With savings rates rising, is it worth investing in income funds?

After years of rock bottom rates, saving has become tempting again as banks raise their rates to the highest level in more than a decade.

By contrast, the stock market has had a tumultuous year, with high-flying US stocks tumbling, the UK’s FTSE gangs recently busted, and the fallout from the mini-budget that has once again sent the UK into a world of financial frenzy.

With over 4 percent interest on offer on the best fixed-rate one-year savings accounts, savers can take a good look at those rates and consider parking their money there.

But there’s another option for those looking to grow their wealth, which investors traditionally counter with a solid interest-paying savings account: Equity income funds are designed to generate dividend income and increase the value of your original investment.

With the ability to provide income and capital appreciation, interest in these types of funds could grow as inflation remains red-hot and investors look for funds that generate income to compete with the rising cost of living.

But savings accounts backed by FSCS protection offer capital security, and with further interest rate hikes inevitable, it can seem tempting to stick with cash.

We look at whether cash really is king or whether equity funds give you a better chance of growing your pot.

Is cash still king?

There has been a flight from the stock market since the start of the year amid market turbulence due to higher interest rates and in the UK, the impact of the mini-budget.

In September alone, investors took out £2.4 billion from equity funds, according to fund network Calastone.

By contrast, average easy access rates have risen from 0.25 percent to 1.05 percent since March, according to Moneyfacts. The best easy-access savings deals pay more, with the highest rate of 2.75 percent from Sainsbury’s.

Fixed-income deals also rose from 0.92 percent to 3.1 percent, with Atom Bank paying 5 percent for a five-year fix.

Stocks yield less than 3.5 percent these days, so if you invest £100 in a stock, your dividend yield will be £3.50, which is less than the interest on many current savings rates.

Interest and dividend yields are of course difficult to compare. Darius McDermott says, “They’re fundamentally different things, with different risk profiles, and what’s right for you depends entirely on your personal circumstances.”

It’s understandable why some low-risk investors stick with cash, especially those who need their money for the next two years. But is it really the best way to grow your wealth?

Jason Hollands, managing director of investment platform Bestinvest says: ‘While it is certainly true that there are now much higher nominal interest rates available on savings accounts than we have seen in many years, remember that cash savings generate zero capital appreciation and therefore real returns in a period of high inflation very negative for savings.’

McDemott adds, “When you invest in a stock, you get something that you can’t get by putting money in a bank account, and that’s the potential for capital appreciation.

To give a realistic example, when the Schroder Income Fund was launched in 1988, the return was about 3.5 percent, and 34 years later, the return is still about 3.5 percent. But because of the growth of capital, that’s 3.5 percent of a much larger number.

So if you had £100 invested at the start of the fund, your dividend would have been £3.50 per annum, but because of the growth in the capital portion, that £100 invested now yields £18 in dividends per annum. because the £100 has grown and the income has grown with it. And that is simply not possible with money on deposit.’

Are equity funds a good option in times of volatility?

The popularity of equity funds has declined in recent years as markets favored growth funds invested in sectors such as technology and consumer spending, which benefited from the period of low interest rates and bond yields.

And they have not been immune to this year’s volatility. Investors have already taken about £1 billion out of UK Equity Income funds this year, according to AJ Bell’s analysis, but given the volatile markets, Hollands thinks it’s a good time to pull out of equity funds.

He says: “That world is now definitely a thing of the past, so it’s time for investors to rediscover the appeal of funds that focus on companies with strong cash flows that are able to reward shareholders with regular dividend payments and the ability to pay them back.” to let grow. after a while.’

UK Equity Income is a good starting point for investors looking to grow their portfolio as it has long been the leading market for dividends. UK Equity Income funds have performed broadly in line with the FTSE over 10 years.

The IA UK Equity Income sector has returned 87.3 percent over the past decade, while the FTSE All Share Index is up 92.71 percent.

‘In the long run, almost all of the real return on UK equities comes from dividends,’ says Hollands.

Since inflation of the UK consumer price index began in 1988, the total return on the MSCI UK index (including dividends) has been 1,169 percent, while excluding dividends it was 267 percent. With the UK CPI up 154% over this period, the bulk of the total real return is clearly attributable to dividends and dividend reinvestment.”

“The UK should be the first port of call for equity funds in my opinion, given the available returns and the incredibly cheap valuation of the UK market at the moment.

“The FTSE 100 is trading at a price-to-earnings ratio of 8.7 times earnings and a huge discount to the rest of the world, which is unfair to large British companies that earn most of their revenues abroad.”

Our experts pick their best income funds

Different managers take different approaches to income investing. Some want to invest in more stable companies that pay regular dividends, while others focus on small to medium-sized companies.

Our experts pick the best equity funds for those seeking higher returns than cash.

Within UK Equity Income, there are five funds that offer returns of around seven percent.

Matthew Read, senior analyst at QuotedData says: “Of these 7+ percent yielders, we think some are best avoided as high yield can be a sign of distress, but two good options are Henderson High Income and abrdn Equity Income.”

abrdn equity invests in FTSE heavyweights such as BP, Shell, Rio Tinto and British American Tobacco, offering returns of 7.22 percent.

The trust’s total NAV yield is down 9.9 percent in a year, below the industry average. Read says it has been “helped by its relatively high allocation to energy stocks – 23 percent – which have been instrumental in boosting returns, as has its holdings in commodities – 17 percent.”

“These relatively new allocations illustrate the manager’s ability to adapt to changing circumstances.”

Henderson high income The fund, which primarily holds stocks, although it has some flexibility to invest in bonds, has a current yield of 6.82 percent and trades at a discount of 2.02 percent.

Current top positions include British American Tobacco, Unilever, Diageo and RELX, although 22.32 percent of the portfolio is made up of companies in the financial sector.

Read says Henderson was “the better performer and has been close to par for over a year, but has recently moved to a modest discount, indicating some recovery potential.”

Highlights of McDermott Schroder Income fund for a more ‘deep value style’ and focuses on companies that pay dividends that should grow faster than inflation.

Last year, where the IA UK Equity Income sector returned -8.1 percent, Schroder Income returned -3.4 percent. And with a return of 4.4 percent, it has consistently increased its dividend over the past 25 years.

In global equities, Hollands kiest chooses Guinness Global Equity Income yielding a return of 2.4 percent. The portfolio is concentrated on 35 stocks, including insurance company Arthur J. Gallagher & Co.

“While they look for global stocks that deliver returns in excess of the benchmark MSCI World Index, they focus on underlying company quality – particularly sustained high returns on capital – before considering dividends.”