Cash has beaten shares for the past two years. This is good news for anyone who wants to earn a steady income without taking risks, but it’s not a long-term solution if you want your cash to keep pace with inflation.
I have been meaning to convert some cash into a long-term, extra source of income for a while now. Holding my savings in cash accounts has not been too bad lately, given where savings rates are, but analysts expect them to fall sometime next year.
The average cash Isa has returned 3.73 per cent in the past 12 months and 1.71 per cent in the 12 months before that, according to the data firm Moneyfacts. Meanwhile the average stocks and shares Isa delivered a total return — that is growth and income such as dividends — of 2.8 per, and lost 3.27 per cent the year before.
Don’t be fooled though — over a longer period, shares tend to outperform. Data from the Barlclays Equity Gilt study going back to 1899 shows that shows that over ten-year periods, UK shares beat cash more than 90 per cent of the time. Cash also produced negative real returns in six of the 11 decades between 1912 and 2022.
So what is the best way to generate income without taking too much risk?
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Buy-to-let property is one option but it has become less profitable with the withdrawal of certain tax breaks for landlords. If you already own a buy-to-let or a holiday home, you are probably overexposed to the property sector, once you include your main home. There are also the repair bills and tenants to think about.
So an income portfolio seems less hassle, cheaper and more flexible.
Advisers tend to suggest holding a mixture of cash and shares, but also other investments such as bonds. These are essentially IOUs from businesses and governments that are looking to raise funds. Bonds issued by the UK government are called gilts.
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These pay you an income, like interest on cash, and you get your original sum back at the end of the term. They differ from a fixed-term savings bond, in that company bonds and gilts can be traded before they mature so their underlying value can change depending on demand.
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Another option is a money market fund, which combines cash and bonds. These predominantly invest in short-term cash deposits with banks, and short-term bonds issued by governments and companies.
There was rising demand for money market funds from Isa investors in 2023 and the trend has continued this year, according to the investment platform AJ Bell. Like cash, money market funds have performed well during a time of rising interest rates. They returned 1.27 per cent on average in 2022 and 4.66 per cent last year — higher than the yield (the average dividend paid over the last year) on FTSE 100 shares, which stands at about 3.9 per cent.
A 4 per cent target yield for an income fund seems achievable while also providing growth opportunities.
I asked AJ Bell to provide an example of how such an income-focused portfolio would look.
It suggests having about 65 per cent in shares, 25 per cent in bonds, 5 per cent in cash and money market funds and 5 per cent in mixed asset funds, which invest in a range of different things including gold and commodities.
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Your own portfolio should be tailored to your specific preferences and appetite for risk, but AJ Bell came up with an example of how such a portfolio could be constructed.
For the shares portion, it suggested 10 per cent of your total portfolio in each of the following equity funds: Schroder Global Equity Income (which yields 4.09 per cent), Evenlode Global Income (2.04 per cent), JP Morgan Global Equity Income (2.32 per cent), City of London Investment Trust (5.10 per cent), Man GLG Income Professional (5.54 per cent). It also suggests 5 per cent in JP Morgan Emerging Markets Income (3.98 per cent), Jupiter Asian Income (4.29 per cent), STS Global Income and Growth Trust (2.76 per cent). [65% of the whole thing?
For bond exposure it suggests 7 per cent in each of Royal London Corporate Bond fund (which yields 5.25 per cent), Artemis Corporate Bond (5.2 per cent). TwentyFour Corporate Bond (4.17 per cent) and 4 per cent in Invesco High Yield (6.17 per cent).
For cash and money market exposure it suggests having 5 per cent in the BlackRock ICS Sterling Liquidity Premier (which yields 4.64 per cent) and for a mixed asset fund 5 per cent in the Troy Trojan fund which invests in a mixture of assets (0.4 per cent).
This seems like a good starting point, although the charges on some of the equity funds are higher than I would like because they are mostly managed by professional stockpickers.
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Jupiter Asian Income charges 1.01 per cent a year and Schroder Global Equity Income charges 0.95 per cent, both on top of your investment platform charges. I tend to invest in lower cost tracker funds where I keep overall charges to below 0.8 per cent.
It would be risky to invest in only one fund at once as markets may take an unexpected fall.
The appeal of cash is understandable at a time when you can earn about 5 per cent from money in the bank. But a large cash balance can easily see you use up your annual personal savings allowance — the amount of interest you can make from cash in a year without pay tax on it. This is £1,000 for a basic-rate taxpayer and £500 for a higher-rate payer. A basic-rate payer would use up the allowance with £20,000in an account paying 5 per cent, and a higher rate payer £10,000. Additional-rate payers get no tax-free allowance.
You can also earn £1,000 in dividends before having to pay tax (falling to £500 in the new tax year in April).
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This becomes less of an issue as I gradually transfer my cash to an Isa — you can shelter up to £20,000 a year from tax in these accounts. Still, I will continue to take advantage of high easy-access cash rates while I still can.
David Brenchley is away
