For UK savers investing for income, it is important to strike a balance between hunting out good dividend paying shares, robust corporate bonds, well-managed funds or just the best savings account. Investing for income for most requires a mixture of investments, to balance risk with returns.
Historically low interest rates have left many UK savers searching for real returns, but the obligatory warning that past performance is no guide to how markets will perform in future always applies.
Utilising UK equity income funds that pay good dividends can have an integral part to play in a well-structured income portfolio. When looking to generate an income from UK equity funds, the objective is to select funds that invest in businesses that have the potential to provide sustainable long-term dividend growth.
The sector is divided in two, making it easier to select a suitable fund. Funds in the UK equity income sector must aim for a yield at least 10 per cent higher than the FTSE All-Share index, whereas UK equity income & growth funds must aim for a yield of at least 90 per cent of the All-Share.
If you invest in a UK equity income fund where the growth potential is not reflected in the valuation of its shares, this not only reduces the risk, it can also increase the upside opportunity.
In the short-term, UK equity income fund prices are buffeted by all sorts of influences, but over longer time periods fundamentals come to the fore. Dividend growth is the key determinant of long-term share price movements, the rest is sentiment.
Even when UK investors don’t need an immediate income from their portfolio, steady and rising dividend yields from UK equity income funds, together with the potential for capital growth, can play a central part in an investment strategy. In addition, dividend income may be particularly relevant as the UK hauls itself out of the economic doldrums we’ve experienced over the past few years.
For UK investors requiring income in retirement, it’s all about the compounding of returns over the long term. UK equity income funds look to invest in businesses that can demonstrate consistent returns on invested capital and visible earnings streams.
Companies with a high and growing free cash flow will typically attract UK investors. These are companies with money left over after paying out for capital expenditure, as this is the stream out of which rising dividends are paid. The larger the free cash flow relative to the dividend payout the better.
As with any investment strategy, diversification is the key to diminishing risk, which is particularly important for UK income-seekers who cannot afford to lose capital. Also, don’t forget to utilise tax shelters, which can deliver tax-free income, or a pension, where contributions attract initial tax relief.
