Investing for income
Let's go back to the £10,000 example we used earlier. If you invest for income, you’re not expecting the amount that you invested to grow into a larger amount. Instead, you’re aiming to make a regular income from your £10,000.
There are lots of ways you can aim to do this. You could put it into a cash savings account that pays regular interest. This is less risky than other investments, so is one of the most common ways to invest for income.
Another way is through fixed-income investments such as gilts and bonds . These also pay regular interest payments, which can provide a steady fixed level of income. The interest rate is set at the point of issue, and will be determined by the general level of interest rates available in the markets and the perceived financial strength of the issuer.
The benefit of fixed income investments is that if they are held until maturity, the issuer promises that you'll be repaid in full provided you invested in them when they were first issued. Having said this, if you invested in them after they were first issued by buying them 'second hand', as is common with gilts, you will have paid whatever their market price was at that time.
At maturity you will get back the face value of the bond, being the amount that was originally paid for it, which may be more or less than the 'second-hand' price. If you wanted your money back before the maturity date, you would have to sell the investment and you may get back less than you invested.
The security of your investment and the regular interest payments depend on the company’s or UK government’s ability to make these payments when due. If they become insolvent, they will not be able to pay you your income or repay the money that you invested.
You can invest in bonds from an individual issuer, eg, from a particular company. However, if you do this, your money will be tied up with that one company and its security will depend on its fortunes.
Gilts are issued by the UK government, so provide you with a safer investment because it’s considered unlikely that it will default on a debt. However, this investment will be for a fixed term and again, because general interest rates will move over time and the income offered may become less attractive, if you sell before maturity, you may get back less than you invested.
At maturity, the gilt will repay the issue price. If you bought it at a premium to its issue price – ie, for more than that price because the interest was attractive compared with the interest rates available – then you wouldn’t get back the full amount you paid. However, if you bought it at a discount to the issue price – ie, for less than the issue price – you may get back more.
Spreading your money and risk
Another way to invest in gilts and bonds is through funds. Because funds invest in a mix of different assets, your money is spread across a mix of companies, markets or, in the case of a gilt fund, UK government bonds with different maturity dates. So your potential risk is spread too.
For this reason, funds that invest in gilts and bonds have always been a popular source of income for investors. They’re popular with investors that hold individual shares in their portfolios too, because they help balance them out. You will find out how in our 'How to diversify' section later.
The value of these funds tends to move less frequently but they're still influenced by general interest rates as well as the financial state of the company or the UK government. These types of funds tend to be more stable in value and have become even more popular in the wake of the economic crisis. As share prices fell significantly, bonds either maintained their value or, in most cases, rose as interest rates were cut. However, if general interest rates rise in the future, their value would be expected to fall.
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