The income you can get by leaving money in the bank is pretty bad these days. It's crazy to think that with a million dollars in the bank the most you might be able to get is $30,000, with most accounts offering less of a return than that.
So, what should an income-seeking investor do?
I think Australian shares are the answer. Many experts agree that, on the income side of things, Australian share investments are hard to match for the income they can produce.
Here are three ideas:
Naos Emerging Opportunities Company Ltd (ASX: NCC)
One of the best strategies to outperform the market is to invest in small caps. Many investors don't venture into the microcap region, so there could be quite a few hidden gems in there.
It can be quite hard to pick which small cap is worth owning, therefore it could be an idea to go with a fund manager that has a good track record.
Naos runs this listed investment company (LIC), it targets businesses with market capitalisations under $250 million – this is the small end of the ASX. Its portfolio has delivered an average annual return of 15.86% before fees but after expenses since inception in February 2013.
Naos makes high-conviction picks for portfolio, meaning its LICs usually only hold around 10 positions. Over the long-term this approach can work very well, but there can be the occasional disappointing year.
It has paid an increasing dividend each year since the second half of FY13 and it currently has a grossed-up dividend yield of 8%.
WAM Microcap Limited (ASX: WMI)
WAM Microcap is also a LIC that aims to beat the market by focusing on small businesses. Its hunting ground are shares with market capitalisations under $300 million at the time of acquisition.
The Wilson Asset Management (WAM) investment team have delivered a great first year of performance. Over the past year its portfolio has returned 30.1% before fees and expenses, which is a really good performance.
Small businesses are where the WAM team first started out, so this is getting back to the 'roots' of its success.
Small caps are likely to be much more volatile than the overall market, but this is the price of entering (perhaps) the best place to create wealth on the ASX.
It currently has a (regular) grossed-up dividend yield of 3.9%. However, it also just paid a special dividend because of its strong performance.
Challenger is Australia's leading annuity business. There is large demand from retirees for a guaranteed source of income from their hard-earned capital. They don't want to risk their life's work. It's then Challenger's job to invest in assets like shares and property to 'outperform' what it pays to retirees.
Over the long-term the number of annuities heading to Challenger are expected to increase because the number of people over 65 (retirement age) is expected to increase by 40% over the next decade.
The size of annuities should also increase because of the mandatory 9.5% contributions, the tax-effectiveness of additional contributions and compounding.
The government also recently announced new budget rules where all superannuation funds are required to offer a guaranteed source of income as an option.
Challenger has been growing its underlying earnings and profit every single year for a while now. Indeed, it has grown its dividend every year since the GFC.
It currently offers a grossed-up dividend yield of 4.5%.
Foolish takeaway
All three of these businesses offer yields that are much better than term deposit rates but also offer much better growth potential too. The small-cap related LICs may be volatile in some years but they may be able to generate the largest returns.
