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How to generate an income from your savings

Cherry Reynard
Written By:
Posted:
10/07/2014
Updated:
10/12/2014

Make your savings work harder with these quick tips for generating an income.

It may seem like a long time ago, but bank accounts once paid 5% and those who needed an income from their savings need do nothing more than sit back, relax and wait for the pennies to roll in. Fast forward to now and investors have to be a bit cannier to build an income stream.

There are lots of investments that pay an income, across property, shares and bonds. The key decision for investors is whether they are prepared to take a risk that their capital might fluctuate in order to generate a higher income, or stronger capital growth.

At the lower risk end, an investor might pick government bonds, which tend to pay a lower income because the risk of the UK or US government not paying their investors back is still pretty low. Alternatively, investors may go for a higher risk option, such as equity income funds, where the income stream relies on companies generating sufficient profit to pay dividends, but where the capital return prospects are far higher.

Options:

1) Bonds for income – investors may choose government bonds – loans to a government – or corporate bonds – loans to a company. In both cases the amount of income received will depend on the perceived riskiness of the borrower. The UK government is considered to be a good bet to pay back its creditors, the government of Argentina, less so. Equally, Unilever would be considered a better bet than a smaller, start-up company, who would therefore have to pay an higher interest rate to persuade people to lend it money.

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2) Equities for income – When companies generate profits, they can reinvest them in the business to promote higher revenue growth, or they can return it to shareholders in the form of a dividend (or both). The level of that dividend will depend on their level of profits, but there are many companies that prioritise a stable and growing dividend and have paid dividends year after year. Equity income fund managers will blend a portfolio of dividend paying companies to provide a more stable long-term income to their unitholders.

3) Property for income – As the economy recovers and rentals yields start to improve, commercial property has started to become popular once again. There are two types of property fund: property share funds and direct property funds. Both invest in commercial property, but property share funds invest in stock market-listed property companies (often called Reits) from around the world, while direct property funds buy and sell whole buildings, acting as commercial landlords: They collect the rent, maintaining the properties and benefiting from any gain when the building is sold.
In practice, many investors will blend some or all of these asset classes in their portfolios. This can help smooth out returns over time. If you would rather a professional did this for you, there is a new breed of ‘multi-asset income’ funds, which provide access to a variety of income-generating assets within one fund. JP Morgan Asset Management, Schroders, Barings and M&G all have funds of this type.

Head of investment at Towry, Andrew Wilson, offers his view on generating an income from your investments: “In order to help generate a steady investment income, you should seek to invest in a diversified multi-asset portfolio with an ‘all terrain’ approach, which will therefore be less risky and calm any concerns you may have on accurately timing the markets.

He says that investors should look widely in their search for income: “Investors should not rely on a small number of yielding asset classes, some of which might be overbought and overpriced, especially right now.He adds: “Additionally, you could seek to use a portfolio manager who takes a ‘Risk-targeted’ approach, meaning there is an agreed and understood limit to the risk the manager will take, and therefore hopefully a smoother overall return to add to your income.”

Remember that if you put your income-generating investments into an Isa structure, the income received will be tax free. Over the long-term, this can provide a valuable boost to your monthly income. There may come a time when investors can generate an income simply by putting their cash in a savings account, but in the meantime, they will have to work a little harder.