Income funds, not surprisingly, are popular picks with many income investors. In fact, most of the big fund management firms offer them.
That said, they do have some drawbacks:
The charges can be high. Neil Woodford's flagship Invesco Perpetual High Income fund, for instance, has a total expense ratio, or TER, of 1.7%.
The geographic spread of investments is chosen by the fund manager, not you.
Income tends to come at the expense of capital growth -- either because the fund contains fixed-income gilts and bonds, or because the shares it holds are steady-as-you-go cash cows.
This begs the question: Is there a better way? Can you get the geographic spread you prefer without such high TERs and with the chance of some growth? Let's see.
One option is buying individual shares -- although it's not a path that appeals to every investor. The trouble is, not everyone feels comfortable picking such shares, or putting their faith -- and their wealth -- in the hands of 15 or 20 companies. Even if those companies are giants such as GlaxoSmithKline, Reckitt Benckiser, and Vodafone. And that's because -- as we've seen in recent times -- even supposedly solid businesses such as Lloyds Banking Group, BP, and BT can misfire, cutting dividends or even canceling them altogether.
Just as importantly, it can be difficult to get geographic diversification from U.K.-quoted shares, even though a lot of the FTSE 100's (INDEX: ^FTSE) income comes from overseas. (That said, two of the sectors profiled in this free report from The Motley Fool "Top Sectors for 2012," have a strong appeal for income investors. In fact, the report details several dividend superstars that I hold myself. To get the low-down, why not request a free copy?)
Enter the tracker
Given this background -- and given the market's current travails -- I've been looking to see if it may be worth considering the humble index tracker as some sort of income play -- or, to be more precise, trackers in the plural. Because index trackers don't just track the FTSE 100 and FTSE All-Share; they also track other global markets of interest, some of which contain some decent dividend-paying shares. Asian companies, in particular, are throwing off dividends aplenty these days, as the number of Asian-centric income funds on the market highlights.
Income units, not accumulation
So I've had a stab at picking five trackers that provide a combination of decent geographic diversity, low costs, and reasonable yield. To be sure, the yield isn't as high as with a pure-play income fund -- but don't forget the growth dimension.
What's more, don't forget the built-in diversification; buy the index, and you're buying into far more businesses than the typical income fund. Neil Woodford's Invesco Perpetual High Income fund, for instance, has just 85 holdings. (And for an in-depth look at Mr. Woodford's investing style and his present focus on eight key shares in three promising sectors, take a look at this free report from The Motley Fool: "8 Shares Held By Britain's Super Investor.")
Finally, in each case, I've gone for the index trackers in the form of income units -- not the accumulation units, in which the dividends are rolled-up into the price. Buy the income units, in short, and the dividends get paid to you.
Finally, I've doubled up in terms of the U.K., partly to minimize the impact of adverse currency movements and partly to capture the higher yield of Vanguard's Equity Income index.
And so, with no further ado, here they are:
HSBC FTSE 100
Vanguard U.S. Equity Index
HSBC European Index
HSBC Pacific Index
Vanguard U.K. Equity Income Index
Source: Hargreaves Lansdown.
Now, it's immediately clear that the yields aren't great. Across the five, the average yield is 2.9% -- meaning that as an income play, you'd have to invested a hefty wad of cash in these trackers in order to be able to live off the income they delivered. However, don't forget that we're looking at historic yield here, and my data source doesn't reflect recent market falls -- so the odds are good that an investor buying today might get an income more than 10% higher than that quoted.
Even so, for someone in retirement, this isn't an ideal scenario -- at least in my book. But for someone working part-time in the immediate run-up to retirement, the situation might well be different. Get some income, but also grab some low-cost capital growth as well -- provided, of course, that the underlying indexes in question deliver that growth. Later, switch to more conventional income plays, and hopefully do so with a pot that's a little larger.
What do you think? Shares, income funds -- or do index trackers offer a halfway-house solution that works? Answer in the box below, please!
Want to learn more about shares, but not sure where to start? Download our latest guide -- "What Every New Investor Needs To Know" -- it's free. The Motley Fool is helping Britain invest. Better.
More investing ideas from Malcolm Wheatley:
At the time thisarticle was published Malcolm owns shares in GlaxoSmithKline, Reckitt Benckiser, Lloyds Banking Group, BP and BT. He does not have an interest in any other companies listed.Motley Fool newsletter services have recommended buying shares of Vodafone Group Public. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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