Our fund picks deliver £10,000 knockout blow to inflation

It can be difficult to keep investing during difficult times, but there is no better way to accumulate wealth over the long term. So forget about saving in a Best-Buy Individual Savings Account, paying tuppeny ha’penny in interest – other than to build an emergency fund. Also forget owner-occupied homes, now a minefield for amateur landlords.

Stocks and shares are the way forward, even if you have to accept that there will be times when inflation will undermine what you want to achieve. Still, investments at least give you the arsenal to combat inflation and its corrosive impact on wealth creation. If, on the other hand, you put £100,000 under your mattress two years ago, it would now be worth only £85,400 in real terms.

Of course, the temptation to turn off the premium tap on Investment ISAs and pensions will be too great for some people to resist.

It is understandable. Inflation isn’t going away any time soon, food bills will continue to rise, and mortgage rates are still going up.

And, as the Institute of Fiscal Studies think tank said a few days ago, all this financial pain is being caused as the government sucks more and more of our income into taxes.

But – and it’s a huge ‘but’ – if you can resist the temptation and keep investing, you’ll hold up well financially for the future. With inflation at just over 10 percent, investors face a major hurdle if they want to see their portfolios grow in real terms. But they can set up their ISAs and self-administered pensions to mitigate its impact.

The key is to build a portfolio that benefits from dividend income backed by long-term capital appreciation.

Think of the income as your ongoing reward for being an investor. It can be reinvested to buy more shares (a good trick if you’re still working) or it’s deposited as soon as it’s paid (although it’s not possible to get dividend income from a pension until at least age 55 ).

Dividend income, which exceeds interest from a bank or savings account, can provide a welcome boost to stressed household finances.

And it’s not scarce. Mark Peden, an asset manager at Aegon Asset Management, says stock markets are entering a new “golden age” of dividend yields, offering investors “an important source of total return in challenging markets.”

Market experts from asset manager AJ Bell agree, estimating that aggregate dividend payments from the UK’s 100 largest publicly traded companies should rise 11 percent this year.

This month alone, some of these companies – such as cigarette giant British American Tobacco and banking groups Lloyds and NatWest – will pay dividends worth £8.4bn.

In addition to an income trend, portfolio diversification is required.

Diversification takes many forms. It means investing in a range of funds managed by different asset managers, rather than individual stocks. Funds spread their assets over many holdings, diluting (not eliminating) investment risk.

Exchange-traded mutual funds are particularly investor-friendly, whose shares are easily purchased online through all major investment platforms, such as AJ Bell, Fidelity, Hargreaves Lansdown, and Interactive Investor.

This is because the ongoing annual costs of many of these trusts – especially the larger ones – represent good value for money. Some trusts are also great generators of income growth.

Diversification also means investing globally. From an income perspective, the US stock market is a fertile breeding ground for dividends. For example, Peden, who is a co-manager of Aegon Global Equity Income, says more than two-thirds of fund holdings in the first quarter of this year delivered dividend increases.

Nearly half of the fund’s assets are in the US. Finally, you should also ensure that part of your portfolio is invested in funds that generate income from assets such as commercial real estate, infrastructure, solar and wind farms.

WHAT CAN AN INCOME PORTFOLIO LOOK LIKE?

A year ago, when inflation hit 7 percent, The Mail on Sunday asked the Association of Investment Companies (AIC) to put together a portfolio to fight the curse of rapidly rising prices.

It included all of the diversification rules previously mentioned and included ten trusts operated by different groups. All ten had income arrears with dividend payments during the year.

We assumed £10,000 had been invested in each of these trusts by 30 April 2021 and then looked at how it would have performed over the next year.

Last week I asked Annabel Brodie-Smith, a director of the AIC, to provide an update two years from now.

Not bad is the answer, although it hasn’t been able to beat inflation.

As the table shows, the portfolio has held up well, mainly thanks to income. Over the last two years it has generated £9,226 in revenue. Taking stock performance into account, £100,000 has grown to £109,171. For comparison, we also published another income portfolio that the AIC compiled for The Mail on Sunday that consisted of trusts that invested only in equities rather than alternative assets.

Over the last two years it has produced less income (£8,893 on £100,000 invested), but this has been offset by better returns on its share price. The result is that £100,000 has become £111,809.

To put these numbers in perspective, they are much better than what an equivalent deposit into a savings account has yielded.

Anna Bowes, a director of savings advisor Savings Champion, says a combination of deposits into a good, easily accessible account and the best fixed income bonds would have turned £100,000 into £101,894. For now, inflation is winning. This is because its impact over the past two years has been undermining for wealth builders.

In fact, if someone had put £100,000 under their mattress on April 30, 2021, their purchasing power would have been reduced to £85,415.

Brodie-Smith says, “It’s been a tough environment for investors.

“In challenging circumstances, it is reassuring that several mutual fund portfolios have generated a strong and reliable source of income.

“In an uncertain world, diversification is key to generating a consistent stream of income.”

• For more information on investment income, visit theaic.co.uk/income-finder.