How to turbo-charge your investment income

‘Make sure your money is working hard.” It’s a phrase used by lots of financial companies hoping to gain custody of your long-term savings. They’ve got a point — putting your money where it can generate a handsome return, is a smart move.

Savers haven’t had to work too hard for a good return lately because cash savings accounts have been paying high rates of interest. But that could soon change.

The Bank of England base rate went up 14 times from a record low of 0.1 per cent in December 2021 but it has stayed at 5.25 per cent since last August. A cut is expected in the coming months which means that cash savings rates will fall too. In fact, they have already started dropping.

This will encourage those seeking returns to look elsewhere, like the stock market, and they could consider income-generating investments to turbo-boost their wealth. While these types of product are usually synonymous with investors who have retired and want to replace their salary, they can also be attractive to those who don’t need the income.

Equity income funds

There is an array of opportunities across stock markets, bond markets and areas such as property that will earn you an income. For starters, how about an equity investment that aims for a higher-than-average income as well as increasing the underlying value of your investment?

This is what equity income funds aim to do, and they might just become a must-have this autumn as savings rates fall. These funds focus on a broad spread of solid businesses with the financial strength and prospects to pay good, growing dividends to their shareholders.

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Dividends are the portion of earnings that a company distributes among its shareholders every year. Instead of pocketing (and spending) this income, it can be reinvested. And the power of investing for income that you don’t need to spend is great, mainly thanks to compounding — probably the simplest way to boost your wealth. By automatically reinvesting your dividends, you can earn an income on a bigger number of shares. It is a snowball effect that requires no input from you at all.

A UK equity income fund is also a way to bet on the UK’s revival. These funds will earn you a return that combines dividend income and any growth in value of the underlying investments. Funds display the expected income from a company’s dividends, known as a yield, and expressed as a percentage of your investment.

The Artemis Income fund is widely considered to be one of the stalwarts of the UK equity income market. It holds more than £4 billion of savers’ money, has a dividend yield of about 4 per cent and has returned 40 per cent over five years.

Its managers Adrian Frost, Nick Shenton and Andy Marsh have decades of experience. They invest predominantly in FTSE 100 companies with strong balance sheets, sustainable cash flows and attractive valuations, with holdings including the retailer Next, the data company Relx and the pharmaceutical giant GlaxoSmithKline.

Aiming to grow income and capital over five years, this fund has consistently beaten the average returns of rivals and the general stock market. It focuses on companies that can maintain and grow dividend payments to investors regardless of inflation or economic upheaval in the wider economy.

The fund is one of the five biggest UK equity income funds in the Investment Association’s UK Equity Income sector, alongside CT UK Equity Income, BNY Mellon UK Income, Jupiter UK Income and JOHCM UK Equity Income.

If you’re interested in investing further afield there’s the Baillie Gifford Responsible Global Equity Income fund. Its managers James Dow and Ross Mathison invest globally in companies that they believe can deliver dependable incomes and real growth in income and capital. They want the companies to be managed ethically and to behave responsibly when it comes to the environment and society.

The fund’s holdings include Watsco, which sells air conditioning, heating and refrigeration equipment that helps consumers and businesses reduce their carbon footprint, and the energy solutions group Schneider Electric SE, as well as Microsoft and Apple. The fund yields 2 per cent dividend income and has returned 69 per cent over five years.

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Investment trusts

You could also consider investment trusts. The way they are structured, as companies in their own right, listed on the stock exchange, means they can build up reserves in good years — up to 15 per cent each year — and so maintain the level of dividends to shareholders when times are tough. One option is Merchants Trust which has just served up a 42nd consecutive year of higher dividends. It yields 5.09 per cent, but has returned just 14 per cent in five years.

You might be drawn to funds with higher than average yields. The BlackRock World Mining Trust aims to provide long-term income and capital growth by investing in mining and metal assets worldwide. It yields almost 6 per cent and has returned 65 per cent over five years. As mining is a specialist area it is a risky investment, though, so should perhaps form only a small part of your portfolio.

Bonds

You can also get an income from bonds, also known as fixed income investments, which are popular with those who like the peace of mind that comes from knowing you will get regular payments for a fixed period. Bonds are essentially IOUs. You lend money to governments or companies and in return they give you regular interest payments over the life of that bond, then return your initial investment on the date it matures.

The returns aren’t usually as exciting as those from equity investments, unless you go for the riskiest kind of bond — emerging market bonds issued by companies in developing countries. Emerging market debt carries more risk because there’s greater chance of the company or country you are lending to defaulting and they are at the mercy of currency movements. But they can be rewarding — Brazilian ten-year sovereign bonds yield 12.28 per cent. A bond yield is the amount of interest the bond pays to its owner, expressed as a percentage of the price.

You can buy some bonds yourself, but you can also invest through a fund that gives you exposure to a diversified selection. Some bond funds focus on a particular sector, such as corporate or UK government bonds, known as gilts. Or a strategic bond fund invests in a range of bonds with different risk profiles. One to consider is the Aegon Strategic Bond fund, which has a dividend yield of 4.45 per cent and holds mostly UK and US bonds.

Acc versus inc

When you want to reinvest income, you just have to make sure you select an accumulation version of the fund or trust you like — usually it has “acc” after the name. This means that dividends or income is reinvested, so that it accumulates. It is possible to switch this so that you can withdraw income if you suddenly need a cash injection, by simply moving to the “inc” version of the fund. It’s usually free to do, requires a simple instruction to your investment firm and should take a couple of days.

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Don’t be tempted to do this when you have gotten a little carried away in the summer sales and racked up a big credit card bill, because you will miss out on future gains, but it might be useful if you take a career break to look after children or to help pay school fees.

Other asset classes that can provide an income include as property and infrastructure. If you can’t decide which to choose, a multi-asset income fund will cost you a bit more for a fund manager to decide on the mix of assets on your behalf.

Tax

If you hold income-generating investments outside an Isa or pension then you will need to think about tax. With bond funds, income is treated in the same way as savings interest, so you will pay tax on it at your usual rate of income tax. Basic rate taxpayers get a £1,000 a year tax-free savings interest allowance while higher-rate payers get £500. Additional-rate taxpayers get no allowance.

With stocks and shares funds held outside of an Isa, you will pay dividend tax on your income at 8.75 per cent for basic rate taxpayers, 33.75 per cent for higher-rate payers and 39.35 per cent for additional-rate payers. Everyone gets an annual tax-free dividend allowance of £500.