Managed income solutions

There are several ways to generate income. You can buy shares in some of the dividend-paying companies and hope you have picked the right ones at the right time. This route is riskier, however, than buying a managed fund instead.

 

Managed funds are an ideal method for income investing, as a basket of carefully selected stocks helps spread risk. These stocks can be British companies or companies in other countries or regions, in many different industries and sectors.

The following sections outline some of the ways you can earn an income from investments. In each example your capital is at risk and the value of your investment can go down as well as up.

 

Income-starved investors in particular should consider equity income funds, as they can generate returns above the rate of inflation, which is very hard to obtain elsewhere. They also offer the potential for capital growth. Such funds can be an effective way to diversify your income stream away from low-yielding cash and bonds, however they do come with higher risk.

Whether you’re a cautious or adventurous investor, it’s important to diversify your dividend stream. Fund managers look for companies that offer fair value, a strong and sustainable dividend yield and are fundamentally good businesses with strong cash flow. A fund makes regular payments of income, either quarterly or monthly. The level of income can vary, and so future income payments are not guaranteed.

All of these funds operate in different ways, so when selecting one you need to ensure it suits you. A financial adviser can help determine the level of risk appropriate for your circumstances.

 

These are often the first port of call for an income investor, forming a core holding of a typical investment portfolio. They focus on holding companies listed on the London Stock Exchange that offer attractive prospects for income.

If you hold a few UK equity income funds, you should be looking to achieve diversification from each of the individual fund’s holdings. An overlap of holdings may make you more exposed to a dividend cut. It’s worth noting that even those who think they’re investing solely in the UK are often tapping into international opportunities since many British companies have dealings abroad.

There is a growing case for adding extra global exposure to an equity income portfolio, as well as the fact it offers a good way of ensuring your income portfolio has a healthy level of diversification.

A global equity income fund offers diversified access to different companies and markets for income as well as capital growth. Using these funds, investors can gain access to certain sectors which might otherwise be difficult to gain exposure to. Overseas companies are increasingly paying attractive dividends, and regions that have historically been off the dividend map are now some of the highest-yielding stocks.
Many investors are keen to tap into the established dividend culture that has emerged in the US and Asia, for example. Much of this can be explained by the economic changes as well as improved attitudes by companies overseas to please shareholders.


Investments in overseas markets can involve a higher degree of risk. Fluctuations in currency can impact the income earned on an investment. Investing in emerging markets can also carry greater risk as they are less well regulated

Multi-asset funds arguably have a big role to play in a low-return and volatile investment environment because of their ability to switch between assets. They can generate income from a combination of sources, which can be held directly or through funds, investing across equities, bonds, cash and property.


Some multi-asset funds run on a fund-of-funds basis where one manager runs a portfolio of funds on your behalf. Each fund has a different strategy with some delivering a high income and some a growing income.

Investment trusts are another alternative for income seekers. These are structured companies that hold assets such as shares and are run by a fund manager, who is backed by an independent board, appointed to act in the best interests of shareholders.


Investment trusts can create steady returns by squirreling away up to 15% of their dividends each year and using this money to boost dividends in difficult years. This means that some have very long records of raising dividend payments year in, year out.

In certain circumstances, investment company boards may elect to pay income out of capital – while this can erode the long-term capital returns generated by the funds, many investors are happy to prioritise short-term income payments.

 

Bond, or fixed income, funds offer an income and are popular with savers who like to be able to count on regular payments made for a fixed period. Bonds are issued by governments and companies, which guarantee a fixed income over a set number of years, as well as your capital returned at the end of the term.
UK Government bonds, or ‘gilts’ are widely regarded as safer bond investments as they are backed by the UK Government. Corporate bonds are issued by companies, come in many guises. Those with strong balance sheets are known as investment-grade bonds. Companies with a higher level of risk associated with them are known as high yield or non-investment grade.

Market conditions have driven down returns from bonds in recent years and their value can be eroded by inflation. There are however ‘index-linked bonds’ available, that are designed to help protect against inflation.

 

Investing in bricks and mortar is popular for income as it helps protect future purchasing power; property values and rents run largely parallel to inflation. This asset class achieves ‘real income growth’ over the longer term because put simply, they are managed by landlords who increase rents, and the value increases.

Investing in a buy-to-let property is an obvious choice for many, but it does leave you heavily exposed to one asset class and is expensive to get started once you factor in stamp duty and other costs. It can also be difficult to get your hands on the original capital if the market doesn’t allow you to sell quickly, known as liquidity risk.

Property funds invest in real estate and can overcome some of the liquidity risks associated with direct investment in property.

Whether you choose direct investment or investment in property funds, there are tax implications. A financial adviser can help talk you through the options.

Income is not the only style of investing. Growth funds back firms that reinvest their dividends in their business rather than paying out profits to shareholders. They are popular among long-term savers who do not need to take an income from their investments. Growth fund managers will typically choose to invest in companies that they believe will be able to significantly grow their earnings over time.


These funds feature in most balanced portfolios because, after all, most savers are looking for investments that generate an income, protect their capital and have potential for capital growth.


Financial situations change with time, which means making the necessary adjustments to your portfolio. As your investment needs change you might need to switch your balance of growth funds and income funds.

 

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