Investing Basics: Let income funds do all the work for you

If you are new to investing or not yet confident in picking your own investments, one of the easiest and quickest ways to start investing and generating a regular income is to invest in an income-paying fund – writes Christian Leeming.

Investing in a fund allows you to achieve an instantly diversified portfolio of investments that would usually require a high level of knowledge, time and cost if you were to construct it yourself.

over the long-term this means your income and capital should be less volatile, but probably most importantly you get to benefit from the expertise of a professional investment manager who will continuously look for the best income opportunities in the market.

The manager is responsible for looking after an investment portfolio that will meet the fund’s income and growth objectives; they also keep a close eye on all the under-lying assets and make changes whenever necessary, which means that all the hard work is done for you.

Mutual funds

The most common type of funds are mutual funds, also known as ‘open-ended’ funds, or OEICs and unit trusts, which means more shares can be added to the fund in response to investor demand.

Unlike stocks and shares, the price of mutual funds won’t fluctuate throughout the day; the majority are priced by the fund managers once a day to reflect the value of the underlying assets.

Funds operate in different sectors of the market with two of the most popular areas being UK Equity Income Funds that invest in dividend-paying British shares, and Sterling Corporate Bond Funds, which provide exposure to bonds issued by British companies.

Most open-ended funds are available as either income (‘inc’) or accumulation (‘acc’) share classes; accumulation funds roll up the income in the fund and reinvest it in order to increase their value, whereas income funds distribute it on a monthly, quarterly or six-monthly basis, depending on the fund.

Learn more about share classes here.

Investment Trusts

The oldest type of fund is an investment trust, with some dating back more than a hundred years.

They are sometimes referred to as ‘closed-ended’ funds because they have a finite number of shares available; they are listed on the London Stock Exchange as investment companies, with investors able to buy or sell the shares via a broker.

Unlike an open-ended fund, the share price can trade at a premium or discount to the net asset value (NAV) of the underlying assets, based on the appetite from investors for trading these investments on the relevant trading exchange.

Income-focused mutual funds have to pay out all of the income that accrues over the course of their accounting year, but investment trusts have more flexibility as they can retain up to 15% of their annual income.

This is then added to their cash reserves, which they can use to smooth out the dividend payments from one year to the next.

City of London, Bankers, Alliance Trust and Caledonia Investments have all successfully increased their annual dividend for 50 consecutive years and a further 16 investment companies have done so for 21 years or more. You can find out more information about these funds by looking at the key features documents or their latest annual report and accounts.

To learn more about actively managed funds read the latest issue of Focus on Funds magazine: