With interest rates low, investment funds look attractive

A fund from investment giant Fidelity is offering an annual income of around 7% – or 14 times the interest paid on the average easy access account. Shares in Royal Dutch Shell, Legal & General and HSBC are all expected to pay dividends worth 7% or more. Is now the time to take on more risk and put at least some of your savings into funds and shares?

Savers will, quite rightly, be nervous – most would be much happier if accounts were paying 4% or 5% interest rather than risking the swings and roundabouts of markets. It is a dilemma that financial adviser Brian Dennehy, of Dennehy Weller, acknowledges: “In a world of very low interest rates, many will find themselves in income-generating stock market funds through lack of choice, rather than due to a huge enthusiasm.”

Savers need to adjust their mental approach, he says. “This means not obsessing about the day-to-day moves of the capital value, rather focussing on the lack of volatility and relative predictability of the income.”

But where do you start? Your choice comes down to buying individual shares or buying into a fund. Individual shares are riskier as if the company collapses all your money is wiped out. Funds typically have 50 to 60 different shares, so if one goes down the impact is much less.

There is, though, a bewildering choice of hundreds of different “equity income” funds. The Fidelity one, paying 7%, is a bit of an outlier. Dennehy reckons savers should expect 3.5%-4% from funds that have a long record of consistently paying out, year after year. He recommends J O Hambro UK Equity Income, paying 4.4%; Artemis Income (3.8%); and BlackRock UK Income (4.0%). Each has grown its income in at least eight of the past 10 years.

At advisers Chelsea Financial Services, Darius McDermott says: “At the lower end of the income scale we like Rathbone Income. It yields 3.4% at the moment but it is very consistent and has only cut its dividend once in 20 years.

“At the higher end we like Fidelity Enhanced Income. It uses covered call options to boost income. This means the managers give up a bit of growth potential to get a higher level of income. At the moment it is yielding 7%.”

But what is the likelihood of funds having to chop their income payouts, particularly if there’s a post-Brexit recession? “There were concerns towards the end of last year that the UK’s biggest companies were going to struggle,” McDermott says. “Brexit has helped many of them, though, because the pound has fallen and they have most of their costs in sterling and revenues in dollars. So profits are boosted and they are better able to pay dividends.”

The investment director of Britain’s biggest advisers, Mark Dampier of Hargreaves Lansdown, says savers have no choice but to go up the risk spectrum if they want a decent income. He has been a lifelong believer in equity income funds, not just for paying income but for the capital growth they can also offer. He says someone who put £10,000 into a popular equity income fund in 2002 would have received an income of £360 a year later, equal to 3.6%. Fourteen years later, the £10,000 has turned into more than £19,000, and the income is £780 a year, equal to 7.8% on the original investment.

Dampier also tips the Artemis and J O Hambro funds, as well as Marlborough Multi Cap Income, Threadneedle Equity Income and Jupiter Asian Income. He says that the renowned investor Neil Woodford is likely to launch a new equity income fund in the next few months with a greater leaning towards income than his current funds.

But don’t just look at funds: there are also investment trusts that look interesting. “They have the unique ability to squirrel away some of the income they receive each year and when times get tough the investment company can use this saved income to boost their dividends,” says Annabel Brodie-Smith of the Association of Investment Companies. “There are 20 investment companies which have increased their dividends every year for over 20 years – so-called ‘dividend heroes’ – with the City of London Investment Trust increasing their dividends for an impressive 50 years.”

Also consider index funds, which track the performance of a particular market and can pay an income, too. They are generally much cheaper to buy and own that conventional trusts. Vanguard’s UK Equity Income Index fund is a good place to start.

If you want to do your own research on funds there are plenty of sites worth consulting: Trustnet.com and Morningstar.co.uk let you search for prices and performance data. FundCalibre.com lists lots of “elite” funds. When you have made your choice, you then have to actually buy it. There are now lots of online investment platforms that allow you to keep your funds (and individual shares) in one place, buying and selling units when you want, such as Hargreaves Lansdown, Fidelity and Bestinvest. Which is best for you will depend on how much you want to invest.

Small investors can download the “Come and have a go” Lang Cat report, which contains a guide for people who know little about investing as well as sophisticated traders, without charge at Langcatfinancial.com. It looks at service, support, size, products and online facilities at the platforms, as well as costs and charges.