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I’d forget buy-to-let and use these low-cost dividend funds for income instead

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Investing is surely best when it’s simple, cheap and profitable. That’s why I’m steering clear of the buy-to-let market. 

There was a time when purchasing a property with the aim of renting it out was a great strategy for building wealth. Not only did the monthly income contribute towards (or completely cover) mortgage payments, but landlords also stood a good chance of making a profit when selling the property due to consistently rising house prices.

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These days, however, making a mint is a lot more difficult. Prospective landlords now pay higher stamp duty when buying their property and higher mortgage rates compared to your typical homeowner. There are numerous new regulatory hoops to jump through and the likelihood of bigger tax bills, to boot. There’s also the ongoing maintenance costs to consider. 

On top of all this, concerns over a slowing economy, Brexit-induced or otherwise, could mean house prices stay as they are or possibly fall in the short-to-medium term. So what options are available for those looking to generate income, but unwilling to take on the inherent messiness of the buy-to-let market? 

A better way…

Well those willing to put in the effort could pick individual company stocks. These days, a large number of the UK’s biggest companies, such as Royal Dutch Shell and Lloyds Bank, pay dividend yields of over 5%. The key is to select those that are able to sustain these payouts from those who will end up needing to cut them. 

Another option would be to pick a bunch of income-focused funds run by professional investors. While a less demanding strategy, this still involves trying to separate the (human) wheat from the chaff. Actively-managed funds can also be expensive and some may do little more than imitate the benchmark they’re required to beat. Remember, the more of your returns you give back to the person running the fund, the less money you’ll have to compound over time.

Go passive

For me, passive investing is the best way for time-poor people to generate a second income, specifically through the use of cheap, exchange-traded funds. 

US giant Vanguard, for example, offers the FTSE All-World High Dividend Yield fund. For an ongoing charge of 0.29%, this tracks the performance of an index featuring a huge number of high-yielding large and mid-cap companies from developed and emerging markets. In addition to giving you instant diversification (thus reducing risk) the dividend yield was 3.53% at the end of September.

Alternatively, iShares provides the MSCI World Quality Dividend fund. This is composed of higher-than-average yielders that also exhibit characteristics of quality businesses. It charges 0.38%, and pays out 2.9%. 

If you’d like to stick to companies closer to home, however, iShares also offers the far-more-concentrated FTSE UK Dividend Plus. For an ongoing charge of 0.4%, your money will be invested in ‘just’ 50 stocks generating a stonking 6.8% yield (at the time of writing).

Of course, you don’t need to stick to income-focused, exchange-traded funds to get your dividend fix. By simply investing in a low-cost product that tracks the FTSE 100 or FTSE 250, you’ll receive yields of around 4.5% and 2.8%, respectively.

The only thing worth considering here, however, is that the latter contains more companies with a domestic focus, meaning that your capital isn’t as well spread out around the world as it would be with the former.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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