Investing Basics: Letting Income Funds do all the Work
If you are new to investing or not yet confident in picking your own investments, then the idea of investing in a fund probably seems a step too far by Tom Sieber
In fact, one of the easiest and quickest ways to start investing and generating a regular income is to invest in an income-paying fund.
Investing in a fund allows you to achieve a degree of diversification that, if you were to do it on your own, would usually require a high level of knowledge, time and cost.
This means your income and capital should be less volatile over the long-term. But, probably most important of all, is that you get to benefit from the professional expertise of an investment manager who will continuously look for the best income opportunities in the market.
The manager is responsible for looking after a well-diversified portfolio that will meet the fund’s income and growth objectives.
They will also keep a close eye on all the under-lying assets and make changes whenever necessary, which means that all the hard work is done for you.
The most common type of funds are mutual funds, also known as ‘open-ended’ funds, or OEICs and unit trusts, which means more shares can be added in response to investor demand.
Unlike stocks and shares, the price of these won’t fluctuate throughout the day. The majority of these are priced by the fund managers once a day to reflect the value of the underlying assets.
These operate in different sectors of the market with two of the most popular areas being UK Equity Income funds that invest in dividend-paying British shares and Sterling Corporate Bond funds, which provide exposure to bonds issued by British companies.
Most open-ended funds are available as either income or accumulation share classes. Accumulation funds roll up the income in the fund and reinvest it in order to increase their value, whereas income funds distribute it on a monthly, quarterly or six-monthly basis, depending on the fund.
The oldest type of fund is an investment trust, with some dating back more than a hundred years.
They are sometimes referred to as ‘closed-ended’ funds, which means they have a finite amount of shares available, and are listed on the London Stock Exchange with investors able to buy or sell the shares via a broker.
Unlike an open-ended fund, the share price can trade at a premium or discount to the net asset value (NAV) of the underlying assets based on the appetite from investors for trading these investments on the relevant trading exchange.
Income-focused mutual funds have to pay out all of the income that accrues over the course of their accounting year, but investment trusts have more flexibility as they can retain up to 15% of their annual income.
This is then added to their cash reserves, which they can use to smooth out the dividend payments from one year to the next.
City of London, Bankers, Alliance Trust and Caledonia Investments have all successfully increased their annual dividend for 50 consecutive years and a further 16 investment companies have done so for 21 years or more. You can find out more information about these funds by looking at the key features documents or their latest annual report and accounts.