Investment for income ideas
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Times are hard for those wanting to generate a regular savings income. Considering the average savings account is paying around 3% at a time when inflation is running at more than 3%, it's easy to see how quickly the value of investment can be eroded.
Yet against this worrying backdrop, growing numbers of people - both working families and those who have retired - are looking for extra income, not only to pay for luxuries but increasingly to cover the basic costs of everyday living.
The question investors face is where to put their money, according to Tony Stenning, head of BlackRock's UK retail business. "With yields from government bonds and cash deposits unable to keep pace with inflation, income-seeking investors are facing a conundrum," he says.
One solution is income-producing equity investments. This involves either buying shares in individual companies that pay regular dividends, or opting for an income-oriented fund and letting the manager make all the necessary buying and selling decisions.
Geoff Penrice, an independent financial adviser with Honister Partners, sees the attraction of equity income. He points out that the payment of a dividend is effectively a statement of confidence by the management team about the future prospects of their business.
"Not only do you receive an income, but from the right shares you can also expect capital growth," he continues. "So over the long term you will be generating income from an increasing capital base, which does not happen with cash or bonds."
Investors can either use this income or reinvest it to boost their capital further for better gains in the future.
This can be an attractive option. It is illustrated by the 2011 Barclays Equity Gilt Study, which shows that £100 invested at the end of World War II would have been worth just £5,721 in nominal terms at the end of 2008; yet if the gross dividends had been reinvested, that original investment would have been worth a staggering £92,460.
One of the key figures for income investors is the 'yield' on offer - the dividend paid by a company, expressed as a percentage of its share price. While the FTSE 100 currently yields on average 3.3%; some firms are yielding in excess of 5%.
However, a high yield shouldn't be an investor's sole focus, because the dividend may prove unsustainable, according to Mark Barnett, manager of the Invesco Perpetual UK Strategic Income fund.
Barnett places more emphasis on companies that offer the prospect of dividend growth, because paying a rising dividend is seen by the market as tangible evidence of a business model that actually works.
"I want companies that can deliver sustainable, long-term dividend growth because this drives the capital return," he says.
Downsides to share dealing
However, there are potential downsides in embracing the stockmarket for income. Not only may share prices fall but dividends may be either reduced or stopped on the whim of a company's management board.
That's exactly what happened during the financial crisis, but things have subsequently improved. UK dividends totalled £15 billion during the first quarter of 2012 - an increase of 10.3% on the same period in 2011 and the highest first quarter total for a number of years, according to research by Capita Registrars, which acts for more than 50% of listed companies in the UK.
However, investors remain heavily dependent on a relative handful of dividend-paying companies in the UK, with only five blue-chip names accounting for just over half - £7.6 billion - of dividends paid during the first three months of 2012.
Pharmaceutical giant AstraZeneca took the top spot, having gradually moved up over the last five years, followed by Vodafone, Royal Dutch Shell, International Power and HSBC.
The same names have featured in the list for a number of years, although there is a notable absentee: BP., the global oil giant was forced to cancel its remaining 2010 payouts after the Deepwater Horizon oil spill in the Gulf of Mexico.
Apart from BP, Mark Barnett at Invesco Perpetual believes that the outlook for dividend generation is promising. "We are finding income at the moment from sectors such as pharmaceuticals, telecoms, tobacco, utilities and aerospace," he says.
Of course, the UK is not the only source of shares with growing dividends. There are increasing opportunities around the globe and these are the focus for portfolios such as the M&G Global Dividend fund, which was launched four years ago.
Manager Stuart Rhodes aims for a regular and increasing income from a portfolio of healthy global companies that offer both consistently rising dividends and long-term growth. His fund is well diversified by sector, geography and size, thereby lowering risk.
Stocks or funds?
So for those sold on the idea of equity income investing, is it best to buy individual stocks or opt for an income fund? Justin Modray, founder of Candid Money, says such a decision will come down to a combination of the knowledge and experience of the individual, their investment goals and overall attitude to risk.
"Investing in individual companies is cheaper because you don't have to pay a fund manager to do the job of choosing where to invest," he says.
"But if things go wrong, you'll probably be more exposed by only holding a handful of shares rather than a greater number in a fund."
Funds provide much greater diversity for small investors. For most people, therefore, the most sensible option will be to buy into an investment fund because they will have an investment professional making the decisions and monitoring the portfolio regularly.
One particular plus for income investors is that investment trusts (unlike unit trusts, which must pay out all their dividend income each year) can reserve up to 15% of the income they receive in a year. This 'smoothing' process helps them pay and even grow dividends in more difficult years.
But there's no guarantee of strong returns just because the fund chosen is run by a specialist manager, warns Patrick Connolly at AWD Chase de Vere.
For instance, looking at returns generated by funds in the IMA UK Equity Income sector, over the past five years the best funds have delivered around 60%, while the worst have lost almost 20%.
"Investors must consider the track record of the fund manager, their investment team and the resources they have available," he adds. "It's important to be aware of any possible hindrance to future performance, such as the investment fund becoming too large."
Investors also need to understand how a manager invests, says Justin Modray. "Some opt for pure income shares, while others combine a mix of growth and high income shares," he explains. "In the current uncertain climate, funds that invest in defensive income sectors like utilities, healthcare and tobacco look very sensible."
Invesco Perpetual Income
Fund manager: Neil Woodford
Geoff Penrice, a financial adviser at Honister Partners, says: "It will be on most people's lists because of its consistency over the long run. Neil Woodford also has a strong enough track record not to have to follow short-term fads or fashions, and can therefore focus on long-term objectives."
Fund manager: Robin Geffen
Patrick Connolly, spokesperson for AWD Chase de Vere, says: "This is a traditional equity income fund that invests in 33 equally-weighted shares and focuses on total return (both income and capital growth) rather than maximising income. It has a consistent performance record."
Schroder Income Maximiser
Fund manager: Thomas See
Patrick Connolly: "Schroder's Income Maximiser holds virtually the same underlying shares as the income fund, but gives up some of the growth in these shares to generate a higher level of income. It targets an income of 7% each year and has exceeded this to date."
INVESTMENT TRUST RECOMMENDATIONS
Manager: James Henderson
Mick Gilligan, head of research at Killik & Co, says: "It combines a fiduciary services business with a global equity portfolio. It has rarely traded as cheaply as it does today. The current lack of recognition appears shortsighted and we would encourage equity income seekers to add this one to their portfolio."
Perpetual Income and Growth
Managers: Ciaran Hallan and Mark Barnett
Gilligan says: "The objective of this trust, which was launched in March 1996, is to generate capital growth with a higher-than-average income from investment mainly in the UK equity market."
How much investment is needed to generate different incomes?
£100 each month (£1,200 a year): £30,000 investment
£500 each month (£6,000 a year): £150,000 investment
£1,000 each month (£12,000 a year): £300,000 investment
Based on average equity income fund yielding about 4% a year.
Source: AWD Chase de Vere
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).