In search of inflation-busting income
David Prosser considers how savers should tackle falling savings rates and rising inflation.
The Bank of England Monetary Policy Committee’s decision to cut interest rates earlier this month was an unusual one. Rate reductions typically imply that the MPC is undershooting on its inflation target, courtesy of lacklustre economic growth. But while the UK economy is certainly stuttering, inflation remains stubbornly and significantly above the 2% the MPC is supposed to aim for; in July, the most recent month for which data is available, inflation stood at 3.8%, up from 3.6% in June.
That leaves savers facing a double whammy. As bank and building societies follow the MPC’s lead, interest rates on many savings products are dropping; the average savings account now pays less than 3.5% a year according to Moneyfacts – and many pay even less. Meanwhile, rising inflation will erode the real value of your money even more quickly.
It’s worth remembering that in many cases, you’ll be losing money in the bank or building society once you take the impact of inflation into account.
David Prosser
All is not lost, however. For more adventurous savers at least, investment trusts offer a potential source of salvation. Research just published by analysts at Trustnet reveals that in nine separate investment trust sectors, the average fund currently offers a yield of more than 4%.
These sectors include specialist areas, such as Renewable Energy Infrastructure, where the average fund yields 6.7%, and Asia Pacific Equity Income, yielding an average of 6.5%. But more conventional funds also offer decent levels of income – the Global Equity Income and UK Equity Income sectors currently offer average yields of 4.5% and 4.3% respectively, Trustnet reports.
Remember, a yield isn’t quite the same thing as an interest rate. It tells you how much income an investment trust offers relative to what it costs to buy shares in the trust; yields therefore move up and down all the time as investment trusts’ share prices rise and fall.
The other critical point here is that unlike with bank and building society savings accounts, investment trusts don’t guarantee your capital won’t fall in value. Shares in investment trusts can fall as well as rise, so you need to be prepared for that possibility.
Nevertheless, if you’re a long-term investor focused on generating income from a portfolio of assets that you don’t intend to cash in over the short term, investment trust yields look alluring. At current share prices, many sectors offer an attractively priced stream of dividends. There’s also the possibility – not guaranteed – of capital growth; that could protect you from inflation even if you need to draw down some or all of the dividends that investment trusts pay.
Funds such as investment trusts can’t promise they will continue to pay dividends at the same level; that will depend, in part at least, on the income that the fund earns on the assets in which it invests.
However, investment trusts do have an advantage over other types of funds in this regard. Uniquely, they are allowed to keep back some of the income they earn each year to build up a dividend reserve fund; this can be used to subsidise income payments to shareholders in leaner times. This attribute has seen some investment trusts raise their dividends year after year, no matter what has happened to the underlying portfolio. In some cases, investment trusts now have a record of annual dividend increases that goes back more than half a century.
Often, savers feel reluctant to make the leap from cash savings products to an investment that can fall in value as well as rise. But it’s worth remembering that in many cases, you’ll already be losing money in the bank or building society once you take the impact of inflation into account. If you’re comfortable with short-term risk, an investment trust – or a portfolio of investment trusts – could provide you with more income and the potential for inflation-busting capital appreciation.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
