Benchmarking Financial Systems with a New Database


How do financial systems around the world stack up? Which one has the highest number of bank accounts per capita? Where in the world do we find the lowest interest rate spreads, and where are they the highest? Which country has the most active stock market? Has competition among banks increased or decreased in recent years? Are financial institutions and financial markets in developed economies more or less stable than those in developing ones? Answers to these and many other interesting questions can be found in the Global Financial Development Database, accompanying the 2013 Global Financial Development Report. Both the database and the report were published earlier this month.

The Global Financial Development Database is the most comprehensive publicly available dataset on financial development. It contains over 70 financial system indicators for more than 200 economies on an annual basis from 1960 to 2010. All these indicators are categorized in four broad categories: (a) size of financial institutions and markets (financial depth), (b) degree to which individuals can and do use financial services (access), (c) efficiency of financial intermediaries and markets in intermediating resources and facilitating financial transactions (efficiency), and (d) stability of financial institutions and markets (stability). The selection of these indicators, their detailed definitions and links between the empirical data and the conceptual literature on financial development are discussed in an underlying working paper.

Considerable effort was involved in collecting, cleaning and checking this unique database, which builds upon and improves upon several existing data sources. One of the earlier efforts in this area was the Database on Financial Development and Structure, introduced inBeck, Demirgüç-Kunt, and Levine (2000), and subsequently updated several times. The Global Financial Development Database extends, updates and recalculates these country-by-country indicators, many of which are based on underlying data for individual institutions and markets. (For completeness, the Database on Financial Development and Structure has now been updated again, to be consistent with the more comprehensive Global Financial Development Database.)

In addition to the large electronic file with the Global Financial Development Database, there is also a smaller, pocket version of the dataset, published as the Little Data Book on Financial Development. The booklet shows a subset of indicators for the four categories of financial system characteristics (depth, access, efficiency, and stability) explored in the main database. The data are shown for individual countries as well as for country groups.

Uses of the global financial development database

The database has many possible uses. One of them is illustrated in the Statistical Appendixof the Global Financial Development Report, which uses a subset of the data illustrating the state of financial systems around the world in 2010. Table 1 below, adapted from the Statistical Appendix, shows how some of the countries compare relative to the overall distribution of countries around the world. The data presented in the Global Financial Development Report illustrate that deep financial systems do not necessarily provide high degrees of financial access; that highly efficient financial systems are not necessarily more stable than the less efficient ones, and so on. The data also demonstrate the effects of the global financial crisis. This is discussed in more detail in the underlying working paper.

Table 1. Countries and Their Financial System Characteristics (Example)


Source: Data from and calculations based on the Global Financial Development Database.
Note: The four blue bars summarize where the country’s observation is vis-à-vis the global statistical distribution of the variable in the Global Financial Development Database. Each blue bar corresponds to one quartile of the statistical distribution. So, values below the 25th percentile show only one full bar, values equal or greater than the 25th and less than the 50th percentile show two full bars, values equal or greater than the 50th and less than the 75th percentile show three full bars, and values greater than the 75th percentile show four full bars. The blue bars on the far left are based on a simple (unweighted) average of the eight financial characteristics, each converted to a 0–100 scale. For details, see Čihák, Demirgüç-Kunt, Feyen, and Levine (2012).

The Global Financial Development Database can also be used to create map-based visualizations. Figure 1 below shows one such example. It uses the dataset to emphasize the uneven sizes of financial systems around the globe. The figure illustrates that, for example, financial systems of many individual European countries are larger (in terms of total assets) than the combined financial systems of all countries in Sub-Saharan Africa.

Figure 1. The Uneven Size of Financial Systems

The Global Financial Development Database will be updated on an ongoing basis as financial systems evolve. It is expected that its coverage will increase as more data are compiled, especially on non-bank financial institutions and financial markets, where the data coverage is still lower than in the banking sector. These updates and extensions will be reflected infuture editions of the Global Financial Development Report and the Little Data Book on Financial Development.

How do financial systems compare globally?

Returning to the initial question of this blog post, how do financial systems around the world stack up? Table 2 below (adapted from Chapter 1 of the Global Financial Development Report) provides a partial answer by showing summary statistics for the main income groups of countries. It illustrates that while financial systems in high-income countries tend to have more depth, provide more access, and are more efficient than those in lower-income countries, they score about the same in terms of stability.

How about answers to the other questions mentioned in our opening paragraph? We encourage you to download the dataset, explore the data, find the answers, and send us your responses and suggestions to!

Table 2. Financial System Characteristics Summary, by Income Group, 2010

Source: Calculations based on the Global Financial Development Database.
Note: The indicators are on a scale from 0 to 100, relative to the distribution of the variables for 203 jurisdictions in 1960-2010. Financial Institutions—Depth: private credit/GDP (%); Access: number of accounts per 1,000 adults in commercial banks; Efficiency: net interest margin (inverse); Stability: z-score. Financial Markets—Depth: (stock market capitalization + outstanding domestic private debt securities)/GDP; Access: market capitalization outside the top 10 largest companies (%); Efficiency: stock market turnover ratio (%); Stability: annual standard deviation of the price of a 1-year sovereign bond divided by the annual average price of the 1-year sovereign bond. For details, see Čihák, Demirgüç-Kunt, Feyen, and Levine 2012.



Bank Ownership, Lending, and Local Economic Performance During the 2008 Financial Crisis



In September 2008, the collapse of the Lehman Brothers investment bank precipitated a financial crisis and a sharp decline in international credit. Massive layoffs and an economic recession in the U.S. and many industrialized and developing countries ensued. In some countries, however, the effects of the financial crisis were limited and short-lived. This was true for Brazil and China, both of which continued to experience high rates of economic growth in subsequent years. A cited reason for these countries’ relative success during this period has been government involvement in the banking sector 1.

In a recent paper with my co-author Leo Feler, we explore the argument that government banks can mitigate economic recessions. We create a unique database combining locality-level bank branch locations, locality-level balance sheets, employment censuses and additional locality-level controls 2. This database, along with aggregate bank balance sheets, allows us to, first, assess the lending patterns of Brazil’s government and private banks at both the national and the locality-level. Secondly, we can assess the local economic impact of government banks during the financial crisis.

Our results suggest that localities with a higher fraction of bank branches that are government-owned, experienced better than expected changes in lending, output, formal sector employment, and the number of firms in operation during and immediately following the financial crisis. These localities continued to grow and did so faster than otherwise comparable localities with a smaller share of government bank branches. 

As a variation of our locality-level results, we also assess whether the lending by government banks is concentrated in politically-aligned areas or in areas that are, by traditional measures, more bank dependent. In the Brazilian case, we find that lending was neither targeted to localities with more bank dependence nor that it was targeted politically. Instead, it was simply allocated to areas where government banks had a greater presence. We lastly assess the quality of the loan portfolio and find that, at least based on short-term outcomes, government banks did not relax their lending standards while increasing their lending.

These results should be interpreted with some caution. There is ample evidence that government banks are subject to political capture and that their lending can become politically motivated, with detrimental effects (Dinc, 2005; Khwaja and Mian, 2005; Carvalho, 2012; and Barth, Caprio, and Levine, 2001). Even in Brazil, this was the case when individual state governments owned banks (Feler, 2012). While we find that government banks propped-up the economy in Brazil and prevented a deeper recession from occurring following collapse of Lehman Brothers, it is unclear what the longer-term implications of government bank intervention might be. At least during this crisis in Brazil, government bank lending had significantly positive and fairly immediate effects on output, on employment, and helped firms to remain in business

Banking Union for Europe – Risks and Challenges


The Eurozone crisis has gone through its fair share of buzz words — fiscal compact, growth compact, Big Bazooka.  The latest kid on the block is the banking union. Although it has been discussed by economists since even before the 2007 crisis, it has moved up to the top of the Eurozone agenda.  But what kind of banking union?  For whom? Financed how?  And managed by whom?

A new collection of short essays by leading economists on both sides of the Atlantic — including Josh Aizenman, Franklin Allen, Viral Acharya, Luis Garicano, and Charles Goodhart — takes a closer look at the concept of a banking union for Europe, including the macroeconomic perspective in the context of the current crisis, institutional details, and political economy. The authors do not necessarily agree and point to lots of tradeoffs.  However, several consistent messages come out of this collection:

  • No piecemeal approach. Centralizing supervision alone at the supra-national level, while leaving bank resolution and recapitalization at the national level, is not only unhelpful but might make things worse.
  • A banking union is part of a larger reform package that has to address sovereign fragility and the entanglement of banks with sovereigns.
  • Immediate crisis resolution vs. long-term reforms. There is an urgent need to address banking and sovereign fragility to resolve the Eurozone crisis. Transitional solutions that deal with legacy problems, both at the bank and at the sovereign level, are urgently needed and can buy sufficient time to implement the many long-term institutional reforms that cannot be introduced immediately.


The push for a banking union stems from the realization that the financial safety net for the Eurozone is incomplete. Although the original Eurozone structure did not foresee it, the European Central Bank (ECB) is effectively the lender of last resort, but — as argued byCharles Wyplosz — it is ill-equipped to act as such. First, it has limited information about banks and no authority to intervene. Second, national authorities with the responsibility to intervene, restructure, and recapitalize banks procrastinate as long as possible, putting additional pressure on the ECB to intervene, but only when it is too late. Several authors criticize the sequential introduction of supervision and bank resolution, which might lead to less, rather than more, stability, as conflicts between the ECB and the national resolution authorities are bound to arise.

Several contributors point out that one should distinguish between solutions to the current crisis and institutional solutions to make the Eurozone a long-term sustainable currency union by constructing a banking union. Using a Eurozone-wide deposit insurance and supervision mechanism to solve legacy problems would be like introducing insurance after the insurance case has occurred; it would also entangle important changes in the European architecture with distributional conflicts related to crisis resolution. One suggestion is to establish a crisis resolution mechanism (European Resolution Authority), using the European Financial Stability Facility and the European Stability Mechanism as backstop funding sources, while at the same time establishing the necessary structures for a banking union.

The resolution of the banking crisis and the creation of a banking union have to go hand in hand with the resolution of the sovereign debt crisis, as stressed by Viral Acharya.  In terms of regulatory reform, this requires adjustments in capital charges for sovereign bonds, and government bonds eligible for liquidity holdings must be in the highest quality bucket and possibly diversified across sovereigns.

A properly working banking union would also help address the existing macroeconomic imbalances within the Eurozone. Daniel Gros starts from the observation that the desire to protect the home turf in Northern Europe has bottled up large amounts of savings there, thus contributing to the severity of the Eurozone crisis.  Providing the ECB with supervisory authority could have an important macroeconomic impact because the ECB would not penalize cross-border lending in the way national supervisors do today. Such a move would thus allow the Single European Market in Banking to function again, including intra-bank capital markets, i.e., flows between parent banks and subsidiaries, a critical condition not only for making the credit channel of monetary policy work again, but also for restarting growth especially in peripheral countries, and thus dampening the multiplier effect of fiscal policy.

Banking union for whom?

One critical question is whether the banking union should be “just” for the Eurozone or for the whole European Union. In my contribution, I argue that the need for a banking union is stronger within a currency union, as it is here where the close link between monetary and financial stability plays out strongest. It is also where the link between government and banking fragility is exacerbated because national governments lack the policy tools that countries with an independent monetary policy have available. By contrast, Jeromin Zettelmeyer, Erik Berglöf, and Ralph de Haas, from the European Bank for Reconstruction and Development, argue that non-Eurozone countries should be allowed to opt into the banking union but, if they do so, they must be given a say in its governance and access to euro liquidity through swap lines with the ECB.  Apart from full membership, intermediate options could be considered that would extend some but not all the benefits and obligations of membership to all financially integrated European countries — including countries outside the European Union.

The institutional details

Should the responsibilities for running the banking union be concentrated in the ECB?  There is certainly a strong argument for centralizing responsibility on the supra-national level. There are clear arguments to separate bank resolution and deposit insurance in an institution outside the ECB, to avoid conflicts between monetary and micro-stability goals and introduce additional monitoring (Dirk Schoenmaker). One argument for a supra-national supervisor is that it would help reduce the political capture of regulators that has been observed across Europe over the past years and became obvious during the current crisis. This lesson can also be learned from Spain, as Luis Garicano points out: “the supervisor must be able and willing to stand up to politicians.” In addition, there is a supervisory tendency to be too lenient toward national champions, while bailing them out is too costly, explains Charles GoodhartFranklin Allen, Elena Carletti, and Andrew Gimber argue, however, that the ECB might not necessarily be a tougher supervisor than national supervisors. It might actually be more lenient, because it is concerned about contagion across the Eurozone and it has more resources available. Tying its hands by rules might therefore be necessary.

Looking west across the Atlantic

This time is not different.  Studying history can be insightful, for both economists and policymakers. Accordingly, several observers have looked for comparisons in economic history for clues on how to solve the Eurozone crisis.  Joshua Aizenman argues that the history of the United States suggests large gains from buffering currency unions with union-wide deposit insurance and partial debt mutualization. It is important to note, however, that it took the United States a long time to get to where it is now, and quite a lot of institutional experimentation and several national banking crises. And, as is currently being discussed in Europe, the United States had to address both banking fragility and state over-indebtedness.  Fiscal and banking unions go hand in hand.

It’s the politics, stupid!

In addition to a banking, sovereign, macroeconomic, and currency crisis, the Eurozone faces a governance crisis.  Diverse interests have hampered the efficient and prompt resolution of the crisis. And as financial support for several peripheral Eurozone countries has involved political conflicts both between and within Eurozone countries, so the discussion on the banking union has an important political economy aspect, Geoffrey Underhill points out.  More importantly, there is an increasing lack of political legitimacy and sustainability of the Eurozone and for the move toward closer fiscal and banking integration. “Citizens in both creditor and debtor countries increasingly perceive rightly or wrongly that the common currency and perhaps European integration tout court have intensified economic risks.” A banking union can therefore only succeed with the necessary electoral support.

The essays in this collection lay out an impressive agenda for policymakers in the Eurozone. Over the past years, the crisis has been exacerbated by half-baked approaches and unsustainable policies. Political inaction has put greater responsibility and stress on the ECB, expanding its realm far beyond monetary stability and its democratically assigned responsibilities, and forcing it to go for second or third-best solutions. It is high time for Eurozone governments to take bold steps not only to address the current crisis, but also to put the euro on a long-term sustaina

Trends in new firm creation through the crisis and into recovery


A recession is a difficult time to start a business. Credit is tight, consumers are wary, and the future appears uncertain. It seems logical that entrepreneurs would have been deterred from starting a new business during the 2008-09 global financial crisis, but how widespread was this phenomenon, and are there signs that new firm creation has begun to recover?  The 2012 Entrepreneurship Database released today provides a novel look at these trends. Based on data from business registries in over 130 economies, the Entrepreneurship Database measures the number of newly registered private limited liability companies per year.  

The data leaves little doubt that the global financial crisis of 2008-09 had a destructive effect on new firm registrations. The figure below shows that new firm entry density – the number of newly registered private limited liability companies per 1,000 working age adults –dropped sharply in 2008 and 2009 in high-income economies. In the developing world, many economies experienced a slow-down and drops in new firm registrations, particularly in 2009. Indeed,  previous work with Inessa Love based on the 2010 edition of this data found that the speed and intensity with which the crisis affected new firm registration varied by income level and crisis intensity. Economies with higher levels of income (GDP per capita), those with highly developed financial systems (as measured by the ratio of domestic credit to GDP), and those hit the hardest by the crisis experienced early and sharper contractions in the rate of new firm creation.  In Ireland, for example, new firm registrations fell by 29 percent between 2007 and 2009. Ethiopia, on the other hand, experienced an 11 percent increase in new firm registrations over the same period. 

Entry density in 52 economies, 2004-11

Although we lack counterfactuals to empirically assess how many economies experienced slowdowns in new firm registration as a result of the crisis, measurements of year-on-year growth in entry density provide compelling evidence that the impact of the crisis was indeed widespread. Before the crisis, about 70 percent of economies in our sample achieved positive year-on-year growth in entry density. In 2008 and 2009, this value was 60 and 34 percent, respectively.  Just 6 percent of high-income economies had more firms registering in 2009 than in 2008. It is clear that the impact of the crisis on entry density is not merely a case of a few large economies skewing aggregate trends – but instead a major and widespread adverse effect on new firm creation in the majority of economies.

Share of economies with year-on-year growth in entry density, 2005-11

The 2012 edition of the Entrepreneurship Database provides the first look at patterns of recovery in new firm registrations. Given that many economies are still experiencing the effects of the crisis, it is too early for a comprehensive examination of post-crisis rebounds in new firm registrations. However, a few clear patterns are starting to emerge. There was an undeniable turnaround in 2010, with 66 percent of economies in the sample experiencing an increase in entry density over their 2009 levels. In 2011, about 60 percent of economies saw an improvement in the rate of new firm registration, considerably below the precrisis annual average of 75 percent. For the majority of economies, entry density in 2011 remained significantly lower than in 2007.

Learn more about trends in new firm creation over the crisis and recovery by downloading the country-level data, 2012 Entrepreneurship Database Viewpoin

Should Wall-Street Be Occupied?


What would the United States look like without a financial industry? This question is the starting point of my recent paper, “Should Wall-Street Be Occupied? An Overlooked Price Externality of Financial Intermediation.” At first glance, the recent crisis suggests a grim answer to this question. As financial activity collapsed, the real economy halted. Lack of financing was associated with record-level unemployment, low investment, and overall reduction in economic activity.

Much of the thinking about the social value of finance has been framed in these terms: we know that finance is important because it performs many socially useful roles, and when financing “dries up,” the economy suffers. However, this logic is somewhat flawed, because the consequences of a shock to financing may be different from a permanent reduction in financing. Equating the two is similar to equating the mental state of someone who just got divorced with the mental state of someone who is single: disappearance is very different from absence, because presence creates dependence. Once you have a spouse, you become emotionally attached, as well as financially and logistically dependent. Once that spouse leaves, it may be difficult to re-adjust.

Finance has a similar attribute: a large financial system creates more dependence on finance. Assume that you want to buy a house, and need to take out a mortgage. You might say, “It’s a good thing that the financial system is here – without a mortgage loan, I could not afford to buy this house.” This statement neglects to take into account that without a financial system, the price of the house and your financing needs would be different. Just because you need a certain amount of financing in the current environment does not mean that you would need the same amount of financing in an environment with less abundant credit.

The key is that, if credit were less abundant, it would be less abundant for everyone: it might be harder for you to get a mortgage loan, but it would also be harder for the other potential buyers. As a consequence, the seller of the house would end up selling it for a lower price (note that a temporary disappearance of credit such as a financial crisis may not trigger the same price reaction, because prices take time to adjust and because sellers may prefer to wait until credit conditions recover). At the lower price, you would need less credit to purchase the same house.

What happened here? In the current environment, you need to borrow to buy the house. But, if we permanently reduce the aggregate amount of credit and allow sufficient time for prices to adjust, you suddenly need to borrow less to buy the same house! What is the source of this black magic?

Two things are going on. First, an observant reader might note that, while the reduction in credit makes buyers better off, the seller may be worse off because he has to sell his house at a lower price. So there is some “redistribution” from sellers to buyers. The second thing is more nuanced: the value of money increases. The value of a dollar can be measured, for example, by the amount of housing that a dollar can purchase. When credit is abundant, it takes many dollars to buy a house. When credit is scarce, fewer dollars are needed to buy the same house. This means that dollars are worth more! So, even though sellers get fewer dollars from selling their houses, these dollars are more valuable.

On some level, the financial system transfers dollars from people who do not need them right now to people who do. This increases the money in circulation and raises nominal prices; the purchasing power of money declines. This is somewhat analogous to a money-printing machine: the financial system takes “unused” dollar bills and brings them back into circulation. At a given set of prices, we might think of this as a very useful activity, because people would not be able to afford their purchases without these extra “borrowed” bills. However, if these extra bills were permanently out of circulation, the value of money would be higher and people would be able to afford the same things with fewer dollars.

Realizing that part of our need for finance is because of the abundance of finance suggests that we should rethink the tradeoff between the social benefits of financial intermediation and its costs (both in terms of the large resources spent on financial activities, and in terms of vulnerability to financial crises). Because of the inefficient dependence that it creates, an unrestricted financial system is too costly, and there is room for government intervention aimed at containing our dependence on finance.




wealthy Asians are ditching western wealth management products

…that according to a recent article by Bloomberg.

how so?

Two quotes in the article seem to me to sum up the situation:  ”We felt we could do better ourselves,” and “There is a disparity between banks’ income requirements and clients’ interest.”

The conclusion doesn’t surprise me very much.  After all, Americans have been leaving traditional brokers for a do-it-yourself approach for years.  What is news to me is that wealthy Europeans appear to be increasing their reliance on wealth managers, not paring back their exposure.

unattractive products

There are two basic reasons I find most “sophisticated” wealth management products less than compelling.

the deal structure may be poor

In many traditional tax shelter products, for example, the upfront fees and commissions that clients, as limited partners, pay can be as much as 20% of the money they put in.

Their cash flow share is usually disproportionately small.  The general partner will contribute, say, 20% of the partnership assets but collects 40% of the cash flow.  The limited partner puts in 80% and collects the remainder.  The general partner’s contribution may not be cash, but rather assets whose appraisal value is open to question–something which could tilt the sharing of cash flow further against the limited partner.

the client may not get access to the best assets

Marketing materials invariably illustrate how the investor will hold equity in, say, fast-growing privately held firms in areas where foreign ownership is severely restricted.  The apparent promise is of extraordinarily high gains.  If, however, you examine the returns investors have achieved in the past from similar offerings by the same local promoter, they’re probably equivalent to those of the local stock market.  Lots of sizzle, then, but little steak.

pressure to cover high fixed costs

Traditional wealth managers can have surprisingly high fixed costs.  They will likely have offices in high-rent buildings.  They may have extensive administrative and support staffs.  Successful salesmen may have guaranteed contracts at high compensation.  As a result, firms may need to sell a lot of products each year–whether good deals are available or not–just to cover their costs and make a contribution to corporate overhead.  In a situation like this, the pressure is typically to push iffy deals to clients with fingers crossed in the hope they will succeed.

inherited wealth in Europe?

Why are Europeans content with at best so-so treatment?  I don’t know.

Bloomberg says it’s because wealthy Europeans tend to have inherited their money, and are therefore more patient (does this mean clueless?), while wealthy Asians (at least potential wealth management clients) are self-made men and tend to be less tolerant.

“good” families and “bad”

I’d offer a slightly different thought.

Anyone who studies Asian equity markets soon realizes that the region contains many family owned conglomerates.  Virtually always, the family will have its assets in both privately held and publicly held companies.  In all cases, the private company does better than the public one.  That’s just life.

What separates the public companies of “good” families from “bad” is how they treat minority shareholders in the public entities.  ”Good” families will select assets/projects for the public to hold that have strong profit characteristics; “bad” families will select ones where they have already squeezed out most of the profit potential in the private company.  In the former case, the public investors can consider themselves sort of junior family members, maybe distant cousins.  In the latter, they’re just a disposal service.

I think wealthy Asian investors have concluded that western wealth management looks much more like the work of “bad” families than “good.”  They’re probably right.

European clients may not be as hands-on, and their more mature equity markets may

Seeking income in the current climate

Receiving a regular income from investments is important at any age, providing extra financial support to make life easier. When you start thinking about giving up work and enjoying your retirement, investment income can be an essential pension supplement. However, with low interest rates, low bond yields and relatively high inflation rates, how can investors get a regular income in the current climate?


Economic climate and traditional methods

Since the financial crisis the traditional methods to receive income, including high interest accounts and gilts, have taken a knock. Between 2007 and 2009, the Bank of England base rate nosedived from 5.75% to 0.5% and has not moved since. Worse, the most recent minutes from the Monetary Policy Committee (MPC) suggested there was some support to lower the base rate even further.

At the same time UK gilt yields have fallen to a record low. On July 12th 2012, the bid yield on benchmark 10-year gilts fell to 1.518%, down from the previous low of 1.524% in April.

Although the UK inflation rate has recently fallen to 2.4%, with the interest rates so low investors could find themselves making a real-term loss through traditional income approaches. Indeed, some have warned that this dip in inflation could have been partly caused by the poor weather affecting purchasing habits. Whatever the cause, consistently high inflation in real terms has caused many to look at other ways to seek income.

In an interview with Moneywise, Alec Letchfield, deputy chief investment officer at HSBC Global Asset Management, summed up the options: “Equity income funds, commercial property, high-yield and emerging market debt, together with convertible bonds, all offer significant income opportunities for investors with longer-term investment horizons.”


Looking for the right investments

Having explored bonds before [link to bonds article], it is clear that as with any investment, higher returns bring with them higher risk. Bonds pay out a regular income which serves as the interest on the debt. However, bonds considered the least likely to default pay the lowest levels of interest, meaning investors could see their low risk returns eroded by inflation.

People looking to maximise their income from investments over the longer term need to look beyond the obvious choices and the danger of the current climate. It is vital to think about the best combination of different assets classes to get the best level of income while fitting in with your overall strategy and risk appetite. This means not only considering dividend-paying stock, but also looking at investing internationally.

Most often it is companies that are no longer in expansion mode that are more likely to pay out dividends as they use profits to reward investors rather than to generate growth. However, it is worth really doing your homework when looking at dividend-paying shares, as well as remembering that a company may not always be able to achieve its projected dividend growth. A long history of dividend payments can be a good indicator of income in the future, but there are no guarantees when it comes to investing. There really is no shortcut to doing the research.

“Look for companies with a high and growing free cash flow – that is, money left over after all capital expenditure- as this is the stream out of which rising dividends are paid. The larger the free cash flow relative to the dividend payout the better,” Anthony Nutt, head of Income and UK Equities Teams at Jupiter Asset Management, which manages the Jupiter High Income Fund and the Jupiter Dividend and Growth Trust PLC, told the Telegraph.

Depending on how much cash you have to invest and your time horizon, some income-seeking investors also turn to property. With rental incomes at an all-time high, this approach can provide rewards, but it can also be very time-consuming and demanding.


How should it fit into a balanced portfolio?

Although the current economic climate does make seeking income harder for investors, it does not mean it is an impossible task. It is possible that considering options that may not be considered ‘traditional’ for seeking income investments provides people with a much more balanced portfolio than they may otherwise have had.

Investors need to think carefully about their risk appetite. Investing in the stock market and buying high-yield bonds is riskier than having a portfolio of cash and gilts, but with proper diversification it can work. Look at each investment, not just individually, but also in relation to the rest of your portfolio. Do you have too much exposure to property? Are you taking a balanced approach to currency exposure? Would your portfolio be improved by looking at international investments? Stuart Rhodes, manager of the M&G Global Dividend Fund, which invests in blue chip companies such as Wal-Mart, Intel and Nestle, highlighted this issue to the Telegraph.

“Within the UK, five companies account for 40% of UK dividend payouts and only five companies have delivered 25 years of consecutive dividend increases. But in the US, nearly 100 companies can boast that longevity of dividend growth,” he said. Big dividend paying firms in the UK included British American Tobacco and Tesco.

If you are seeking income to supplement your pension, you cannot neglect reviewing your risk appetite before making any changes to your strategy and portfolio. Modern Wealth Management’s Ideator tool asks you questions based on your time horizon, experience and strategy to help provide some guidance in identifying how you feel about risk. Although traditional approaches are proving challenging there’s no reason investors should miss out on significant opportunities with the right approach.