How to boost your income through investing
If you have been relying on savings for income, the years since the credit crunch have not been easy. The low base rate combined with wider economic problems means most savings accounts have been paying out piddling amounts and, as a result, people have become much more interested in investment income in recent years.
Here, we look at the main income-producing investments, starting with the lowest risk, and examine whether or not they are a good bet.
If you're looking for a slightly better rate than you'd get from a savings account but don't want to take on too much risk, UK government bonds, known as gilts, could be a good start. A government bond is an IOU to a government in exchange for a fi xed rate of interest over a set time.
The amount of interest bonds pay is tied to how risky the loan is considered to be. Historically, government bonds have been regarded as the safest type of bonds because governments are unlikely to be unable to repay the debt when the bond matures; they therefore pay investors a lower rate of interest.
Bond yields - the rate of interest they pay as a proportion of the price paid in the market – go down when bonds are in demand, and 2011's escalating eurozone crisis has driven investors to look for safe havens, pushing UK government bonds and US treasury bond yields to their lowest levels for decades. This means these ‘safe haven' yields are now well below inflation, so investors are losing money in real terms.
On the next step of the ladder is corporate bonds, where you loan money to a business. These pay different rates of interest depending on how secure the issuing company is. But, while riskier, both investment-grade bonds (issued by blue chip firms) and high-yield bonds (issued by less established, riskier companies) are currently a better bet than gilts.
"Many companies are in a better position than their governments," says Andrew Wells, chief investment officer for fixed income at Fidelity. Bond yields are up across the board because investors are worried about macroeconomic problems, so demand has weakened. But the companies themselves are in good shape, making this a great time to buy.
High-yield corporate bonds are riskier than investment grade but Wells believes they can work for longer-term investors. He says the markets are anticipating high default rates for firms issuing high-yield bonds, which are paying generous yields to reflect the risks involved. But these expected default rates "do not reflect company fundamentals", which are pretty robust.
So corporate bonds are one of the most attractive income-generating investments around right now.
STRATEGIC BOND FUNDS
The sensible option for many bond investors is a strategic bond fund that can move between bond classes as circumstances change. A strategic bond fund is particularly attractive as it's not limited by geography or types of bonds: it can hold corporate bonds from UK blue chips alongside government bonds from emerging market economies. The latter are attractive at present as emerging market bonds are expected to deliver impressive growth in coming years.
So what should you buy? Melvyn Bell, investment manager at Lowes Group, suggests M&G's Strategic Corporate Bond fund, run by Richard Woolnough, which yields 4.1%.
The top three highest-yielding strategic bond funds
AXA Framlington Managed Income
Return over three years: 55.78%
Premier Strategic High Income Bond
Return over three years: 24.1%
St James's Place Corporate Bond
Return over three years: 43.65%
UK EQUITY INCOME FUNDS
Equity income funds hold companies that pay regular dividends. Investors in the sector had a great year in 2011. According to Capita Registrar's latest dividend monitor, the amount paid out by UK companies reached its highest level since summer 2008, growing by 16% over the third quarter of 2011. These funds have always been a core holding for people in need of an income; you just need to choose one that best suits your needs.
High-yield equity income funds focus on generating a high target level of income. Adrian Lowcock, senior investment adviser at broker Bestinvest, singles out Schroder's Income Maximiser fund, currently yielding almost 7.5% as one of the best. But, he warns: "In focusing on maximising income, this fund sacrifices much of the potential for capital growth."
If you don't need an immediate high income, you're better off looking for a fund that aims to deliver some capital growth and a rising dividend payout over the years – ideally one that will keep pace with inflation.
Traditionally, the FTSE 100 has been the equity income managers' hunting ground but they are increasingly looking at smaller companies.
"The fact is that 90% of UK companies yielding more than 5% are outside the top 100," says Mark Slater, manager of the multicap MFM Slater fund. Many of these smaller companies have not historically paid much in the way of dividends because they've reinvested the money to expand the company instead. But the best are likely to grow rapidly and become the key dividend payers of the future.
Funds aiming to deliver growing dividends over time include MAM's Acuim UK Multi Cap Income fund, run by Gervais Williams, and Marlborough's Multi Cap Income fund, managed by Giles Hargreave.
The top three highest-yielding UK Equity Income funds
Insight Investments UK Equity Income Booster
Return over three years: 5.22%*
Elite Charteris Premium Income
Return over three years: 4.61%*
EFA OPM Equity High Income
Return over three years: 34.15%
*Three-year return unavailable, one-year return shown
Source: Morningstar, 20 January 2012
GLOBAL EQUITY INCOME FUNDS
The past few years have seen a growing interest in income funds with a global perspective as firms around the world start to focus on paying dividends. Stephen Thornber, manager of the Threadneedle Global Equity Income fund, explains that the beauty of these funds is their flexibility: "We can move away from struggling regions so we've been coming out of Europe in favour of Asia and emerging markets, where we still expect good growth." He also says it's "not too difficult" to find companies in these areas that are paying generous and rising dividends while also enjoying serious capital growth.
Anna Sofat, managing director of Addidi Wealth, recommends the Global Equity Income funds from Lazard or Newton's more targeted Asian Income fund "because they are well-rated funds, paying good levels of income and have the potential for decent equity growth".
The top three highest-yielding global equity income funds
Threadneedle Global Equity Income
Return over three years: 53.25%
Skandia Global Equity Income
Return over three years: 39.86%
Lazard Global Equity Income
Return over three years: 52.87%
It is possible to find income-focused funds that hold both corporate bonds and equities, known as distribution funds. These can work well for income seekers who also want some capital growth.
Distribution funds are not as widely used as they used to be but they are still useful, especially for smaller investors, says Patrick Connolly, spokesperson for AWD Chase de Vere, not least as they are easy to understand. Gavin Haynes, managing director of Whitechurch Securities, recommends the Invesco Perpetual Distribution fund as it is managed by a highly skilled team.
Neil Woodford looks after the equity part of the fund while Paul Read and Paul Causer look after the fixed interest investments. It is paying a yield of 6.5% at present.
The final option for income hunters is structured products. These give some capital protection and a set level of income, provided the index in question doesn't fall below a certain level. Sofat singles out Gilliat's product, paying 6% a year over its six-year term, with capital secure unless the FTSE 100 falls by more than 65% over that time.
"For people who need income, can tie up their capital for that length of time and understand the risks, these products are not a bad deal - but I'd only use them as a small part of a mixed income portfolio," she says. The risk with structured products is they can be complex and there are no guarantees you will get all your money back.
So where are the best places to invest for income? Haynes says recent price falls of equities and corporate bonds mean these sectors are offering great yields. As a result, UK equity income and global equity income funds, plus corporate bonds, look the most desirable.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
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).
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%.
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.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Named after a high value gambling chip, the term is used for an investment seen as solid and whose share price is not volatile. Blue chip companies are normally household names and have consistent records of growth, dividend payments, stable management and substantial assets and are the bedrock of a pension fund’s portfolio.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
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.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).