crash and not lose any capital but that’s easier written that actually done.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.