When you retire, a reliable monthly income will probably be one of your top priorities. After all, you’ll need to replace your employment income.
The traditional choice is an annuity. These provide a guaranteed income, but annuity rates are low and choosing this option means you lose control of your capital forever.
An alternative choice is to invest your pension fund directly to provide a monthly income. By doing this you keep hold of your capital and retain the option to spend it or — potentially — leave it to someone else.
Today, I want to explain what the options are for UK investors seeking a monthly income from the stock market. I’ll also discuss how I’m building my own retirement income portfolio.
Choosing a fund
There are lots of UK income funds available to investors, but only a small number of these offer a monthly income.
Most funds will pay dividends quarterly or, more often, every six months. For example, fund supermarket Hargreaves Lansdown lists more than 70 UK equity income funds, but only 10 which pay income monthly.
If I wanted a monthly income fund, I might consider the Threadneedle UK Monthly Income fund, which has a long track record and currently offers a 4.8% yield.
For a higher yield, the Fidelity Enhanced Income fund (6.5%) might be worth a look. However, it’s worth remembering that funds with names including enhanced, maximiser or booster are generally structured so they provide a higher yield today but won’t generate any capital gains.
What I’d really do
To be honest, I probably wouldn’t buy a monthly fund. There are two reasons for this. The first is you get a much bigger choice if you’re willing to consider funds which pay every three or six months.
The second reason is I think it’s pretty risky to rely on monthly fund payments directly for your living expenses.
What most financial advisers recommend is that you should build up a buffer of perhaps 12 months’ living expenses in a cash savings account. You then take your monthly income from this account while allowing your investment income to build up for the following year.
Doing this means if markets crash, your monthly income will be safe for another year. This provides time for the market to recover and protects you from the risk of having to be a forced seller, accepting low prices for instant cash.
I’m buying shares
I think there are some attractive income funds available at the moment. But I’ve chosen to buy dividend shares directly to build an income portfolio for my retirement. What I’m looking for are large businesses with good cash generation and attractive dividend yields.
Examples of the kind of companies I’d buy for a long-term income in today’s market are Royal Dutch Shell (6.3% yield), HSBC Holdings (6.7%), GlaxoSmithKline (4.4%) and Aviva (7.6%).
Stocks such as these can be found in many top income funds. But if you’re prepared to do a little research, you can invest directly and save yourself the annual fund management fees. That’s what I’m doing.
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Roland Head owns shares of Aviva, GlaxoSmithKline, and Royal Dutch Shell B. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Hargreaves Lansdown and HSBC Holdings. 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.