Beginner's guide to picking a high income fund

If you are looking to invest for income, follow our guide to finding the right fund.

Investing and pensions

Look at the yields

Looking for equity income is not as simple as just choosing the fund with the highest annual income yield.

It's one thing for an investment to offer a huge yield today, but if it cannot grow, then it is likely that the value of your income will be eroded over time by inflation. By chasing ultra-high income, you may well reduce your ongoing capital gains.

A fund that pays out a very high income, but shrinks in value as a result, is not a sustainable investment for long-term income. So never consider income yields in isolation - always look at the long-term total returns from funds. 

Who is the fund manager?

Past performance is seldom an indicator of future returns. That said, there are some fund managers whose skill in stockpicking seems to pass the test of time.

When weighing up a fund, check the experience and tenure of its current manager. A fund with a great five-year record that recently appointed a new manager is probably not a wise bet. By identifying highly acclaimed fund managers, you may find one that puts total returns and a long-term view above fleeting, short-term gains.

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What is the manager's style?

Before buying into a fund, inspect the manager's style. Are they a 'top-down' investor that selects shares based on a big picture view of the UK economy and its business cycle? Or are they a 'bottom-up' stockpicker who focuses on individual company fundamentals and prospects?

Do they favour value over growth, or vice versa? Do they prefer blue-chip shares or smaller companies?

All of these are important in deciding whether a particular fund fits your current needs and portfolio.

Don't pay large initial charges

The initial charges levied by funds can vary significantly.

Although many funds don't levy upfront fees, some have initial charges of up to 6%. These charges can turn a £100 investment into £94 on day one, so avoid them at all costs. Buying through a fund platform or discount broker can reduce these initial fees to zero, so always shop around.

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Beward of ongoing charges

Fund managers charge investors a whole host of yearly and ongoing fees for managing their money. Many of these investment-management charges are included in the ongoing charges figure (OCF) shown on websites and in fund literature.

With OCFs ranging from below 1% to above 2.5%, minimising your spend on ongoing charges will help to boost your overall returns.

Where are your charges coming from?

To boost their income yields, some funds deduct their ongoing charges from your capital, rather than docking them from a fund's underlying income. While this boosts cash payouts to unit holders, it also reduces the value of the underlying capital.

So check whether your funds of choice boost their income by subtracting fees from unit valuations.

Watch out for volatility

Some funds are more volatile than others. In other words, their unit prices move up and down more sharply than average. This volatility could be a problem if you need to sell some units to generate cash, so be wary of funds with above-average monthly volatility. Then again, volatility is not the same as risk and isn't so much of a problem for patient, long-term income-seekers.

Beware of sector concentration

Before buying, check to see how concentrated a fund manager's portfolio is. You may find a strong preference for, say, oil and gas, pharmaceutical and telecoms stocks that could skew a fund towards a few key sectors.

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