2017 Guide to Income Investing

Income-paying funds – an alternative to cash-based savings

Investing for income means choosing assets that are able to provide you with a regular income. This is in contrast to investing for growth, which focuses on how much your assets could gain in value. In our Guide to Income Investing, we consider the main investment asset classes that are used to generate a regular income.

People are living longer. Simple demographics mean that supplementary income is no longer a luxury – it’s a necessity. With historic ultra-low interest rates on savings, many investors over the past decade have turned to income-paying funds as an alternative to cash-based savings.

Changing life plans and priorities mean we now encounter varying income needs and
goals throughout our life, and, when investing, certain innate behavioural traits will influence our decision-making. For many people seeking to generate income from savings, the years since the financial crisis in 2008 have been a major challenge.

Seeking Income

Our reasons for seeking income tend to shift through life. Shorter-term goals like supporting a business start-up or funding children’s education may be a priority in earlier years, and then make way for a longer-term focus on boosting retirement income and providing an adequate cushion for later life. The key is working out how much income you need at each stage, and then finding an appropriate investment strategy to help you meet your goals.

Clear Objectives

It’s essential to work out what you need to achieve and set clear objectives. Your savings objectives should reflect the aims of your income plan. If you would like to enjoy a reasonable standard of living in retirement, for example, a useful rule of thumb is to try to save enough to provide an income of between half and two thirds of your final salary. While some of your expenses may fall when you stop
working, such as the cost of commuting and servicing a mortgage, the retirement years could bring greater spending on utilities and healthcare, amongst other things.

Reduce Risk

It’s important to aim for an income solution that’s truly appropriate for your circumstances, objectives, risk attitudes and capacity for loss, rather than simply sticking to what you’re familiar with. Considering a broad range of investments can help you to reduce risk and increase your chances of achieving your objectives.

Useful Alternative

Interest rates on savings accounts have plummeted. In the UK, bank base rates fell to 0.5% in 2009 and stayed there for seven years until they fell even further, to 0.25%, in 2016. Government and corporate bonds have offered a useful alternative, but overwhelming demand has driven prices up and yields down. Investors in shares have generally fared much better thanks to rising company dividends. Although some companies had to cut back their payouts after the financial crisis, dividends as a whole have risen in recent years.

Income Choices

There are various ways in which capital can be used to generate income. Each has its pros and cons, and for most people the ideal solution, where possible, is to spread money among several different types of investments, providing a balance and diversifying risk.

Banks & Building Societies

Savings accounts have traditionally been a clear favourite for many people who rely on the interest payments as a supplementary income. Deposits are seen as a secure option because the monetary value of savings does not go down, and there is protection under the Financial Services Compensation Scheme for deposits up to £85,000 in any one institution should they not be able to meet their commitments.

However, interest rates fluctuate, so the income from savings accounts cannot be relied upon to remain stable. Not only do the returns depend upon the general level of interest rates (which has only fallen over the last decade), but banks and building societies are also able to apply their own discretion to the interest they pay on their accounts. Rates are often inflated by introductory bonuses which then fall away, typically after a year. Inflation can also erode the value of cash on deposit.

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