Investing for income is always a popular investment theme, never more so than in recent months with income solutions ruling the roost over the ISA season for both the cash ISAs and investment ISAs. We take a look at the reasons why as well as our selection of what the market currently has to offer.

Why income?

With the Bank of England interest rate continuing at its record low, this has put a clear downward pressure on the levels of interest available from fixed rate bonds. The governor of the Bank, Sir Mervyn King, is expected to state in tomorrow’s inflation report that this rate could very possibly continue until 2014.

Those who have been waiting for an increase to help them out of this savings dilemma have not only had to wait well over three years, but it also looks like they are going to have to wait a whole while longer. Even worse is that inflation is still well above government targets and there is great uncertainty as to what lies on the horizon. Pay freezes and record low annuity rates also add to the situation so those both in and out of work are affected.

Overall, this makes for a desperate situation and an environment that does not help anyone make a decision with certainty. What is certain is that the pressure to make the most from your savings and investments is higher than ever.

First things first

Perhaps the most important consideration and one which should be considered first is whether you wish to expose your capital to risk or whether a return of at least your original deposit is your top priority. The principle of risk v reward translates to the higher returns only becoming available by moving up the risk ladder, but it should be noted that risk covers a very broad spectrum.

If you are looking for the potential for higher returns from your savings then you must be prepared to tie up your money since there is no increased reward without increased risk and when looking for income solutions this usually equates to longer terms being necessary. However, this must also be considered in the context of the current economic conditions, and in particular the effect inflation can have on the real value of your money.

Capital protection

The current economic landscape combined with continued low rates available from fixed rate bonds continues to cause a real dilemma for savers (see last week). This has caused a significant rise in interest of alternatives and income plans have been particularly popular.

The Fair Investment Income Deposit Plan offers the safety net of capital protection with the potential for higher returns than those available from fixed rate bonds. The potential yield is 7% per annum, a return more commonly associated with equities and fund investments rather than capital protected options.

The trade-off is that the income is not guaranteed, as in order to receive your 7% the FTSE 100 Index must remain between 4,500 and 7,000 points each year. For any year where the FSTE falls outside of these levels, no income is paid for that year. Compared to the leading longer term fixed rates currently paying around 4%, this plan offers the opportunity to earn an additional 2.5% each year.

Higher yields

For those prepared to accept some risk to capital, there are a wider range of options available and this is where the higher potential rates of return can be achieved.

Defined returns

Our selection of investment plans offer a defined return for a defined level of risk. The benefit here is that you know from the outset what has to happen in order to achieve the stated returns.

A popular choice with investors at the moment is the Income Builder Plus from Gilliat with Morgan Stanley acting as counterparty. This plan accrues income for each week the FTSE remains above 3,500 points and offers up to 8.4% each year, with payments made quarterly.

The plan has a popular 5 year investment term with your original capital returned to you unless the FTSE falls below this 3,500 barrier although this is only measured on the final day of the investment rather than throughout the investment term. The FTSE opened this morning at 5,465 and overall this plan offers an attractive balance of risk v return.

Investment Funds

Investment funds offer another way of accessing the potential for a healthy income, with high yields available from a wide range if investment groups. In the equity sector, Schroder’s Income Maximiser has a historical yield of 7.09%* and Newton’s Higher Income fund has a historical yield of 6.36%*. Both funds are A rated by OBSR and make quarterly payments.

In the fixed interest sector Invesco Perpetual’s Monthly Income Plus fund was the biggest seller over ISA season due to a distribution yield of 6.52%*, monthly income payments and the highest AAA rating from OBSR. Aberdeen’s High Yield Bond is AA rated with a distribution yield of 9% and also pays monthly.

Investment funds and your capital

Some of the yields available from investment funds certainly catch the eye but it is important to remember that this income is not guaranteed and subject to fluctuations. In addition, the treatment of your capital is different to the previous two options covered – there is certainly no capital protection offered, nor is there the conditional capital protection associated with Gilliat’s Income Builder Plus and investment plans generally.

This is important since the income yield and any rise or fall to your original capital should always be considered together since both have an effect on your overall return. For example a 9% annual income is not quite as compelling if it coincides with a 9% reduction in your capital as overall you have only broken even.

Do your homework

The Bank’s inflation report is not only expected to cut the UK’s economic forecast but we are also being told to brace ourselves for ‘higher-than-expected inflation’. Along with everything else which is going on with our economy in our search for the best income solution we would do well to make sure we review all of the options open to us.

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Comapre income funds »

* Data accurate as at 31/03/2012.

No news, feature article or comment should be seen as a personal recommendation to invest. If you are in any doubt as to the suitability of a particular investment you should seek independent financial advice.

Some structured investment plans are not capital protected and there may be the risk of losing some or all of your initial investment. There is also a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated, in which case you may not be entitled to compensation from the Financial Services Compensation Scheme (FSCS). In addition, you may not get back the full amount invested if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.

© Fair Investment Company Ltd