ISA INVESTING TIPS: Fund and trust ideas for income investors

Income investing is not just for those who wish to draw a cash return on their portfolio, reinvested dividends are also a great way to build solid growth over time.

If you had invested £100 in the UK stock market in 1945 it would have been worth £179,695 by 2015 with dividends reinvested, or £9,148 without, according to the oft-cited Barclays Equity Gilt study.

Funds and investment trusts are an ideal method for income investing, as by holding a basket of equities or assets they spread risk.

Income investing: Dividends can deliver both a healthy boost to long-term growth and a way to earn from your investments.

Income funds and trusts invest in portfolios of companies that pay a consistent dividend.

Unlike investing in individual shares, risk is spread across a range of businesses and sectors and it can be less volatile than a growth fund as you are putting money into more established firms. 

The power of income: How investments would have fared with or without dividends reinvested

The huge number of funds and investment trusts on offer can be confusing though. 

Fortunately, This is Money’s experts have some ideas to get you started. 

They have picked funds and trusts to use as starting points for what will hopefully be a successful income investing career.

Of course, which fund is best for you depends on your individual circumstances and what investing story you think will unfold. 

So, always do your own research, choose your investments carefully and hopefully you will make your own good investing luck.

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How to use our fund and investment trust ideas

This is Money asks our panel of experts to suggest investments for a variety of investors.

These are people with a long history in the investment field and looking at their choices gives you some pointers. But remember, these are just ideas and whether a particular fund is right for you is your own decision and making that requires deeper research.

Their ideas are suitable for investors opting to use an Isa wrapper or not. Go to the bottom of the page to find out why we like investing through an Isa.

Read the tips, follow the links to the funds’ performance and read This is Money’s Investing section to gather ideas. If you have any doubts, talk to an IFA [find an adviser].

The experts’ fund ideas

Jason Hollands of Tilney Bestinvest recommends:

Standard Life UK Equity Unconstrained fund  

Ongoing charges: 0.9 per cent

Yield: 3.7 per cent 

‘Income fund managers need to take care to dodge potential landmines and roam across the whole market to find robust businesses with the scope to grow their dividends through thick and thin,’ says Hollands. 

‘While most equity income funds focus on large, ‘blue chip’ FTSE 100 companies, the Standard Life UK Equity Income Unconstrained fund will use the whole bandwidth of the UK stock market and invest in medium sized and smaller companies, as well as FTSE 100 big names. 

‘Manager Thomas Moore, an industry rising star, is prepared to avoid some of the major names in the market where he sees the risk of a dividend cut. Key holdings include Sage, a global leader in accountancy and payroll software, insurers Aviva and Legal & General and telecom firms BT and Vodafone.’

Darius McDermott, of Chelsea Financial Services recommends: 

Premier Multi-Asset Monthly Income fund

Ongoing charges: 1.42 per cent

Yield: 4.6 per cent

This fund is designed to produce a high, sustainable income combined with strong absolute and relative growth through robust risk management. 

McDermott says: ‘The team invest in a broad range of assets, investments, managers and funds and have a demonstrable capability for producing excellent results. 

‘With a yield of almost 5 per cent, which is paid monthly, it’s a great alternative for income-seekers.’

Patrick Connolly, chartered financial planner at Chase de Vere recommends: 

Rathbone Ethical Bond fund

Ongoing charge: 1.11 per cent

Yield: 3.7 per cent

‘This is the ideal fund for income investors on a number of levels. It typically pays a competitive yield of around 5 per cent, benefits from a good quality fixed interest manager and invests in many underlying holdings that aren’t found in other funds, meaning it also provides strong diversification benefits,’ says Connolly.

Fund manager Bryn Jones has run this fund since 2004. He aims to invest in good-quality investment-grade bonds and adopts a proven process of looking at investment themes, credit analysis, valuations and risk, before conducting the ethical screen.

‘The ethical emphasis means that the fund contains some interesting bonds paying competitive yields, such as a UK disability charity supporting disabled people and their families, a not-for-profit company focusing on social housing and a mentoring programme for ex-offenders working with social housing associations.’

Gavin Haynes of Whitechurch Securities recommends: 

Artemis Global Income fund

Ongoing charge: 0.84 per cent

Yield: 3.8 per cent

‘For UK investors, investing in dividend-producing shares has long been a staple ingredient of their investment portfolios and I believe it makes sense to diversify equity income exposure overseas,’ says Haynes. 

‘Over 90 per cent of stocks that yield in excess of 3 per cent in the MSCI World index are based outside of the UK. In a global economy currently dominated by low interest rates, dividend yield will continue to be an important part of the total return equation.’

This fund has been managed by Jacob De Tusch-Lec since inception in 2010, and performance has impressive versus the competition. 

‘It follows a contrarian approach with the manager deliberately seeking out companies within global markets that are being overlooked or are out of favour. 

‘This approach can provide high dividend yields and the fund is currently offering around 4 per cent. 

‘The fund has no constraints with regards investment size, industry or region, and the portfolio reflects where De Tusch-Lec sees value in global equity income stocks. The fund’s regional allocation highlights its high conviction approach with 40 per cent of the portfolio currently invested in Europe.’

Investment trust ideas

John Newlands, head of investment trust research at Brewin Dolphin, highlights: 

Finsbury Growth & Income

Ongoing charges: 0.8 per cent

Yield: 2 per cent

Run by investment manager Lindsell Train, the principally UK-focused portfolio has a heavy emphasis on branded consumer goods and services such as Diageo, Unilever, Heineken, and AG Barr. 

Other leading holdings include RELX (the former Reed Elsevier), financial services companies such as Schroders, Hargreaves Lansdown and, to recent profitable effect, the London Stock Exchange.

Newlands says: ‘The manager Nick Train tries to buy stocks which are priced below his estimate of the company’s true worth and then holds them for the long term, regardless of short term volatility. 

‘While past performance is no guide to the future, it is worth noting that in Nick’s hands this trust has produced sector-leading performance over the past decade and presumably he has learned something along the way.

‘The trust’s record has not gone unnoticed by the market but I still regard it as an attractive prospect.’

Simon Lambert, This is Money editor and author of the Minor Investor column highlights Lowland and Diverse Income trusts, as two that target both dividends and long-term growth.

Lowland investment trust

Ongoing charges: 0.59 per cent

Yield: 3.2 per cent

James Henderson, manager of the trust since 1990, holds more than 120 different companies but has a commitment not to invest more than half the trust into FTSE 100 companies. He argues that this approach of holding a large number of companies allowed him to target value and smaller company opportunities – and investing a small amount helps you buy earlier.

He is a contrarian value investor and looks for both undervalued opportunities and smaller companies that can deliver dividends and growth for years to come. This can lead to the trust underperforming the market in the short term, but in the long-term its record is very good.

Diverse Income Trust 

Ongoing charges: 1.26 per cent

Yield: 2.8 per cent 

Gervais Williams, of Diverse Income Trust, invests in smaller companies and has written a book extolling their virtues, The Future is Small. 

He argues that small and micro cap shares have a huge opportunity to outperform lumbering large companies in a world where growth is slowing after the debt binge of the 2000s. 

The dividend heroes 

Every year, the Association of Investment Companies publishes its Dividend Heroes list. These are investment trusts with the longest history of raising their dividend payments year in-year-out.

Investment trusts are ideal for income investors as they are able to smooth dividend payments, keeping some money aside in the good years to cover any shortfall in the bad.

This is different to investment funds, which must pay out all their dividends. This list is from March 2016.

Why invest through an Isa?

Investing with an Isa is one of the few opportunities we have for making money with very little tax but it doesn’t offer complete tax-free status.

Every year the Government gives us a tax-free Isa allowance.

Your Isa allowance for 2015/16 is £15,240 and will stay the same for the new tax year beginning 6 April 2016. You can move money from an investment Isa into a cash Isa or put your whole allowance in a cash Isa. This applies to any money you have invested in previous years.

Any gains within an Isa are free from capital gains tax. Everyone has a CGT allowance of £11,000 per year and many may feel they are unlikely to ever make more than this in profit each year from selling their assets.

However, those who invest consistently over time may one day be surprised at how much those investments are worth and holding them in a tax-free wrapper makes sense.

This is because if they opt to sell all or a large amount of their investments at one time and they are not held in an Isa, then they may be over the capital gains tax limit and face a tax bill. Whereas, hold them in an Isa and you have no such problem and will not even need to fill in a tax form if you sell.

Income from investments is also treated in a more tax-friendly way in an Isa. Corporate bonds and gilts income is tax-free.

Dividends and shares income are still taxed at 10 per cent  before they are received, so basic-rate taxpayers will not gain any extra benefit, but higher-rate taxpayers do not have to pay any extra tax that would normally be incurred.

If you are a basic-rate taxpayer you may hope to be a higher-rate taxpayer one day, so putting your investments in a tax-free wrapper is a sound tactic. Investing through an Isa also removes the headache of filling in a tax return for both income and capital gains. 

Dividend rules are changing at the start of the 2016/17 tax year on 6 April. A new dividend allowance will be introduced whereby the first £5,000 of dividend income earned each tax year will be tax-free. Until then, basic-rate taxpayers pay no tax on dividend income, while higher-rate taxpayers incur a 25 per cent charge and additional-rate payers have to fork out 30.56 on dividend income they receive. 

Dividends received on shares held in Isas will continue to be tax free.