Everyone has their own reason to invest which naturally leads them down different paths and strategies.
One of the many approaches is to boost income - rather than relying on the seemingly erratic movement of a stock ticker, the income strategy allows you to enjoy your stock market gains regularly without having to sell.
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What is equity income?
An equity income fund is one that invests in companies that aim to pay out a dividend.
Companies pay out a dividend from profits they have earned but have no need for - this is usually only found in established companies that are not reliant on large scale growth and reinvestment.
A good dividend yield coupled with some capital growth over time can produce a very attractive total return for a long term investor.
By incorporating an equity income fund into a portfolio, an investor is able to generate cash that they can chose to either reinvest or take out as regular income. This can provide investors with a lot more flexibility with their investments without having to sell off the underlying asset.
Income and growth
The core benefit of equity income investing is you prosper as the company prospers and are rewarded for holding on for the long term.
By using equity income you are able to take advantage of compounding by reinvesting the dividend back into the company - this can grow your investment even if the underlying asset value does not increase
One drawback for investors is that dividends are not "safe" income - a company is under no legal obligation to distribute them or to guarantee any particular amount. An example of this was seen during the 2020 pandemic where UK dividends fell 44%.
This highlights the importance of diversification and tailoring your investment portfolio to your specific needs - this should also include readjusting the portfolio as needed.
Why not sell a fund to make income
The aim of a growth fund is to increase in value over time and generally have no intention of providing any sort of income.
They can be useful to individuals with long term investing in mind who do not need to draw from it. Provided that the fund manager selects the stocks carefully, a growth fund can generate strong returns in the long term.
Even though growth funds are not intended for income investors, they can technically provide income if one so desired. By selling off a small amount of your fund units and keeping the remainder to grow, you are able to create a form of income.
Moreover this "income" would be created as needed rather than at the discretion of the fund manager - commonly two or four times per year for many equity income funds.
The major downside to this strategy is that an investor can be caught out by fluctuating fund valuations and may be forced to sell when the markets have dipped. If you maintain income using this method and sell when the markets are less favorable, your overall return will be greatly hindered.
To add to the pain, you might be subject to exit charges for the fund as well as taxation depending on how you have invested. If you sell of units outside of a tax sheltered account (e.g. a pension or ISA) the transaction will be classed as capital gains rather than income.
This
article is not advice and has not been prepared in accordance with legal
requirements designed to promote the independence of investment research – no
recommendations are given in the buying, selling or holding of any investments.
Past performance is not a guide to the future. Investments rise and fall in
value so investors could make a loss.