People looking for investment income home in on bad ideas like Premier League footballers sniffing out WAGs with loose morals.
Guided by bad advisers, they put their money into opaque structured products, bonds that aren’t really bonds, and all sorts of offshore nonsense.
Every month brings new tales of woe about the sorry results. One recent story The Independent on the ‘epidemic problem’ of investment bonds noted that:
Insurance giant Zurich received a dressing down from the ombudsman after an adviser encouraged a man to unnecessarily move £292,000 into an investment bond, which reportedly came with £17,500 in commission.
But while the products are not new, sky-high commissions continue to lure advisers into recommending bonds, although they are often inappropriate for the investor.
Not only do most bonds carry exit penalties for cancellation within five or six years, they are not always tax-efficient and carry risks which the investor may not be fully aware of.
Don’t be fooled. If you want safety, go for cash or government bonds. If you want a growing income, there’s no getting away from risk.
Incidentally, I’m still waiting for someone to complain that they were miss-sold a product that tripled in value when they only expected it to double.
Funnily enough, people only complain when the bonds do badly!
Investment income from investment trusts
Of course, most reputable banks’ income bonds and guaranteed products do not blow up.
But you’re often still paying over the odds (probably to an advisor) for a mediocre return, and you may not be properly evaluating the risks, particularly if the bond was constructed with derivatives.
And the shame of it is we’ve a proven way of investing for a long-term growing income here in the UK – one that’s fairly transparent and based on enduring investment principles.
I’m talking about stock market listed income and growth investment trusts, which most experienced readers will know about already, I’d hope.
The pick of these trusts have paid regular dividends for decades, with the income rising annually for well over 20 years. The very best have grown their payouts for more than 40 years!
How do they do it?
Dividends: These investment trusts generate the income they pay to investors by investing in FTSE 350 companies that deliver a growing dividend income stream.
Gearing: Most use a bit of debt to increase their returns.
Reserves: By not paying out all their dividend income in the good years, trusts can build up ‘revenue reserves’ to top-up dividend payout in the bad years, and so smooth out the income stream they offer.
And that’s it. Nothing fancy – but it works.
Four great investment trusts
The following four UK growth and income investment trusts have a dividend growth record spanning at least 20 consecutive years, according to their trade body, the AIC.
All boast generous dividend income yields at the time of writing:
| Investment Trust | Yield |
| Merchant’s Trust | 6.9% |
| Murray Income | 5.2% |
| City of London IT | 5.1% |
| Temple Bar | 4.5% |
The right column shows the current annual income yield for each trust
All four companies are generations old, and they manage – and are valued at – well over £1 billion combined. These are not fly-by-night outfits.
The longest period of rising income of my four picks has been achieved by the City of London Investment Trust, which has increased dividend payments annually for 43 years. (Despite this great record, in the recent bear market you could pick up the City of London trust at a 10% discount!)
There are other income-orientated trusts with a slightly less stellar record that are worth investigating, too. One is the Edinburgh Investment Trust, which is under the new-ish management of high-flying income investor Neil Woodford. It’s yielding nearly 5.5%.
There are also a few global and small cap investment trusts with decent yields that you might want to investigate to diversify your income stream.
Risky? Definitely.
If you divided your money between the four investment trusts above, you’d currently buy an attractive average investment income yield of 5.4%. You could reasonably hope that the income will rise over time, too.
With even the very best cash deposit accounts yielding barely 3% before tax (and most much less), that seems to me good value.
True, investment trusts carry annual fees, but they’re not onerous – typically around 0.35% to 0.5% for these giant trusts (although City of London does also charge a rather fiddly performance fee) – and the yields quoted are net of fees.
I’d also argue that investment trusts are pretty simple, compared to the alternatives we discussed at the start of this article.
- No sudden loss of capital if the FTSE falls below 4,521 or some other particular threshold foisted upon the product by options.
- No need to invest in Bulgarian ski chalets or ostrich farms.
- Certainly not a Ponzi scheme.
- You can sell up at any time you choose.
Yet there’s no free lunch, either.
When you buy an investment trust, your capital is 100% at risk. These are companies listed on the stock market, investing in other companies. If markets go down, your trust will likely fall in value, too.
Now personally, I’d far prefer to put my money into a 50-year old investment trust than a structured product dreamed up by some Aussie maths nerd with a six-month work visa at Merrill Lynch.
But I guess I’m in the minority, given how investment trusts are the preserve of old school investors, and more people put money into not-really-bonds et al.
In fact, let’s defend financial advisers for a moment. While many do sell complicated products primarily because they pay great commissions, it’s also true their clients want the impossible – all reward, and no risk.
Most people can’t stand volatility, which is exactly what led to the creation of structured income products. They are an attempt to limit the downside, but at the cost of capping the upside in the best cases, and of mysterious failures or hidden charges in the worst.
In contrast, the risks of buying shares in an investment trust are clear:
- The investment income generated could fall.
- The share price of the investment trust can (and will) go up and down.
To address the first case – falling income – this is a non-trivial risk, but I’d point to the record of increasing payments going back decades.
All four trusts I’ve cited have built up substantial reserves sufficient to offset a moderate level of falling dividend income from the companies they’ve invested in – generally over 100% of their entire annual payout.
As for their share prices, there’s no getting away from fluctuations here. But if you’re investing for the long-term for income, why should you care? What matters is the dividend.
If the market throws a wobbly and share prices halve or double, it shouldn’t matter unless the companies owned by your trust slash their dividend payments, sufficient to reduce your investment income.
Otherwise, as an income investor you can ride it out.
In fact, if you’ve got spare cash it could be an opportunity to buy more of your favourite trust, especially if its discount to Net Asset Value (NAV) has increased.
Ideal for financial freedom seekers
I’ve written before about how I am creating a freedom fund focused on investment income to replace my salary. Investment trusts will be a key part of the mix.
I already own shares in Merchant’s Trust, amongst others. Now that capital gains rules are being meddled with yet again, I think this trust with its attractively high income yield will get more of my money over the months and years ahead.
Please do read my article on investment trusts to ensure you understand the basics. You might also want to read up on how dividend income is taxed (it’s taxed less harshly than cash!)
Comments on this entry are closed.
It’s my goal this year to start investing in an investment trust or ETF to create an aditional pension pot/freedom fund as you so often allude to.
The biggest issue I have found to date is finding somewhere online where I can compare the fees and performance of the multitude of options there are out there. Do you have a favorite site you use when deciding to invest somewhere new?
Hi, I use ishares for ETF research, and I prefer its ETFs as they offer the simplest tax treatment for UK investors, compared to ETFs domiciled in France or Germany.
For investment trusts, a good place to start is Trustnet. Here’s its table of UK growth and income investment trusts. To see the different charges and fees, click on the individual trust name and scroll down.
Good luck with your ambition to start up a freedom fund. Don’t forget to do so in an ISA! 🙂
Thanks!
I’ve just been reading through some of your older posts and came accross your high yield portfolio chain (http://monevator.com/2007/09/28/selecting-the-shares-for-your-high-yield-portfolio-hyp-part-4/).
Did you ever get the subsequent parts you mentioned written (investing monthly vs lum sum etc) as there’s no links at the bottom of the articles as there is in parts 1-4?
@edindie – Er, no, I’ve not written those yet. Sorry! A few readers have asked and my answer is partly that I’m thinking of collecting all the HYP ideas into a little downloadable PDF, but also that my thinking and blogging know-how has slightly evolved since I first wrote those articles and so I intend at some point to give them a spruce-up (I want to make them a proper series, like my corporate bond series).
Thanks for the interest and watch this space! 🙂
Well, it’s good stuff all the same. I’m sure you get this a lot (I’m also sure it’s never going to be a bad thing), but thanks for the many hours you’ve spent explaining things on your site just to help people educate themselves.
Keep up the good work!! Especially the HYP bit :p
Thanks edindie, and you’re most welcome. I love investing and I love writing, so I’m very happy to combine the two – though readers always remember I’m not a financial advisor and that they are responsible for their own money and actions. 🙂
> like Premier League footballers sniffing out WAGs with loose morals
You owe me a new keyboard for coffee spilled when I read that 🙂
Thanks for the explanation. I should have paid attention when my Dad was working out how to invest before he retired, since he was deeply into investment trusts, but I had no money then. It’s been a tour of the weird and wonderful of late, and ITs are a backwater that might reward me with further investigation.
.-= ermine on: Why Office Work is Bad For You =-.
Hey Ermine – Not sure when your dad was retiring of course, but he sounds like he was a smart cookie about it. Sorry about the keyboard… 😉
Hah. Wow. I was just going to attack financial advisors for a moment there, and you offered an interesting point on the other side of the fence. That is, people wanting all reward and no risk.
Even government bonds today are risky. Especially with all of the high inflation running about, the potential for government defaults, the soaring debts, among heavens knows how many other things.
It’s a pity that being a saver just isn’t good for one’s future anymore. But many people seem to forget that all investments have a level of risk. You don’t need to be a risky investor, but everything has potential for downturn. Which scares me how people think they can enter retirement, sit on their portfolio and sip margarita’s all day long. Fort assets is something you have to protect all your life!
I still think a lot of advisors/portfolio managers are kind of chiseling off of people still.
@Aury – Oh, absolutely they are. You’re speaking to the man who wrote a post called Financial Advisors: Swindlers and Leeches. 🙂
this stuff is gold dust!
Thanks for the heads up. Been looking all of these up on iii this morning and noticed that they also pay dividends quarterly which is even better for compounding returns. Nice one monevator.
@fatherb – You’re welcome, very glad you’re finding the information useful.
Hello – just want to add my own nag about parts 5 and 6 of the HYP series to the pile. Also, would you say something about sectors? I’d like to know (a) if there’s a standard classification, and if so what it is, and (b) whether there’s a way of quickly discovering for any sector what its constituent stocks are and, even better, comparing them (so, e.g., if I wanted at least one stock from each sector and knew my portfolio lacked a representative from sector x, I could with one or two clicks compare the candidates).
@Tyro – The simplest way I know of to get a handle on sectors is to use screening tools like Digital Look or possibly the LSE website, or just look in the FT. I’m not sure there’s a cast iron classification, certainly not something that transcends all outlets or even borders.
I have just started investing and find your blog absolutely invaluable. Although I am 9 years from retiring I am lucky enough to have one of those gold plated, copper bottomed final salary pensions which should pay about £27,000 p.a. and a lump sum of £80,000 from age 60. I don’t own any property though and would like to save up to create enough income in retirement to allow me to continue renting without spending all my money on it or alternatively to buy a small flat. I am ashamed to admit that my total savings are only £2600 so far and these are made up of £425 cash, £1400 in a stakeholder pension, £250 lent out via Zopa and the rest in a gold and silver fund. I have decided to start investing £250 per month into Merchants Trust via Halifax sharebuilder in my ISA. I hope this will give me a platform on which to build. Thanks for the blog.
TER on whole portfolio
monevatoer
if one was to split money up and invest in 4 investment trusts or 4 funds, how would the TER work out? would you add up each individual TER then divide by 4?
eg; say trust 1 TER was 0.34 trust 2 TER was 0.55 trust 3 TER0.45 and trust 5 TER 0.5 added together 1.84 divided by 4 = 0.46 so the total TER would be 0.46 on all 4 investments. am I correct?
@Dawn — Hi, yes I think that’d be right if you were investing equal amounts (not financial advice etc!) See this article:
http://monevator.com/how-to-work-out-your-portfolios-cost/
haha – this is getting me a bit closer! It maybe from deep in the archives but super-useful non the less!