By Ian Cowie

The Telegraph

Saturday, December 15th 2012

Where can you find rising income without too much risk, despite dismal returns on deposits and Bank Rate remaining frozen for nearly four years now?

That's the question several readers asked after last week's piece in this space about new rules that make it easier for pensioners to avoid buying an annuity. That form of guaranteed income for life looks doubly unattractive when annuity yields are near historic lows and inflation continues to run ahead of Bank of England targets.

Bear in mind that once you have bought an annuity, you cannot get your capital back. So the risk for pensioners irrevocably locking into low annuity yields today is that rising inflation will make a bad situation worse by reducing the real value or purchasing power of their income in retirement.

An obvious place to look for inflation-beating yields with hopes of rising income and capital growth in future - although no guarantees of either - is the stock market. The FTSE 100 index of Britain's biggest shares currently yields 3.7pc net of basic-rate tax and plenty of blue-chip stocks pay much more.

For example, dividends paid by insurance giants Aviva and RSA deliver eye-stretching net yields of 7.2pc and 7.5pc respectively. Vodafone and AstraZeneca are not far behind, yielding 6pc, while BAE Systems, GlaxoSmithKline and royal Dutch Shell all pay more than 5pc. Lest anyone suspect I am trying to ramp these multi-billion pound global businesses with this modest column, I had better declare that I hold these shares in my self-invested personal pension (SIPP).

A more important caveat is that shares prices and yields can and do fall without warning. ....

....One way to reduce that risk is to invest in pooled funds - such as unit or investment trusts - which aim to diminish the dangers inherent in stock markets by diversification. These funds spread individual investors' money over dozens of different shares to reduce their exposure to setbacks or failure at any one company or country.

Investment trusts can even smooth returns to shareholders by holding back some income from underlying assets in good years to top up dividend payouts in bad years.

If that sounds slightly technical, then consider the fact that City of London - which currently yields 4.4pc - has raised its dividend every year for 46 years now. Put another way, it has increased payouts to shareholders every year since England's football team won the World Cup.

Alliance, Bankers and Caledonia investment trusts can all point to rising payouts for 45 years, while Foreign & Colonial has a 41 year track record. ....

....Plenty of unit trusts pay good income too. Alan Steel of Alan Steel Asset Management said: " To underpin yield and value in a pension plan in drawdown, I would pick a strong back line of income defenders, such as James Harries at Newton Global Higher Income, which has delivered over 31pc total returns after charges, and is yielding 4.3pc.

"Alongside him, I would also select Neil Woodford's Invesco Perpetual Distribution, with a similar total return over the period and which yields 5.4pc. Then Troy Trojan Income, managed by Francis Brooke, which is up by 37pc over three years and yields 4.2pc.

"Rathbone Income, managed by Carl Stick, has delivered 39pc and yields 4.1pc. And finally M&G Global Dividend is up by 33pc and yields 3.4pc."

However, it cannot be overemphasised that - unlike annuity income - none of these yields is guaranteed. Before investing in any stock market based fund, it is vital to beware that you might get back less than you put in. ....

....So, while stock markets cannot provide the capital guarantee that annuities offer, the discipline of dividend-driven asset allocation can reduce risk and deliver a decent income, even if interest rates remain frozen and inflation continues to rise.

Quote Courtesy of The Telegraph

Saturday 15th December 2012