How to invest for an income

There are a number of different investments available that produce an income (or yield as it is also called). 

1. Cash

Cash savings accounts pay an income in the form of an interest rate. They generally fall into two categories: easy access and fixed-term savings. Easy access accounts tend to have lower interest rates, while fixed term accounts usually pay a higher rate, with the pay-off being that you lock in your savings for a specified time period.

In the early 2000s, cash account interest rates were very attractive – as much as 10% at their peak. However, since the global financial crisis interest rates have fallen substantially.

The benefit of investing in cash is that your capital is guaranteed. The Financial Services Compensation Scheme (‘FSCS’) covers £85,000 of your savings should your bank fail. For further information on the FSCS please visit their website.

However, if the interest rate is lower than the rate of inflation, the real value of your money will be eroded over time and if you are paying tax on this interest the real value of your money will fall even further. To avoid paying tax on cash savings, you can wrap them in an ISA

2. Bonds

Bonds can be issued by governments or companies and are like a loan. Investors will lend the issuer an amount of money for a fixed period of time and be paid a regular yield. At the end of the period, the capital is returned to the investor. It is important to remember that yields can fluctuate and, unlike cash investments, your capital is not guaranteed.

Company, or corporate, bonds tend to come in two categories: investment grade and high yield. Investment grade bonds are deemed to be from better quality and less risky companies than high yield bonds.

Government bonds are issued by governments. In the UK they are referred to as Gilts and in America they are referred to as Treasuries. Government bonds of developed markets are usually deemed to be the least risky.

Emerging market bonds are both government and company bonds issued by companies and governments in emerging markets.

3. Company dividends

Another way of obtaining an income is from company dividend payments. Dividends are a way for a company to distribute some of its profits to its shareholders in the form of an income payment.

UK companies have a very strong dividend-paying history but companies in other countries are starting to understand the importance of returning value to shareholders too, so we are seeing more and more foreign companies starting to pay a dividend.

4. Bond and equity funds

While both bonds and stocks can be purchased individually, another option is to invest in either a bond fund or an equity income fund (the name given to funds whose managers look specifically to invest in companies providing a dividend now or in the future). The advantage of both is that a professional does all the research for you and you can spread your risk, as there will be a large number of different bonds or companies in the fund.

The yield on both bond and equity income funds is not guaranteed. As an equity income fund is investing in shares, the risk of your capital falling in value is greater than the risk associated with bond funds.

Some equity income funds can also use 'covered call options' to enhance the income they pay. When a fund manager 'sells a call', they are giving the buyer the right to buy a stock they own at a certain price on a certain date. In return for having this option, the buyer agrees to pay a fee. If the stock remains below the given price on the date agreed, the buyer won't exercise the call since it will be at a loss, so the fund manager still has the stock and the income generated by the fee. If it rises, the call will be exercised. In this instance the fund manager may lose some money as they will have to sell their shares at a lower price than the market, but they will still have the fee.

5. Other types of income funds

Bond funds and equity income funds aren't the only ones to produce an income.

Property funds

There are different types of property funds and they generally fall into two categories. Firstly, those investing in physical property—sometimes referred to as bricks and mortar funds—which will aim for a yield from rental income, as well as capital growth. Then there are those investing in property equities (property securities funds).

It is usually the first category that generates the higher yield, although some property securities funds use covered call options to enhance their yield.

The main risk with bricks and mortar property investing is liquidity (being unable to get your money back immediately if a fund manager is unable to sell a property). Property securities funds have the same risks as equity funds.

But they are generally less correlated with other asset classes, so they can also add another layer of diversification to your overall portfolio. Investors should note that at times of extreme market stress, uncorrelated asset classes can become correlated for a short period.

Infrastructure funds

There are also two types of infrastructure funds: those that invest in equities linked to infrastructure and those that invest in projects or infrastructure assets.

For example, equities linked to infrastructure include anything from companies running airports, ports and toll roads to utilities and hotel companies.

Those that invest in infrastructure assets will do so via stakes and contracts in public or private sector projects, such as construction of motorways or high speed rail links, building schools, hospitals or law courts.

Multi-asset income funds

Multi-asset income funds are funds that invest is all sorts of investments that produce an income. They can offer you a one-stop-shop and give you plenty of diversification.

Venture capital trusts

Venture capital trusts (VCTs) are a type of investment trust with attractive tax breaks. They are listed on the London Stock Exchange and generate returns by investing into smaller companies that are looking for capital with which to develop their business.

One rule with VCTs is that they can retain no more than 15% of income generated, which means they can provide an income for shareholders, particularly the more established and mature portfolios. 

Investing made easy: Chelsea Income EasyISAs 

We know that having a large choice of funds can be overwhelming, so we have two ways to help you narrow down your investment choice.

Firstly, we have the Chelsea Core Selection and Chelsea Selection lists, which contain funds the Chelsea research team believe to be best of breed. On these lists you will find a number of income-producing funds.

Secondly, we have two income Chelsea EasyISAs: Income and Global Income. Each EasyISA invests in six different funds, hand-picked by our research team. They are designed for investors seeking an income-producing investment and offer diversification, with a yield and the prospect for long-term growth. You simply need to select the one that you think best suits your investment style and objectives. Your ISA investment will then be spread equally across the six corresponding funds. 

Alternatively, you may like to consider the VT Chelsea Managed funds

Take an income or reinvest?

One final consideration when thinking about income-producing products is what you want to do with that income. Do you want to take it or do you want to reinvest it for growth?

For anyone not requiring an income now, reinvestment of income has proved to be very rewarding over time, as the more is invested, the more potential the investment has to grow.

Others may want, or need, to take an income to help pay monthly bills, healthcare costs or to supplement retirement income.

The important thing to remember, if taking an income, is that different products will pay income at different times—monthly, quarterly or annually for example—and it may not be a guaranteed amount. This is a particularly important consideration if you plan to pay bills with your investment income.