An essential guide to income investing

Income investing is a strategy of using your portfolio to generate a regular stream of income. It is popular with those hoping to achieve a higher return on their money than they’d get from a savings account, but who also want to use the returns to supplement their income.

Common long-term goals for income investors can range from aiming for an income in retirement, to saving for your children’s education.

And if your investments are generating a higher return than you’d get from cash savings, it also helps keep pace with inflation, reducing the chance of the spending power of your money being eroded over time.

You can invest for income in a number of different ways, but you need to be sure to choose investments which aim to pay out regularly.

Dividend income from shares

When it comes to investing in shares, the income we talk about comes from dividends – a part of the profits that a company distributes among its shareholders every year.

There are many companies which have historically provided significant dividends and that have a track record of growing profits, and consequently improving those dividend payments over time. There are no guarantees this will continue, of course.

Funds and investment trusts managed to generate an income

Some investment funds have the specific focus of producing an income from shares. These are called equity income funds and the manager will look to invest in established, cash generative companies which have potential to pay out significant dividends to shareholders.

There’s also the option to invest in an investment trust that aims to deliver income. They can pay out all the income they receive each year to investors. However, they also have the ability to hold back up to 15% of that income in 'reserve' so if there’s a bad year or two for companies sharing profits, investors can still be paid an income.

Growth funds, on the other hand, aim to provide an increase in the capital value over the long-term.

As growth is the priority, these funds invest in companies that reinvest their earnings back in the business so they can expand, rather than pay it out to investors as a dividend. Though of course there’s no guarantee a company's investments in growth will successfully lead to profit.

Often you can choose from income or accumulation units when investing in a fund, depending on whether you’d like to draw the income from any dividends paid out, or have the dividends reinvested.

Choose “Inc” for Income

If you’d like income to be paid directly to your bank account, to supplement either your salary or pensions, you can arrange this through your Smart Investor account. Simply select the fund units where at the end of the fund name are the letters “inc” and instruct that the income on your account is paid to your current account by logging in to your account and changing your preferences within your investment settings.

Choose “Acc” to reinvest back

For income earned by the fund to be retained in the units and reinvested, choose the fund with “acc” at the end of the name. The main benefit of reinvesting income from your investments is that it is the cheapest and easiest way to increase the value of your holdings over time. Any income within the fund is used to buy more shares which will potentially grow in value and boost your overall returns. The number of fund units you hold will remain the same but the value of each unit should rise.

Reinvesting dividends or interest may seem a logical approach to help your investments grow if, for example, you already have enough income from your job, and you’re saving for a financial goal which is many years away, such as retirement.

Direct shareholders

If you invest in shares directly, you will receive your dividends direct from the company. If you want them to be reinvested automatically, you can usually sign up to what is known as automatic dividend reinvestment (ADR).

Investing for income tax efficiently

One of the most tax-efficient ways to invest is through an individual savings account (ISA).

You have an ISA allowance of £20,000 each tax year, and your money is sheltered from income, dividend and capital gains tax.

Yet if you hold income-generating investments outside an ISA or pension then you will need to consider tax. Where stocks and shares funds are held outside of an ISA, you get an annual tax-free dividend allowance of £500, after which you get will pay dividend tax on your income. The rate of tax is tiered – it’s 8.75% for basic rate taxpayers, 33.75% for higher-rate payers and 39.35% for additional-rate payers.

Getting invested

An equity income fund can be a good way to take advantage of companies that pay out dividends. If you’re interested in UK equity income funds, there are several on the Barclays Funds List, including the Artemis Income Fund, which mainly invests in UK companies, but can invest overseas when attractive opportunities arise. Its holdings tend to be stable, well-established businesses with the financial strength to pay solid dividends to their shareholders.

If you want to broaden your approach further afield you can look at the Janus Henderson Global Equity Income fund which aims to find the best investment opportunities in regions all over the world.

On the Funds List you can also find investment funds that belong to other strategies such as growth, and sector specific funds.

More income options

Other asset classes that can provide an income include fixed income (bonds) which pay a regular amount of interest – you can see the most popular bonds with our customers here – property and infrastructure which both generate income from rent.

If you can’t decide which to choose, you might consider a multi-asset income fund where a fund manager decides on the mix of assets on your behalf. Multi-asset funds invest in a variety of asset classes, such as shares, bonds, property, cash, and potentially even alternative assets such as gold.