Income Investing’s New Rulebook: How to Earn a Real Yield as Rates Keep Rising

For most of the past 15 years, income investors had to choose between near-zero returns and reaching for yield in riskier corners of the market.  

That binary choice is now a thing of the past.  

Australia’s 10-year government bond yield has risen to 5.4% after the RBA’s recent rate rise, near its highest level since 2011, while the US equivalent has increased to a similar level of more than 5.3%, a level last seen in 2002.  

Income investing has entered a decidedly different era.  

You’d think that higher yields would open up a world of opportunity for income investors.  

In some ways they do.  

But the return of higher yields also brings with it some major complications.  

Here’s what the next generation of income investing looks like, and how to build a portfolio that pays its way whichever direction rates move next. 

Key Takeaways 

• Nominal government bond yields of 5%+ look generous, but after tax at a 32% marginal rate they fall below the current 4.0% inflation. 
  
  
• The CGT overhaul will hit fast-growing assets hardest, narrowing the old tax advantage of growth over income for individual investors. 
  
  
• Bank hybrids are being phased out by 2032, and their closest replacements rarely carry franking credits. 
  
  
• Private credit and option-based strategies can lift portfolio yield, but each swaps income for a specific risk that investors need to understand. 
  
  
• The most resilient approach is to optimise your total return: lock in some duration, diversify income sources and match liquidity to genuine needs. 
  
  

The Return of Yield & Its Hidden Catch 

The recent rise in the RBA’s cash rate and the US federal funds rate has been notable. After rising sharply from near-zero levels in 2022–23 and easing in 2024–25, both have resumed hiking, to 3.75% to 4.00% in the US and 4.6% in Australia. 

Inflation is to blame.  

The Fed, under new Chair Kevin Warsh, raised rates soon after he started in the role, with Warsh explaining inflation is ‘too high and has been for too long’ at 3.4% in the year to August. 

Inflation is even higher in Australia. Headline inflation rose to 4.0% in the year to August, with the trimmed mean at 3.6%. 

On the surface, this is a gift for savers, with the best 12-month term deposits now paying 5.50%.  

But beneath the headline numbers is a more troubling story.  

An investor on a 30% marginal tax rate (32% with the Medicare levy) who places $500,000 in a 5.50% term deposit can now earn $27,500 p.a. After tax, that’s $18,700, or 3.7%. Translation: with inflation running at 4.0% p.a., that $500,000 in a term deposit loses some $20,000 of its purchasing power over the course of a year. So, in real terms, this investor is losing $1,300, a poor outcome in most investors’ books.  

In this higher-inflation world, the name of the income investing game has shifted towards generating real, after-tax income.  

Why the CGT Overhaul Changes the Income Versus Growth Maths 

The Federal Government’s CGT overhaul also moves the dial for income investors. 

The legislation, which passed both houses of Parliament on 25 June, replaces the 50% CGT discount for individuals, trusts and partnerships with cost base indexation and a 30% minimum tax on net capital gains, applying to gains that accrue from 1 July 2027.  

The impact of this change depends on capital growth rates.  

Our modelling of a $100,000 holding sold after 10 years, assuming 2.5% p.a. inflation and a 39% marginal tax rate, shows tax falls slightly under the new rules for an asset growing at 4% p.a., but rises from $22,600 to $34,300 for one growing at 8% p.a.  

CapitalGainsCalculator puts the break-even point at a 4.2–5.0% p.a. growth rate when inflation is running at 2.5% p.a. 

For decades, Australian tax settings rewarded investors who converted income into capital growth. That advantage has narrowed for high-growth assets, while franked dividends and interest are taxed exactly as before.  

Inflation makes a major difference too. At 4% p.a. inflation, the break-even growth rate in the above example rises to 7% p.a.  

So, how should investors respond to this shifting of the goalposts?  

Keep a record of your portfolio’s market values at 1 July 2027.  

Think carefully about which assets sit inside your super, since that offers protection from this shift. The prudent response may be to overweight your growth exposure in this portion of your investment portfolio. 

The Dismantling of the Old Income Toolkit 

The next major change afoot is APRA’s decision to phase out bank hybrids by 2032. 

This will remove an income market worth more than $40 billion that Lonsec describes as ‘disproportionately’ owned by retail investors.  

Tier 2 subordinated debt, a market worth $120 billion, is the closest structural replacement, but it pays no franking credits, a benefit Lonsec warns ‘will be harder to replace’. 

Dividends alone won’t fill this gap.  

Plato Investment Management’s Dr Don Hamson forecasts an ASX 200 grossed-up yield of 4.4% this year, with dividends falling 3.6%.  

In his words: ‘in equity income, diversification is the only free lunch’. 

Meanwhile, Australian shares are currently trading on a forward price-to-earnings ratio of 17.6. That represents an earnings yield of 5.7%, barely above the 10-year government bond yield. 

What Next-Generation Income Investing Looks Like 

We see three compelling opportunities for income investors in this environment: 

1. Duration Is a Potentially Useful Tool Again 

As per Buffett’s famous quote, buying when others are fearful is generally a winning strategy. 

Now may well be the time to take advantage of the fear that’s decimating global bond market sentiment. 

Australian investors can now lock in a 5.4% yield on domestic 10-year government bonds.  

While yields may trend higher in the short term, we may also be close to a peak. 

CommBank economists expect the RBA to begin cutting as early as August 2027, leaving investors who sit entirely in cash exposed to falling income from next year onwards.  

To take advantage of the current yield opportunity, consider a diversified bond ETF or managed fund with a focus on lower-risk government debt.  

The trade-off is that bond prices could keep falling if yields keep rising, as our analysis of what happened when US yields last hit 5% explores. 

2. Consider Private Credit Opportunities with Your Eyes Open 

In recent years, private credit has been a go-to asset class for attractive yields, which explains its 500% growth in assets under management over the past decade.  

But it’s time to be selective about which private credit funds you invest in. 

ASIC has been highlighting the risks. In August, ASIC Chair Sarah Court described ‘the first significant cracks’ in the sector after the collapse of developer Bathla. Several managers, including MA Financial, have introduced redemption limits that confirm the sector’s liquidity mismatch risks are real.  

The issues are widespread. An ASIC review of 28 funds found fewer than half of the funds covered had detailed written credit, impairment or default policies.  

So, before investing in a private credit fund, ask who the borrowers are, how often the loans are valued, and what happens if many investors redeem at once.  

If the answers are all thorough and aligned with ASIC’s targeted standards for the sector, high-quality private credit funds remain a valuable source of income in this higher-rate world. 

3. Option-Based & Structured Income 

For more sophisticated investors, option-based and structured income strategies may currently offer income harvesting opportunities.  

In the US, auto-callable ETFs, which package structured notes into a listed fund, have grown to about two dozen funds managing US$2.5 billion in their first year.  

Janus Henderson’s Mike Laughlin describes auto-callable income as ‘underwriting risk, like an insurance company’. 

Covered-call and yield-maximiser ETFs work on a similar principle. They tend to give up some upside, or accept losses in a deep sell-off, in exchange for higher cash flow today. 

No One Knows the Future 

Nobody knows if interest rates have peaked yet.  

Either way, we are now living in a world in which real returns matter more than headline yields. The resulting challenge for income investors has flipped from finding yield to keeping it after tax and inflation.  

At the same time, the instruments and tax settings that defined Australian income investing for a generation have been rewritten.  

The upshot is that the next generation of income portfolios will be more diversified, more tax-efficient and more aware of the risk behind every percentage point of yield.  

They are likely to comprise a core of high-quality bonds and term deposits that lock in today’s rates; diversified, franked equity income; and a measured allocation to private credit. 

In this higher-rate world, each allocation should be sized according to what could go wrong, rather than to what pays the highest absolute yield. 

Frequently Asked Questions 

Are Term Deposits Beating Inflation in Australia Right Now? 

Before tax, yes: the best 12-month rates of 5.50% exceed 4.0% headline inflation. After tax at a 32% marginal rate, the return falls to 3.74%, which is slightly below the current inflation rate. 

How Does the End of the 50% CGT Discount Affect Income Investors? 

From 1 July 2027, capital gains for individuals, trusts and partnerships will be indexed for inflation and taxed at a minimum of 30%. This raises tax on fast-growing assets, while income such as franked dividends and interest is taxed as before, narrowing the traditional advantage of growth over income. 

What Can Replace Bank Hybrids in an Income Portfolio? 

Common alternatives include Tier 2 subordinated bank debt, corporate bonds, diversified credit funds and listed hybrid or income ETFs. Most offer similar or slightly lower yields but do not pay franking credits. 

Is It Too Late to Buy Bonds with Yields Above 5%? 

Higher starting yields provide more income and a larger buffer against further price falls. Bonds will still lose value in the short term if yields keep climbing, so many investors spread purchases over time or across maturities. 

Is Private Credit Safe for Income Investors? 

Private credit can provide steady income, but it is not risk-free. ASIC has flagged weaknesses in valuation, governance and liquidity across parts of the sector, and some funds have limited redemptions. 

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.