Yield a steady income from your investment

As savings rates collapse, investors looking for a steady income have had to look at other options they might not previously have felt comfortable about, including investment trusts.
Unlike unit trusts and open-ended investment companies, it's not tax-efficient for investment trusts to invest in corporate bonds (which are popular among cautious investors) because they have to pay a higher rate of corporation tax. Trusts therefore tend to focus on share dividends in their efforts to produce an attractive yield.
Investment trusts are allowed to hold back up to 15% of the income they receive each year from dividends and keep it in reserve. Unit trusts and open-ended investment trusts, in contrast, have to distribute all their income each year, so they have no reserves.
Annabel Brodie-Smith, spokesperson of the Association of Investment Companies (AIC), explains: "These revenue reserves can be built up in good years, and then used to boost dividends to shareholders in difficult years. This is known as 'smoothing dividends'."

The dividend-smoothing option is particularly important for investment trusts that have a policy of not just paying dividends but actually increasing them by a small amount each year (known as a progressive dividend policy), and research from the AIC shows that a surprising number of trusts aim to do just that.

A fifth of the 159 conventional investment trusts that have been running for more than a decade have increased dividends every year for the past 10 years, and 19 of those trusts have a 20-year record of dividend growth.
So income-seeking investors have the comfort of a regular and growing dividend every year, even when times are hard.
The trusts most likely to pay increasing dividends are found in the Global Growth sector, and especially in the UK Income & Growth sector. The AIC reports almost half of the trusts in each of these two sectors increased dividends every year for 20 years or more.

The longest track record belongs to City of London trust (on a 5.9% yield), with an astonishing 42 years of dividend growth.
But be warned – although these trusts cough up reliably, they're not all necessarily paying out particularly large yields. Trusts in the Global Growth sector do not necessarily have to pay any dividend, and the sector's average payout is only 3.2%.

But UK income and growth trusts have to aim to produce a certain level of dividends each year. The average here is a more promising 6%, with one or two bigger hitters on the income front, such as Merchants, yielding 8%. And with the the Bank of England base rate now at an all-time low of 0.5%, it's important to have the certainty of a steady and rising income.
At Caledonia trust, currently yielding 2.5%, finance director Jonathan Cartwright explains how the long-term benefit works: "With over £250 million of reserves, our progressive dividend policy isn't so dependent on a constant year-on-year growth in income.

For instance, 2008's annual dividend cost £18.7 million, so it was covered many times over by existing reserves, even before adding the income that might be generated in the future.

Trusts in the Global Growth sector may also be able to draw on new sources of dividend growth in other parts of the world. Foreign & Colonial, which is paying 2.9%, has "benefited hugely" from strong dividend growth in emerging markets over the past few years, says manager Jeremy Tigue.

"The weakness of the pound is having a dramatic impact on the sterling value of our overseas dividends. For example, a dividend of $10 was worth £5 a year ago, and is now worth £7."

However, because these trusts are so popular with income-seekers at the moment, they're not cheap.

Many of the share prices in these income-producing sectors are on very small discounts, or even premiums to net asset value.
Buying at a premium is something that you should only do if you believe the trust offers something special. In these cases, if you need an attractive, reliable and growing income, the extra cost may be worthwhile, but it's always worth taking professional advice.