According to data from investment platform Interactive Investor, users’ “bond” investment holdings nearly tripled in the two years to the end of June 2024.
Fixed-rate investments are any investments that pay income to the holder periodically, rather than reinvesting the income to grow in value. As rising living costs in recent years have put strain on the finances of employees and retirees alike, the possibility of earning additional income from such investments becomes increasingly attractive.
Here are explain the different income investment options and the risks you need to consider, whether you’re just getting started in investing or want to broaden your knowledge.
1. Bonds and gilts provide regular interest payments
When you invest in bonds or gilts, you’re essentially lending money to a government or corporation. In exchange, you receive regular interest payments, usually twice a year. Many repayments are made at a fixed interest rate. That’s why bonds are often referred to as fixed-interest investments, although some bond interest rates can be variable.
Gilts are a type of bond issued by the UK government. You can invest in gilts directly or through funds made up of gilts. Direct gilts are growing in popularity, with assets held in direct gilts increasing more than 20-fold since the end of June 2022, according to Interactive Investor.
Gilts are backed by the Treasury, unlike stocks and other bonds. They are also exempt from capital gains tax (CGT) if you sell your shares and make a profit, but income from interest is subject to income tax.
The downside of bond and government bond investments is that they usually don’t offer any opportunity for capital appreciation. If you want your investments to generate good long-term returns, check out our beginner’s guide to investing in alternative assets.
2. Some stocks pay regular dividends
Some stocks distribute profits to investors on a regular basis, depending on the number of shares held. Dividends are usually paid twice a year, but may be paid more or less frequently. Also, dividends are not guaranteed. You can buy dividend stocks outright, or choose funds or mutual funds that aim to generate income. These usually have “income” or “dividend” in the fund name.
Dividend stocks are a good way to supplement regular income and, unlike bonds or government securities, usually offer the opportunity for capital appreciation too. However, direct investment in shares is generally considered to be riskier than other forms of investment and you should consider all aspects of your assets when deciding what to invest in.
Some companies promise to pay attractive dividends to make their ventures more attractive to investors in potentially riskier or less attractive business models or market environments. For example, one of the FTSE 100 companies with the highest dividends is British American Tobacco. Its dividend has increased by 5.2% since 2014, but its share price has fallen by 32% in the same period.
What is a share buyback?
A ‘share buyback programme’ involves a company buying back some of its own shares, thereby reducing the number of shares held by investors. This means that remaining shareholders receive more shares in the company and therefore more dividends.
Investment platform AJ Bell’s Q2 2024 Dividend Dashboard report looked at dividends from UK listed companies. It revealed that FTSE 100 companies overall have filed share buyback plans worth £38.5bn in 2024.
It also showed that analysts expect the dividend to rise 1% to £78.6 billion in 2024 and 7% to £83.9 billion in 2025.
3. Real estate investing can generate rental income, but it takes work
Investing in rental property is a popular way to earn extra income. However, this option requires more care and effort than investing in bonds or stocks.
Financially, you need to consider the costs associated with being a landlord. These include property maintenance and repairs, as well as landlord insurance against theft, damage and sometimes temporary rent loss. And mortgage rates for rental properties are high right now. Not buying the property outright reduces your potential income.
You’ll also need to take the time to familiarize yourself with the laws and regulations governing private rental properties. And unless you pay a fee to an agency, you’ll need to make sure you can find tenants and deal with ongoing maintenance and emergency repairs.
4. Investing through a Stocks and Shares ISA can maximise your income.
You can invest up to £20,000 in a ISA each year. All income from investments held in an ISA (including dividends and interest income) is tax-free, so it’s worth making the most of this. This can make a big difference to your returns, particularly for higher or additional rate taxpayers. You can invest in bonds, government bonds and shares through an ISA. You can’t invest directly in property through a Stocks and Shares ISA, but you can invest in commercial property funds that provide rental income.
Income from investments held outside a Stocks and Shares ISA is subject to different types of investment tax depending on the type of investment. You may have to pay the following taxes:
- Capital gains tax on profits from the sale of investments
- Income tax on interest from bonds and government debt
- Dividend tax on any income you receive from dividends.
Most people receive a tax-free allowance for each of these taxes. This depends on the type of tax and whether you’re a basic, higher or additional rate taxpayer. However, it’s likely that you’ll exceed one or more of the allowance limits, especially if you’re investing for income.
Read our verdict on the best stocks and shares ISAs for 2024, based on feedback from 1,950 customers and fee analysis.
5. If income is withdrawn, the value of your entire investment may decrease
Some people receive income from their investments. This can include part of the “capital value” (the value of the asset if you sell it), or part of your assets. Any dividends.
For example, say you have £100,000 invested in an asset that pays an annual dividend of 3% (the equivalent of £3,000), but you need an investment income of £5,000 per year. You can choose to withdraw the remainder of the capital value. This will amount to 2% in the first year, and could increase further in subsequent years (depending on how your investment performs).
If your investments grow less than you withdraw each year, you will eventually run out of money. This may be part of your plan, but if you are using it to fund a pension, for example, you need to weigh it against future financial expenditures – for example, to fund nursing care in old age.
6. A good financial advisor can help you manage your investment risk
It’s important to take the right level of risk for your financial needs and goals. For example, if you’re interested in retirement income, a slightly lower-risk strategy may be more suitable to avoid unexpectedly losing money you need to live on.
Working with an independent financial advisor is a good way to find out which investments are right for your situation and personal risk tolerance. You’ll get tailored advice that takes your situation into account, but fees may be higher.
If your situation is relatively simple, there are cheaper alternatives such as digital “robo-advisors” and managed ISAs. These platforms typically require you to answer a series of questions to determine your goals and risk tolerance. The platform’s robo-advisor (essentially a smart algorithm) will recommend investments that most closely match your answers. However, they usually offer less personalisation, flexibility and ability to ask questions than a human advisor.