There’s been some good news for those who depend on income from their savings.
After years of interest rates so low you were almost paying the bank to look after your cash, the Bank of England rate hike designed to combat inflation has meant that cash savings accounts have been paying high rates of interest once more.
The Bank of England base rate went up 14 times from a record low of 0.1% in December 2021 to 5.25% since last August and has recently reduced to 5%. It was painful for house buyers but very good news for savers.
The bad news is that could be about to change. Inflation may not be completely beaten, but with the latest figures showing it close to the 2% target set by the government, further bank rate reductions may be expected.
This means that means returns on cash savings rates will fall too. In fact, they have already started dropping, as savings providers price in the cuts which are to come.
At Continuum we are looking at an alternative. Investing for income.
Savings vs investment
Saving involves setting aside money usually in a savings account. There is little or no risk, predictable returns and modest interest.
With investing, on the other hand, your money is used to buy assets like stocks, bonds, or property. There are no guarantees, but it is possible to aim for higher returns over time.
Investing for income focuses on generating regular earnings from investments, rather than capital appreciation. This involves assets that provide steady cash flow, such as dividend-paying stocks, bonds, property, and income-focused mutual funds or ETFs. The goal is to create a reliable income stream, often used to support living expenses, particularly in retirement.
There are several suitable investments which you might want to consider.
Bonds
Bonds are essentially loans made to corporations or governments and are generally considered lower risk than to stocks, providing predictable income and preserving capital. When you buy a bond, you lend money to the issuer in exchange for periodic interest payments, known as coupon payments, and the return of the bond’s face value when it matures. Bonds can be characterised by the level of risk they present. UK government bonds are known as Gilts, and as secure as the UK itself. However, it is also possible to buy less secure bonds, which have various categories down to ‘junk’ status.
The simple rule is that the higher the risk, the greater return a bond may offer.
You can buy some bonds yourself, but you can also invest through a fund that gives you exposure to a diversified selection. Some bond funds focus on a particular sector, such as corporate or UK government bonds, while others will look to providing a broad base to maximise returns.
Equity income
It is also possible to select equity investments – shares – that provide income.
Some established business distributes a portion of earnings they make among their shareholders every year.
Finding and buying the most suitable spread of income-producing shares can be a challenge, and the simple answer maybe to use an equity income fund. These funds focus on a broad spread of solid businesses with the financial strength and prospects to pay good, growing dividends to their shareholders. A UK equity income fund could earn you a return that combines dividend income – or yield – and any growth in value of the underlying investments.
Investment trusts
You could also consider investment trusts. They are structured as companies in their own right, listed on the stock exchange, means they can build up reserves in good years and so maintain the level of dividends to shareholders when times are tough. Both general and specialist funds, focussing on areas such as technology and mining exist.
Other asset classes that can provide an income include property and infrastructure. A multi-asset income fund will cost you a bit more for a fund manager to decide on the mix of assets on your behalf.
Acc or inc? When you want to reinvest income select an accumulation version of the fund or trust you like — usually it has “acc” after the name. The “inc” version of the fund is designed to pay out – you can usually swap from one to the other if you need to.
Tax
If you hold income-generating investments outside an ISA or pension you will need to think about tax. With bond funds, income is treated in the same way as savings interest, so you will pay tax on it at your usual rate of income tax. Basic rate taxpayers get a £1,000 a year tax-free savings interest allowance while higher-rate payers get £500. Additional-rate taxpayers get no allowance.
With stocks and shares funds held outside of an ISA you will pay dividend tax on your income at 8.75 per cent for basic rate taxpayers, 33.75 per cent for higher-rate payers and 39.35 per cent for additional-rate payers. Everyone gets an annual tax-free dividend allowance of £500.
Getting some help
Getting the security and the level of return you want from your income generating investments can be a challenge, unless you are an investment expert with a broad knowledge of the market.
Fortunately, you don’t have to be. Just call us at Continuum for the expert help you need.
Bank of England cuts base rate to 5% – what it means for you (moneysavingexpert.com)
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice, or a recommendation to a particular investment or saving strategy you should seek independent financial advice before embarking on any course of action.
The value of an investment can go down as well as up. When investing Capital is at risk.
Equity based investments do not afford the same capital security as deposit accounts.
A pension is a long-term investment; the fund value can go down as well as up and this can impact the level of pension benefits available. Pension Income could also be affected by interest rates at the time benefits are taken. Pension savings are at risk of being eroded by inflation.
Levels, bases and reliefs from taxation are subject to individual circumstances and may be subject to change.
The Financial Conduct Authority does not regulate taxation advice, deposit accounts and UK Government Securities.
