Investing in a stocks and shares ISA is a good option for achieving capital growth. However, investment trusts can also generate a regular income from your ISA, with some offering yields of over 6%. This income may be useful if you’re looking to supplement your state pension in retirement or if you’re looking to hedge against inflation, which is predicted to hit 8% next year.
According to Moneyfacts, a leading easy access cash ISA currently pays 0.85%. With inflation at 6.2%, you’re effectively losing 5% of your money in real terms each year.
I’m going to explain what you need to know about choosing investment trusts for your ISA portfolio, together with Interactive Investor’s model portfolio to generate a £10,000 annual income.
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Why are investment trusts a good choice for income?
Unlike funds, investment trusts do not have to pay out all of their annual income. They can retain 15% of income to build reserves. These ‘rainy day’ reserves can then be used to supplement income in future years.
The Association of Investment Companies (AIC) publishes an annual list of ‘dividend heroes’ that have increased their dividends for 20 consecutive years. There are 20 such dividend heroes, including City of London, Bankers, Alliance and Caledonia who have increased their dividends for over 50 years.
But investment trusts aren’t just a good choice for income. They also offer capital growth for your ISA. According to Trustnet, Scottish Mortgage Investment Trust took the top spot amongst global trusts, achieving a five-year return of 185%. You can also receive an income stream without having to sell any ISA investments, which can restrict future gains.
How to generate a £10,000 income from your ISA
Helen Pridham from Interactive Investor picks a hypothetical portfolio of investment trusts to generate an annual income of £10,000.
For the seventh year running, her portfolio passed the £10,000 test in 2021. Here’s her portfolio for 2022:
|
|
Yield |
Investment |
Income |
|
UK equity income |
|
|
|
|
City of London (CTY) |
4.9% |
£35,000 |
£1,701 |
|
Diverse Income Trust (DIVI) |
3.3% |
£25,000 |
£830 |
|
Merchants Trust (MRCH) |
4.9% |
£30,000 |
£1,461 |
|
JPMorgan Claverhouse (JCH) |
4.2% |
£25,000 |
£1,050 |
|
Global income |
|
|
|
|
JPMorgan Global Growth & Income (JGGI) |
3.2% |
£30,000 |
£969 |
|
Murray International (MYI) |
4.7% |
£25,000 |
£1,175 |
|
Securities Trust of Scotland (STS) |
2.5% |
£16,000 |
£394 |
|
Henderson International Income (HINT) |
3.6% |
£25,000 |
£908 |
|
Specialist Trusts |
|
|
|
|
BMO Commercial Property Trust (BCPT) |
4.1% |
£15,000 |
£608 |
|
Standard Life Private Equity (SLPE) |
2.4% |
£15,000 |
£354 |
|
Utilico Emerging Markets (UEM) |
3.8% |
£15,000 |
£563 |
|
Total investment/income |
|
£256,000 |
£10,013 |
What can we learn from this? Firstly, an ISA portfolio of £256,000 is required to generate this income, which is higher than the £237,000 needed in 2021. This is due to a fall in yields as a result of rising share prices.
However, Helen Pridham warns that “while it might be tempting to invest in the highest-yielding trusts, you would end up with a portfolio of highly specialist companies.” She believes that a more balanced approach is advantageous in the long run.
1. UK trusts (45%)
According to Pridham, “There are good prospects for a recovery in the UK stock market this year, which has been undervalued compared to other global stock markets.”
Both the City of London and Merchants trusts are focused on large-cap companies and have a long history of increasing dividends. Pridham describes the City of London Trust as “a ‘steady eddie’ both on the capital and income fronts” while Merchants Trust achieved the third-highest return of 32% amongst its peers in 2021.
Diverse Income Trust was chosen to provide exposure to smaller-cap businesses, with nearly 40% invested in AIM companies. JPMorgan Claverhouse has increased dividends for 48 years, and is well-balanced in both growth and value stocks.
2. Global trusts (38%)
These trusts were selected to provide exposure to a range of sectors and regions for the ISA portfolio.
JPMorgan Global Growth & Income is the top performer in its sector, with a five-year return of 93%, according to Trustnet. Pridham believes that Murray International’s “greater exposure to Asia than other trusts will pay off in the long term”, although it performed disappointingly in capital terms in 2021.
Securities Trust of Scotland is a more defensive trust and provides UK exposure. Henderson International is orientated towards value stocks in Europe and Asia, providing diversification to the portfolio.
3. Specialist trusts (17%)
BMO Commercial Property Trust provides a consistent income, and Pridham hopes its share price will recover from the impact of the pandemic.
Standard Life Private Equity has delivered a five-year return of 113%, one of the highest in its sector.
Utilico Emerging Markets invests in infrastructure-related assets in emerging markets, and should provide a consistent source of income irrespective of the economic situation.
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How can you invest in trusts?
Purchasing investment trusts within your ISA gives you the advantage of paying no tax on income or capital gains. Our experts have compiled a list of our top-rated ISA providers, including fees and choice of investments.
Investing in trusts rather than funds can also save fees. My ISA is held with Hargreaves Lansdown, and their fees start from 0.45% per year, and, unlike funds, the fees for investment trusts are capped at £45 per year. This could save you over £400 per year if you invested £100,000 in trusts (rather than funds).
