When thinking about using investment companies to generate income, there are a few basic questions you should ask yourself:
Asking a few basic questions can help you get the results you want.
Investment companies come with risk to income and capital. They are not a substitute for deposit type investments or annuities. If you need a guaranteed income, or cannot afford to lose capital, you should not invest in them. Generally, the longer you are investing for, the more risk you can take on, as your investment has longer to ride out the ups and downs in the market. This can make investment companies very suitable for pensions, where you may be investing over decades. You should find out whether an investment company is going to use gearing to boost income, as this will increase the risks.
Generally, the higher the level of immediate income an investment company pays, the less chance it will grow significantly in the future. This means that, over time, inflation is likely to reduce its purchasing power. If you can afford to start with a lower level of income, you might want to consider an investment company which aims to grow its dividends over time. You should bear in mind, however, that there is no guarantee that the income will grow and keep up with the rate of inflation.
All investment companies come with risk to capital, but some actively try and grow it in addition to providing an income. This is likely to mean that the income you receive will be lower, but it might be worth considering if you want to grow capital over time, perhaps to hand on to your children. Remember, even if you don’t need the income today, you shouldn’t ignore investment companies that pay dividends, as many of these have performed well over the long term. You can use the dividends you receive to buy more shares. Some wrapper schemes make this easy for you by offering to reinvest the dividends automatically.