Income investing: Five ways to diversify your portfolio

There is a strong argument to suggest that if you want to buy just one fund, a strategy focused on generating regular income through investments - like dividends from stocks or interest from bonds - is the safest route.

Please remember that the value of investments will fluctuate and returns may be less than the amount originally invested. Tax treatment depends on your individual circumstances and the ISA and tax rules can change. Chelsea does not offer advice and so you must manage your ISA yourself.

There are a couple of ways investors can approach using income funds. One is to simply take the dividends paid out – be it on a monthly, quarterly or annual basis – to pay for life’s needs, as and when they occur. The second is reinvesting your dividends – we cannot understate the importance of this factor in producing long-term returns for investors.

The difference in returns is stark. According to Barclays’ 2023 Equity Gilt Study, £100 invested in UK shares in 1945 would have grown to £215 by March 2024, after adjusting for inflation – equivalent to an annual gain of just 1% in real terms, over almost eight decades. However, an investor who continually reinvested the income generated by those same shares would have seen their wealth grow to £5,636 – again, after inflation. That equates to an average annual return, in real terms, of 5.4%*.

UK Equity Income funds have often been the go-to for investors – and with good reason. The UK is comfortably the most mature market for dividend payments in the world and investors can expect around 4-4.5% yields from many of the funds investing in the FTSE 100 (the largest 100 companies in the UK).

UK dividends stood at £92.4bn in 2024**, but the challenge is that the concentration of dividends comes from just a handful of companies – with the top 15 accounting for over 60% of all dividends**. All it takes is for just one or two of these companies to suspend dividends and it would have a significant impact on portfolios.

We’re not saying be wary of UK income – far from it, in fact, as it has proven to be an excellent long-term investment. But investing in a number of income streams is an excellent way to reduce risk and smooth out returns by spreading investments across various assets, styles, industries, and geographies, ensuring stability and potential for long-term growth.

Here are five alternatives to consider:

Guinness Asian Equity Income (3.45% yield)***

The case for Asian dividends is thoroughly misunderstood. For example, a common misconception is that Asia is driven by growth, when the reality is that dividends drive the majority of long-term equity returns (71%)****. Also, Asian dividends have more than tripled over the past two decades**** and, importantly, are ripe for further growth.

Guinness Asian Equity Income, managed by Edmund Harriss and Mark Hammonds since its launch in 2013, is different because it invests in 36 companies, and each position is equally weighted. This, together with their one-in, one-out policy, means there isn’t a long tail of smaller holdings, so each stock can make a meaningful contribution to performance.

The managers favour well-run companies that have fallen out of favour in the short term but have historically shown an ability to perform in both good and bad economic environments.

Fidelity Global Dividend (2.29% yield)***

Those who are not sure which markets to use to find diversified sources of income might prefer a global equity income fund. These funds allow the managers to invest actively across the various regions to find the right balance of income and growth. They often have strong exposure to the US, the world’s largest market, but can switch direction as and when opportunities arise.

A global income alternative to consider is the Fidelity Global Dividend fund. Manager Dan Roberts looks for companies with understandable business models and predictable, resilient returns, and is happy to pay a fair price for a good company. The criteria for selecting companies falls mainly into two buckets. The first is valuation support, with Dan wanting to make sure he does not overpay for stocks – regardless of how good they look – as he does not want to dilute returns. The second is the quality of the franchise, with the emphasis on investing in resilient businesses which can be depended upon.

Jupiter Monthly Income Bond (6.97% yield)***

Choosing the right bond fund is no simple task, particularly in this uncertain economic environment. One way for investors to swerve the difficulties of choosing between a gilt, corporate or high-yield bond fund – and the individual challenges each sector of the bond market faces – is to use a strategic bond fund. These funds give managers the flexibility to diversify their bond holdings across a range of sectors, allowing them to shift allocations as they see fit. A number also offer excellent yields to investors.

Jupiter Monthly Income Bond runs quite a short duration, meaning it is less exposed to interest rates versus many other bond funds. The fund is a combination of investment grade and high yield bonds, with the manager varying the weight between these two buckets, depending on whether they want to be more aggressive or defensive. The monthly income payment is also a nice feature, and when combined with the fund’s yield, makes this an attractive option for income seekers.

Rathbone Ethical Bond (5.1% yield)***

Those who might want an investment grade vehicle might consider Rathbone Ethical Bond. Managed by Bryn Jones since 2004, the fund invests in quality investment grade bonds, looking for a competitive income whilst generating attractive total returns. Ethical exclusions are simple: no mining, arms, gambling, pornography, animal testing, nuclear power, alcohol or tobacco. This rules out about one third of the index. All positions must also have at least one positive environmental, social or corporate governance quality.

FTF ClearBridge Global Infrastructure Income (4.34% yield)***

Infrastructure investing offers a bit of everything to investors. Mature infrastructure provides stable, long-term, income-generating returns, while growth and development infrastructure offers capital appreciation. Infrastructure assets are relatively well protected from high inflation thanks to their ability to contractually pass on cost increases to customers as well as the inelastic demand for their services.

FTF ClearBridge Global Infrastructure Income combines regulated utilities with demand-based infrastructure such as railways and roads. The fund is designed to provide a good income with stable growth and some inflation protection.

*Source: Allianz Global Investors
**Source: Link Dividend Monitor, Q4 2024
***Source: FE Analytics, at 17 March 2024
****Source: Schroders, Why Asian dividends deserve a closer look

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.