Conal Gregory: Forget deposit rates and make cash with dividends and bonds

If you have been running a deposit account for some time, check the rate as it is likely to be dire. Even the top-paying no notice accounts disappoint: Virgin Bank 1.51 per cent, Tesco Bank 1.50 per cent (including 0.75 per cent bonus) and Paragon Bank on 1.46 per cent. A variable cash ISA is fractionally better with 1.56 per cent (Virgin Money) and 1.51 per cent (Post Office).

A fixed rate cash ISA is slightly more generous: 2.51 per cent (Virgin Money) and 2.30 per cent (Yorkshire Building Society). However, such deals lock the saver into a low rate when there could be changes. The Bank of England has held official interest at 0.5 per cent since April 2009 and many economists expect an upward move next year.

Halifax say that average savings are now £16,690 with more money being squirreled away monthly, up from £85.71 a decade ago to £113.77 today.

Holding cash makes no sense in real terms. According to Barclays Capital, equities rose 4.1 per cent over 10 years, Treasury stocks (gilts) by 3.7 per but cash actually lost 1.2 per cent. Over 50 years, the results are even more marked: 5.7 per cent up for equities, 2.9 per cent gilts and a small rise of 1.5 per cent for cash.

To spread risk, seek equity income through a fund which brings the benefit of an experienced stock-picking manager. Most such collectives offer:

- Regular payments which can boost retirement income

- Interest at more than double deposit rates

- Growth potential which is denied with deposit accounts

To gain a competitive advantage and not have too much tied up in the UK, select one or more funds with a global mandate. The risk in having too much invested here is that the Bank of England may shed some of the massive £375 billion it holds through its quantitative easing programme, even though Governor Mark Carney has denied such a move until rates reach two per cent.

A fund can protect savers far more than trying to select individual companies. Those opting for good payers in the past may have chosen Centrica, Drax, Glencore, Serco, Standard Chartered and Tesco, all of which have cut their dividends recently. This list has now been joined by Amec, which has made its first cut in 18 years.

Yet the 350 leading FTSE companies yield four per cent on average. Managers look for firms which have the financial resources to pay an uncovered dividend with good cashflow even when under pressure. These include BT, Carnival, IAG and Reckitt Benckiser.

Dividend income accounts for four-fifths of total return from UK equities. Martin Payne of wealth manager Brewin Dolphin in Leeds likes British American Tobacco (“a relatively defensive company” yielding 3.8 per cent), Sky (2.8 per cent yield with strong dividend growth), Unilever (with eight per cent annual compound over the last 20 years) and Vodafone (4.9 per cent yield).

Payne likes three investments trusts in this sector: Temple Bar (with a contrarian manager who invests in UK equities which have fallen at least 50 per cent from their peak), Schroder Oriental Income (notably Asia Pacific with 60-70 holdings) and JP Morgan Global Emerging Markets Income.

Garry Ibison, Chartered Financial Planner at advisor Chase de Vere in Leeds, says that equity income funds are increasingly used by investors looking purely for capital growth with income reinvested, as well as those seeking a regular and rising income with the potential for growth.

He warns against investing in more than one UK fund in the sector as it may not produce diversification since 80 per cent of dividend income is produced by 15 companies and 50 per cent by just five firms. Instead Ibison suggests investing in some smaller companies and also international equity income funds. He tips Threadneedle UK Equity Income (4.2 per cent yield), Rathbone Income (3.7 per cent) and further afield Artemis Global Income (3.8 per cent) and Newton Global Income (3.6 per cent).

Over five years, UK income investment trusts have risen 74.1 per cent on average. The top performers are Finsbury Growth & Income (up 119.5 per cent), Perpetual Income & Growth (up 107.5 per cent) and Lowalnd (up 104.1 per cent).

Equity income funds “remain a good core holding for most, if not all, portfolios, as they either provide an income in the form of dividends or you can reinvest them and benefit from the wonder of compounding,” says Darius McDermott of Chelsea Financial Services.

He tips Evenlode Income with a 3.9 per cent yield. It is a concentrated fund and not afraid to radically depart from its benchmark and ignore entire sectors.

Many companies based outside the UK may not have our long-standing dividend culture, using profits instead to grow further, but they have started to pay more consistently. McDermott likes Legg Mason IF ClearBridge [correct] Global Equity Income which has a 3.3 per cent yield, saying, “This unique fund takes a very different approach to peers and, as a result, will often invest in parts of the market that others ignore or miss.”

Stephen Message of Old Mutual UK Equity Income says that, in almost six years as its manager, the yield premium has typically been 10-20 per cent higher than the market. Some 70 per cent of revenue from UK listed businesses is generated outside the UK, like Burberry in Asia and plumbing merchant Wolseley in North America.

Josh Crabb from Old Mutual Asian Equity Income notes that his sector is “vastly under-represented” in income-producing portfolios but that it is far easier to identify Asian stocks with relatively attractive yields.

Saga recently linked up with Tilney Bestinvest and offer 126 equity income funds as well as ready-made portfolios. Their income fund is invested in Asia Pacific 6 per cent, emerging markets three per cent, Europe 11 per cent, Japan two per cent, North America 14 per cent and UK 64 per cent.

Fixed income bonds is another approach. Private client stockbroker Killik favours Bruntwood (providing office space), Intermediate Capital (managing institutional assets) and Paragon (which lends on buy-to-let mortgages), all to be redeemed in 2020 and paying a nominal six per cent but 6.25 per cent in Intermediate Capital’s case.

BlackRock Income Strategies use a multi-asset approach including equities, bonds and alternatives like property is favoured by Tim Whitehead, investment manager at stockbroker Redmayne-Bentley. The fund aims to achieve four per cent above inflation over five to seven years and currently yields 4.8 per cent.

Whitehead also likes Invesco Income Growth with £190m split 70 per cent in the FTSE 100, 22 per cent in FTSE 250 and eight per cent in the FTSE small-cap. Bt including some medium and smaller companies, it has outperformed its peers.

Case study: The right choices

Barry and Marlene How from Stanley, Wakefield, have chosen equity income funds to boost their retirement income. They are advised by Jan Anderson of Chase de Vere in Leeds.

Barry, 77, a heating engineer who later ran a shop for 12 years, invested in Newton Global Income in 2008 and Marlene, 78, chose Threadneedle Global Select three years ago. The two funds have 49 and 85 holdings respectively. To be tax-efficient, the investments are in their ISAs.

The couple says, “Jan is very helpful. We are very happy with her recommendations.” They enjoy gardening and visiting their daughter who lives in the US.

- Chase de Vere 0845 300 6256.