Investor Education Centre > Useful Tips & Knowledge > Guaranteed Income Investments: Don’t believe what you read
Guaranteed Income Investments: Don’t believe what you read
When it comes to investments, everyone wants a way to secure their returns while minimising risk. Guaranteed income investments propose just that, with the promise of regular income in a safe package that is often hard to resist.
Guaranteed income products are not everything you might think, however, and these investments are typically associated with a lack of flexibility and a low rate of return. In order to maximise your return on investment, it's normally a better idea to sacrifice the myth of stability and embrace the natural ebbs and flows that accompany normal market conditions.
What is a guaranteed income investment?
A guaranteed income investment is a financial product that comes with the guarantee of a fixed rate of return. These products differ considerably in terms and conditions, with stable income typically provided for life. These investment products are often used by retirees who want stable and low risk income to cover their everyday living expenses. There are two main types of these products: an annuity, and a reverse mortgage.
After making an initial investment, an annuity involves a guaranteed income stream for life. There are both fixed-rate and variable-rate annuities; the former offers a fixed level of income for the entire term while the latter changes with inflation and is linked to the overall performance of an investment portfolio.
A reverse mortgage involves borrowing money from your property in exchange for a guaranteed income stream. At the time of death, the money borrowed must be repaid or the property must be granted to the lender.
Benefits of guaranteed income products
While a guaranteed income investment is severely limited, in can be beneficial in certain conditions. This type of investment product functions much like a self-funded pension plan, with retirees and other investors benefiting from safe and consistent returns for a long time period. The known rate of return associated with these products can lead to less stress and simpler money management. Guaranteed income products also make budgeting simpler due to regular cash flow and income that remains insulated from wider market conditions.
Drawbacks of guaranteed income products
Despite the safety and consistency of guaranteed income investments, there are a number of significant drawbacks associated with these products. First and foremost, these products come with a very low rate of return compared to other investments. While stability and safety are enticing, there is a very real price you have to pay. Not only are your returns likely to be much lower than with more diverse instruments, your costs are also likely to be much higher.
Secondly, these products are completely inflexible and suffer from a lack of liquidity. Once you've made the decision to invest in a guaranteed income product, there may not be a way out. You will be stuck in your contract regardless of inflation and other changing economic conditions. From a practical perspective, there is a significant opportunity cost associated with these products, and the money you put into your initial investment will be unavailable for other more profitable investments when the opportunity arises.
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