Gareth Shaw: Always look on the bright side of life

I know you don't want to read yet another article about the dire state of the savings market. You don't want to know that with inflation now creeping up to 1.8 per cent this week, just one in 30 savings accounts can match or beat rising prices. And I'm sure you've had enough of managing your money in this bonkers world where you can earn more by leaving your cash sitting in your bank account than you can in a savings account or cash Isa.

Record low interest rates have laid waste to conventional savings returns and mean that other methods have to be turned to
Record low interest rates have laid waste to conventional savings returns and mean that other methods have to be turned to

So, let’s skip the tale of woe about the damage that record low interest rates have done to your savings returns and get to the point – how can you generate a consistently healthy income from the money you’ve diligently tucked away?

If it’s income you’re after, it’s clear that cash isn’t your best option. If you’re turning to the stock market for the first time in pursuit of a better return, or already investing, equity income funds could be a powerful part of your armoury to generate a regular profit to prop up your pension, salary or other earnings.

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The benefits of these investment funds – which pool your money with other investors to buy shares in companies that pay high and consistent dividends, in turn translating into a regular income for you – are no new fad. Some £15 billion of private investor Isa savings are held in equity income funds, according to the Investment Association.

But perhaps savers still desperately scrambling around for morsels in the cash savings market may soon wake up to the opportunities that equity income funds can bring. Last week, it emerged that Neil Woodford, a well known professional investor, would be launching a new equity income fund, which aims to pay 5 per cent in its first year, more than his existing Woodford Equity Income fund (which is currently yielding 3.4 per cent). It’s due to land next month as Isa season reaches fever pitch ahead of the end of the financial year.

The new fund will reportedly look to invest overseas as well as in the UK to try and achieve that 5 per cent income goal (and keep in mind it’s a goal not a guarantee – as successful as Mr Woodford has been in the past, it’s near-impossible to predict how his investment choices will perform in the future).

And this raises an important point if you’re looking to invest in an equity income fund – they come in all shapes and sizes, and some may be better suited to your needs than others. Most funds in this sector invest relatively conservatively, buying shares in large, well-established companies that pay healthy and consistent dividends – a payment of the profits a company makes to shareholders. That means you might see slower and lower growth in the value of your initial investment, all the while receiving an income. Of course, you could reinvest your income back into the fund to grow your capital – this can be an option if you don’t need the income right away.

There are, however, other equity income funds that offer super-high yields in the region of 8 per cent or 9 per cent. While this may seem deliciously attractive, there is a downside. These funds – sometimes referred to as ‘enhanced’ income funds – turbo-charge their returns by selling off the profits they make from the shares they hold and buy derivatives, complex financial contracts called ‘call options’, to boost the income you receive.

The trade-off there is that you may see little or no growth in the value of your initial investment as the profits have been used to ‘enhance’ the income. This all depends on the strategy the fund manager uses: some will take all the profits and use it to boost your income as much as possible, whereas others limit themselves to around 60 per cent of the profits. Suffice to say, investing for income is not like the relatively simple, off-the-shelf selection you make when choosing a savings account.

However, these funds can be a compelling option in this era of pitiful cash savings rates, where just 23 out of 697 accounts – that one in 30 I mentioned earlier – on the market beat the latest inflation rate. I know you don’t want to be reminded of that.

Gareth Shaw is head of Which? Money Online