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Income investing: Managed funds vs. ETFs

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There are a number of options when it comes to choosing an income investment scheme. Investments that generate regular income can be useful in a number of various situations, such as funding your retirement lifestyle.

Despite the potential benefits, investing for income has become challenging for many people in today’s low-interest rate environment, with cash-based investments such as savings accounts and term deposits creating minimal income. Looking elsewhere can provide options such as managed funds or exchange-traded funds (ETFs).

Managed funds are where your money is pooled together with other investors and then bought and sold by an investment manager via shares or other assets on your behalf. ETFs are a type of managed fund that can be bought and sold on a secondary market like a share. Choosing between the two investment vehicles can be a tough decision, as there are both notable similarities and differences to consider:

Managed funds:

  • Pricing: When buying and selling managed funds, investors won’t know their exit price until the next day as pricing is set on a T+1 (day of trade plus 1) basis. A sale takes place either at the end-of-the-day price or on the net asset value of the assets. You could have to wait several days to receive your money from the sale.
  • Risk: It is up to the individual fund manager to invest in particular stocks, allowing you to access a diversified portfolio made up of varying asset classes. This can reduce your level of risk by minimising the impact of poor performance by a particular industry or sector.

ETFs:

  • Transparency: ETFs are typically more transparent than actively managed funds. An investment manager’s website can have its underlying investments readily able to be seen, where managed funds provide relatively little information about the holdings of the fund.
  • Buying and selling: Arguably faster and more convenient than the trade of managed funds, ETFs are bought and sold like shares, meaning you will need a sharemarket account and a broker. On the other hand, a managed fund is bought from the fund manager.

Managed funds and ETFs are legally known as trusts, with the underlying assets owned by the trustee on behalf of unitholders. As unitholders, you are entitled to receive dividends (after fees) and any capital gains after any capital losses. They are both typically open-ended investment funds, meaning that they are not limited by a fixed number of units. Depending on supply and demand, they both regularly create and redeem units, making them liquid investments.

Raising early stage capital in your business

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Raising capital is a step that every startup faces. When a business is brand new, the question of how to get money must be addressed. If you intend to launch a business that needs significant capital expenditure, such as a retail business or a company that employs several other people, then you won’t get far without initial funding.

Small businesses and startups must search for capital in a number of unconventional ways, as many do not have the size to issue valuable bonds or trade stocks and lack history with banks. Every investor has pro’s and con’s, and it is best to know what ways will work best for your business.

Friends or family investors:
Going to friends or family members can be the first point of contact to raise capital for your business. This is often a stage of funding that comes early in the process of getting a company’s operations off the ground. Investments from family and friends usually come in the form of loans, which you can arrange to pay back. A benefit from the investor’s perspective is that it could be considered less risky as there’s no mystery about the founders or their history. However, bringing issues of money into personal relationships can cause difficulties. It’s important to ensure that documents such as a formal business plan and legal agreements are drawn up professionally and to be transparent about expectations surrounding the investment.

Angel investors:
Angel investors refer to wealthy individuals who enjoy helping entrepreneurs in their business ventures. They can be important to a new startup, investing their money in exchange for a share or part ownership in the business as an equity investment. However, they can also provide loan investments in the same way as family and friend investors. As angel investment is high risk and high return, most informal funders require a guaranteed high return on investment. This requires a small business to provide a thorough business plan for considering investors.

Venture capitalists:
One of the most popular forms of startup funding is through venture capital. These are wealthy investors that support small businesses and startups by providing them with capital to grow and expand. Unlike family or friend investors, venture capitalists are generally equity investors with the expectation of a stake in the business. While they can be a great way to raise capital, they are often one of the hardest as these funds are typically looking for startups with high growth potential. It can also be about more than just return, as some venture capital firms have their own specialist areas and will look for founders or businesses they can add value to.

Pension income streams within an SMSF

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One of the best ways to ensure regular, flexible and tax-effective income as a pensioner is through an income stream from your SMSF. As a member, you can receive an income stream in a reoccurring series of benefit payments from your SMSF.

Income streams from an SMSF are usually account-based, which means that the amount allocated to the pension comes directly from a member’s account. Once an account-based pension commences, there is an ongoing requirement for the trustees of the superannuation fund to ensure the pension standards and laws are met.

Standards that must be met in order for SMSFs to pay income stream pensions are:

  • The minimum amount must be paid at least once a year.
  • Once the pension has started, the capital supporting the pension cannot be increased by using contributions or rollover amounts.
  • When a member dies, their pension can only be transferred to a dependent beneficiary if they have any.
  • The capital value of the pension or the income cannot be used as security for borrowing.
  • Before you completely change a pension, you must pay a minimum amount in certain circumstances.
  • Before you partially change a pension, you must make sure there are sufficient assets to pay the minimum amount.

Once they have satisfied these minimum standards, the pension will be treated as super income stream benefits for tax purposes. The funds may then be able to claim an exemption for the income earned on pension assets. This is known as an exempt current pension income (ECPI).

SMSF trustees may need to amend fund trust deeds to meet the minimum pension standards. For more information on how to do this, you should consult a legal adviser. Records must be kept of pension value at commencement, taxable elements of the pension at commencement, earnings from assets that support the pension and any pension payments made.

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