9th September 2010
The Bank of England has kept UK interest rates on hold at a record low of 0.5% for the 18th consecutive month.
And it's not about to get better any time soon, according to the experts. Azad Zangana, Schroders' European economist said the rate hold was no surprise. Schroders estimates savers will have to wait until August of next year before we see any increase in the base rate. And then Zangana's only forecasting a very modest rise – to just 1.25% by the end of next year.
This is bad news for anyone relying on the interest from their savings, but those prepared to accept some risk can increase their income by investing in a mixture of the following.
As Kevin Mountford, head of banking at moneysupermarket.com, says: "Inflation has slowed but Britain's savers still face an uphill struggle to generate value from their savings."
A recent poll on the moneysupermarket.com website revealed that 52% of people want the base rate to start rising to give their savings pots a much needed boost.
As Mountford says: "It's undoubtedly difficult for savers to make a positive return on their money with inflation well above the Bank of England's 2% target and interest rates at an historic low. However, many people could be doing more than they are to lessen the effects of the current economic environment."
And Mindful Money has some of the answers in this handy guide to making money in the current climate. Using a mixture of the following investments it is possible to substantially boost your income – it all comes down to what level of risk you're prepared to take.
There are many different types of bond funds and they all have different risk profiles according to where they invest.
The majority hold UK government bonds, corporate bonds, or a combination of the two.
Corporate bonds are further divided into those issued by companies with reasonably high levels of credit worthiness, known as investment grade, and the riskier high yield equivalents.
Caroline Hitch, senior portfolio manager in the HSBC World Selection range, says that there are a number of reasons why sterling bond funds could be attractive to investors seeking extra yield.
"Our central forecast is that official UK interest rates will stay low for at least the rest of this year, hence sterling bonds look reasonable value by comparison."
She goes on to add that we are currently in the earnings reporting season and many companies are not only reporting good earnings but also beating analysts' forecasts.
"This is recognised as being good for a company's shares and good for their bonds too."
Government bond funds currently have an income yield of about 3.5%, investment grade corporate bond funds about 4.5% and the high yield equivalents as much as 7.5%.
One of the most popular options is to invest in a strategic corporate bond fund.
These give the manager the freedom to invest in whichever bonds he thinks will provide the best return.
John Pattullo, head of fixed income at Henderson Global Investors, says that strategic bond funds allow an investor access to one flexible bond fund which has the potential to perform in all economic environments.
"The manager will vary the interest rate and default sensitivity of the fund as the cycle moves from recession, to recovery to boom to bust, thus asset allocation is provided in one fund, which makes it a kind of outsourcing solution"
Investment trusts are often overlooked, but some of these funds have a great record of growing dividends.
This provides investors with a rising level of income to help combat any increase in the cost of living.
Hitch warns that an investment trust has a different legal structure to a unit trust or OEIC.
"Not only can its market price stand at a discount or premium to its net asset value but this can vary over time, which is something investors need to factor in."
Those concerned about the long-term impact of inflation on their capital might prefer to invest in a UK Equity Income fund.
These typically have a yield of 3.5% to 4%.
Andrew Jones, UK Equity Income fund manager at Henderson Global Investors, says that their income funds aim to achieve both long-term capital growth and an above average yield relative to the FTSE All Share.
"Certain companies will have low yields but have superior capital and income growth prospects, some offer growth at a reasonable price and average dividends, whereas others will have higher dividend yields but more modest capital potential."
By constructing a portfolio of companies with different yield relatives that in aggregate exceeds the market yield they feel it is possible to provide both income and long-term capital growth.
Last year over half of the FTSE All-Share yield came from just 10 companies.
"We've seen that this degree of concentration comes with inherent risks, as many of the companies which were the biggest contributors of market yield were forced to cut them," explains Dan Roberts, manager of the Gartmore UK Equity Income Fund.
This first became apparent among banking stocks, which contributed over 20% of the market yield in 2006 before the financial crisis, and then came to light again very recently in BP.
Roberts says that at Gartmore they try to diversify their sources of income so that they are not bound to the index, while targeting a 20% yield premium to the market.
"This reduces our exposure to stock and sector specific issues."
The difference between these funds and purely income orientated funds is that a proportion of the holdings are invested for growth.
The composition of such funds can vary widely including investing in overseas assets, so it is vital that people understand the exposure they are taking on.
"We believe investors should aim to diversify their investments between different asset classes as much as possible and a UK Equity and Growth Fund is likely to be more diversified than a pure UK Equity Income Fund," notes Hitch.
e, manager of the Schroder Income Maximiser fund, says that in the last few years a new breed of equity based product has emerged.
"These aim to offer investors a higher level of income than generated by a standard equity income fund."
Known as covered call funds, these funds can target a yield that exceeds that of a traditional income fund by 3% or 4%.
"They do this by using derivatives to sell some of the potential upside in the stock portfolio," explains See.
Covered call funds add a "covered call option" overlay strategy to enhance the yield by selling ─ in return for a fee to be taken as income ─ some or all of the potential upside of the stocks held in the portfolio.
"These funds therefore offer investors the potential to benefit from capital growth in addition to the enhanced income," says See.
Covered call funds are included in the UK Equity Income Sector.