Can trackers beat expensive income funds?
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 (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.
Which begs the question: is there a better way? Can you get the geographic spread that you prefer, without such high TERs, and with the chance of some growth? Let's see.
Individual shares
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, and putting their faith -- and their wealth -- in the hands of 15 or 20 companies. Even if those companies are giants such as GlaxoSmithKline (LSE: GSK), Reckitt Benckiser (LSE: RB) and Vodafone (LSE: VOD).
And that's because -- as we've seen in recent times -- even supposedly solid businesses such as Lloyds Banking Group (LSE: LLOY), BP (LSE: BP) and BT (LSE: BT-A) can misfire, cutting or even cancelling dividends altogether.
Just as importantly, it can be difficult to get geographic diversification from UK-quoted shares -- even though a lot of the FTSE 100's income comes from overseas.
That said, two of the sectors profiled in this free report from The Motley Fool ‑‑ "Top Sectors Of 2012" -- have a strong appeal from income investors; in fact, the report details several dividend superstars that I hold myself. More to the point, perhaps, it probes two other shares, one of which I bought last week, and one I hope to buy this week. To get the low-down, why not request a copy? It's free.
Enter the tracker
Given this background -- and given the market's current travails -- I've been looking to see if it may be worth taking a look at 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 (UKX) and FTSE All-Share, they also track other global markets of interest.
Some of which contain some very 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 in-built diversification -- buy the index, in short, 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, incidentally, for an in-depth look at Mr Woodford's investing style, and his present focus on eight key shares in three set-to-outperform sectors, take a look at this free report from The Motley Fool: "8 Shares Held By Britain's Super Investor".
It tells you exactly what Mr Woodford looks for in selecting stocks for his income portfolio -- and, just as importantly, the red flags that put him off. As I say, it's free, so what have you got to lose by requesting a copy? It can be in your inbox in seconds.
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 UK, partly to minimise the impact of adverse currency movements, and partly to capture the higher yield of Vanguard's Equity Income index.
Famous five
And so, with no further ado, here they are:
| Index tracker | TER | Historic yield |
|---|
| HSBC FTSE 100 | 0.27% | 2.97% |
| Vanguard US Equity Index | 0.20% | 1.3% |
| HSBC European Index | 0.31% | 2.93% |
| HSBC Pacific Index | 0.37% | 2.43% |
| Vanguard UK Equity Income Index | 0.25% | 4.7% |
Source: Hargreaves Lansdown
Now, it's immediately clear that the yields aren't great. Across the five, for instance, the average yield is 2.9% -- meaning that as an income play, you'd have to have a hefty wad of cash invested in these trackers in order to be able to live off the income they delivered.
But, that said, 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 over 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 very different. Get some income, in short, but also grab some low-cost capital growth as well -- provided, of course, that the underlying indices 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 offers a half-way house solution that works? Answers 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:
> Malcolm owns shares in GlaxoSmithKline, Reckitt Benckiser, Lloyds Banking Group, BP and BT. He does not have an interest in any other companies listed.
