Should you prioritise generating income for your Isa? Experts give their top picks

With just days to go until the end of the tax year, you might be looking for some last-minute inspiration for your Isa.

Income funds and dividend-paying stocks continue to be popular among investors this year as they hunt steady returns.

These high yield investments can help to generate extra cash to help in the immediate term, while compounded interest can further boost gains over the long term.

Income-seekers: Investors are looking to income funds and bonds for steady returns 

And as the tax burden rises as a result of frozen thresholds, holding income-generating assets in an Isa is more valuable than ever. 

We ask experts where income-seeking investors should consider parking their cash.  

Why invest for income?

While inflation might be nearing the Bank of England’s 2 per cent target, it continues to eat into savings pots and banks are starting to cut their savings rates.

Adding dividend-paying investments into your portfolio can provide you with reliable income and capital growth.

If you’re looking for shares and funds that will generate income, you will want to target those with a high yield. The higher the yield the more cash it pays out relative to the cost of the fund.

Jason Hollands, managing director of Bestinvest notes that investors ‘should not necessarily pursue the highest yields as this might come at the expense of growth potential.

‘If you need your investments to support you in retirement over many years, it is important that the capital value isn’t eroded and payouts rise over time to offset inflation. Equity income fund offer greater potential for this than bond funds or infrastructure.’

Darius McDermott, managing director of FundCalibre says: ‘Prioritising income in your Isa has multiple benefits: pocketed yield can supplement your lifestyle or help pay the bills, while compounded interest can further boost capital gains over the long term.’

Diversifying your portfolio across different investment styles, assets and geographies will be crucial to ensure it keeps pace with inflation.

Where should income-seeking investors look?

If you are looking to invest for income, you can include any individual shares in companies that pay out dividends.

There are also funds and trusts designed specifically for income, which may be a simpler option.

If you are looking to invest in income funds, look for those with ‘inc’ in their title, rather than ‘acc’ which indicates growth. ‘Inc’ funds will pay dividends straight to investors rather than reinvesting it back into the fund.

There are plenty of options available to income-seeking investors across equities, bonds and property, as well as alternatives like renewable energy.

Dan Coatsworth, investment analyst at AJ Bell, says: ‘The UK market is blessed with lots of income opportunities, many of which pay higher dividend yields than you might find in other geographies such as the US. That is music to the ears of people in retirement who might be reliant on their investments to generate an income to pay the bills.

‘A lot of the UK equity income funds are concentrated in the same group of stocks, principally in the banking, oil and life insurance sectors where some of the most generous dividends can be found.

‘Earnings growth is low or unpredictable in these sectors, hence why companies use generous dividends to make their shares attractive to investors.’

Paul Angell, head of investment research at AJ Bell favours Man GLG Income which invest in ‘undervalued and unloved companies… those trading below their replacement cost and those where the market appears to be undervaluing profit streams.’

He says: ‘Fund manager Henry Dixon is very experienced and his analytical mindset provides a level of pragmatism that allows the fund to navigate through a variety of market conditions.

‘This is a very actively managed fund, which can diverge significantly from the index and have high levels of turnover. These factors often result in both the fund’s volatility and transaction costs being elevated.’

Hollands singles out Blackrock UK Income which backs companies ‘with strong dividend growth potential rather than the highest payouts today.’

Its top holdings include Shell, AstraZeneca, Rio Tinto and HSBC, and it has a current yield of 3.9 per cent.

Bonds are back in favour

Fixed income can also be a good start for investors looking to add some income to their portfolio. In an era of ultra-low interest rates, bonds were yielding close to 0 per cent meaning they were overlooked by investors. 

With rates now at higher levels, investors have fallen back in love with bonds which have ‘reclaimed their rightful place as an income staple,’ says McDermott.

Darius McDermott says bonds have become an income staple again

Yields on investment-grade corporate bonds are at their highest levels in years, giving investors the opportunity to lock in income for the foreseeable future.

McDermott favours the Liontrust Sustainable Future Monthly Income fund and Royal London Corporate Bond, both of which currently offer a yield exceeding 5 per cent.

‘Risk averse investors may prefer government bonds, such as gilts or treasuries, which also currently offer competitive yields,’ he says. ‘Historically, they have a negative correlation with equities at times of market stress and therefore can anchor your portfolio should stocks take a dive.’

Jason Hollands recommends TwentyFour Corporate Bond fund, which focuses primarily on investment grade bonds, although it invests in government bonds too.

‘The fund has the flexibility to invest up to 20 per cent in riskier, high yield bonds (those issued by companies with less financial strength). However, in practice these currently represent just 6.4 per cent of the fund.

‘The latest yield on the fund is an inflation and cash beating 6 per cent, with distributions made to investors on a quarterly basis.’

Cheap investment trusts offer attractive yields

Investment trusts also offer opportunity for income because, unlike open-ended funds, trusts can hold back up to 15 per cent from their investments and use it to supplement dividends in future years.

City of London Investment Trust is unrivalled when it comes to payouts having increased its dividend for 58 consecutive years.

Jason Hollands favours two longstanding investment trusts 

Coatsworth says: ‘City of London Investment Trust has a blend of value and income for its investment style. Its 0.37 per cent annual charge is among the lowest in the UK equity income space and a 5 per cent yield is higher than the FTSE 100 which offers 3.9 per cent.

‘One can understand why this trust is so popular among investors given this enhanced yield, with City of London regularly featuring among the most bought investment trusts on the AJ Bell platform.’

Hollands recommends Murray Income Trust which has ‘produced consistent long-term performance, especially in weaker market environments.’

It has grown its dividend every year since 1973 and has a current dividend yield of 4.6 per cent.

He also recommends Temple Bar Investment Trust, managed by value investors Nick Purves and Ian Lance.

‘With the UK market currently unloved and valuations very cheap compared to global equities and longer-term trend, this is exactly the sort of environment throwing up incredible opportunities for the team.’

Trusts focusing on alternative assets like renewable energy, shipping and supermarkets can also provide a reliable income source, says McDermott.

‘Many of these trusts currently trade at substantial discounts to their NAV, despite stil offering an attractive and stable dividend, presenting an exceptional opportunity for investors.’