Investing money into different asset classes is about more than just saving money. While savers and investors can watch their money grow in value and hopefully beat inflation, some individuals also want to earn a regular income from their money. That's possible by taking advantage of different investments and utilising and employing a different strategy than you would find with someone investing for pension pot growth alone. In doing so, it can be possible to earn a regular income with your investments paying you back some money each month or year.
We're going to look at where you could potentially invest any nest egg you have built up to help ensure a monthly income. Investing money in this way, hoping to earn money to spend each month, is often referred to as making a passive income. We'll go over what passive income is, too, before discussing how a financial adviser can help you decide on the best investments.
What is a passive income?
Passive income is an attractive prospect as, when done correctly, it requires little effort to earn money each month or year. Initially, however, you (or your financial advisor) will need to spend some time researching the best passive income strategy in terms of returns in light of your financial objectives and circumstances. That means taking heed of your risk profile and risk appetite to find the most appropriate solution for you.
Passive income vs passive investing
Passive income is not to be confused with passive investing. Passive investing is when you invest a lump sum into an index-linked fund. You buy shares in that fund which then tracks an index. You make money when dividend-yielding shares in that fund payout, as well as benefiting from any capital growth of the underlying assets. However, if the index you are tracking with your investment falls, such as the FTSE 100, your capital can lose value. Passive investing has been popular in the last decade as stock markets have performed strongly on the back of cheap cash provided by central banks to stimulate growth in the wake of the financial crisis and the pandemic.
Passive income with active investments
You can still earn passive income through active investments. You can make active investments through stock picking or buying bonds or any other asset class - hoping they yield money while you own them. Of course, you will also benefit from any capital growth through increasing share prices.
Or you can employ a fund manager to help you earn an income and capital growth from investments. Fund managers are meant to have superior knowledge of the market and thus be able to make more money than an index-linked fund with which you can invest passively.
Do remember, though, that while they hope to make money for you from fluctuations in the price of individual investments, that isn't always the case. Plus, good past performance is no guarantee of strong future performance. However, if you dislike the idea of passive investing but still want to earn a passive income from a nest egg of money, using a fund manager can be one way to achieve this.
Potential types of investment
You could use one, all or a combination of all of the below to get regular monthly payments paid back to you.
While savings accounts alone will likely not be enough on their own to earn you an income, a combination of them and other investment types could be. A Cash ISA is an excellent example of a savings account that will make you an annual return, which you could take out at the end of each year to give yourself an income. However, remember that you cannot reinvest withdrawals from most Cash ISAs back into the same ISA.
Many different lenders offer these low-risk, tax-efficient savings products that are not subject to income tax. That tax efficiency can help you make more significant returns. While cash ISAs, like other savings products, rarely earn a colossal interest rate return, they're attractive to savers because of their low risk and guaranteed return. It means you can be sure that at the end of the year, your nest egg will have made money - there aren't many other investments in asset classes that can say the same.
Other savings accounts that could help build up a return over a year, to then portion out into a monthly income the following 12 months, are regular savings accounts, easy access accounts, notice accounts and fixed-rate accounts, which are technically a bond. We discuss bonds in more detail below.
Stocks and Shares ISA
When talking about investing, most people automatically assume that means investing in the stock market. While you can invest through an investment platform with a general account, you could try doing so through another tax-efficient product - a stocks and shares ISA. Through this type of product, your returns are tax-free each tax year. You can open one and invest in shares, exchange-traded funds (ETFs) or other investments, knowing that any growth or income you receive won't be subject to capital gains tax.
As with savings accounts, you can withdraw your returns at the end of the year. Alternatively, if you have invested in dividend-yielding companies, you could withdraw returns as and when you receive them. That's not generally how many people use an ISA, though - they typically like to leave all funds invested as they are always protected from tax - so your cumulative returns are even further magnified due to the tax saving.
However, it is certainly possible to make investments that earn you a monthly income through this type of product.
One of the more obvious ways to make a monthly income is to purchase a buy-to-let property where you receive a rental income each month. One reason they are attractive is that many people 'understand' property investments, as opposed to other asset classes, which can be more subjective and complex. However, property has its drawbacks. Property is an expensive investment, where you may have to put a large portion, if not all, of your nest egg, into buying just one house or apartment. That means you lose out on diversifying your portfolio to minimise risk exposure. Those risks could be a massive property market slump where you lose the value of your investment or even that the property stays dormant without tenants for a long time - losing you yet more cash.
Additionally, you need to consider many other costs in your yield (return) calculations. For example, your initial investment will require you to pay stamp duty, which can be sizeable on a buy-to-let property with a larger levy placed on second homes. Plus, you need to consider the upkeep of your property, any letting agent fees and the general stress of keeping the property compliant with current laws for renting out a property to tenants.
You could also consider real estate investment trusts which can earn an income too. These are popular with some investors who like the positives of the real estate asset class but want to do away with the negatives - such as the upkeep of properties or day-to-day dealing with tenants. The drawbacks are that, like a property itself, they can be pretty illiquid, so recouping your investment from a sale can take time.
Purchasing some bonds for your portfolio could be a suitable investment vehicle to earn you that required monthly income. If you buy a bond, you are giving an entity money. In return, they promise to pay you back that money at the end of the bond's term (as stated from the outset). To compensate you for your trouble, the entity also gives you back extra money in the form of interest payments. They can pay you that interest on a monthly or annual basis. Some even pay the interest in one lump sum at the end of the bond's term (sometimes called maturity).
There are several types of bonds out there. Common ones are
- Government bonds
- Corporate bonds
- High-yield bonds.
Government bonds tend to be the ‘safest’ out there, as it is an agreement between you and a country’s Government. The hope is a country’s Government won’t go bankrupt, so they should be able to repay your bond on maturity. That said, Government bonds do come with different levels of risk. US bonds, or treasury notes, are among the best-rated, lower-risk bonds out there, while Gilts (UK Government issued bonds) are seen as slightly higher risk.
Corporate bonds are issued by businesses that use that cash to help grow their company. Depending on the company, the risk you take by buying such a bond can vary. High-yield bonds are riskier still, issued by companies or entities at a higher chance of defaulting and not being able to make their debt repayments to you.
Generally, the riskier the bond, the higher the interest rate. You must carefully consider the risks you are taking versus what you could earn to help meet your financial targets. A higher rate can look particularly attractive if you are trying to make a monthly income on which you can live easily. However, it usually comes at the price of taking on more risk. That risk could be losing the entire value of your investment.
The clue is in the name of this type of investment vehicle. Income funds are types of mutual funds which specifically aim to provide investors with an income stream. There are lots of different income funds on the market, all of which promise and aim for slightly different things. As with any investment, the different types attract different levels of risk and reward.
A cash fund is an income fund widely seen as low-risk. Your money is pooled with other investors' cash to get an income by investing in cash deposits. In that way, they are similar to a savings account. But as investing happens on a far bigger scale through pooling money with others, the return you receive should be higher. Another attraction of these funds is that they are very liquid, so they are easy to sell should you need to recoup your initial investment.
Fixed income funds
These funds target bonds to create an income return. As with a cash fund, you pool your money with other investors by buying units in your chosen fixed-income fund. You then get regular interest payments paid by the borrowers or issuers of the underlying bonds. Because you are pooling your money, you can target higher rates and use a fund manager's expertise. Fund managers run these funds and structure a portfolio according to its investment objective.
Equity income funds
These types of income funds use dividend payments to provide investors with income. If you think equities are a good place to invest your cash at that moment because you believe the stock market (or a section of the stock market) is booming, they can be attractive as you benefit from those payments and capital growth. In these funds, managers target stocks that pay, or should pay, higher dividends. Equity income funds are often favoured because they can pay, and sometimes have paid, more in income than fixed income or cash funds. The problem is that that comes at a higher risk of losing your initial investment.
Multi-asset income funds
These funds aim to give investors the return they seek through a mix of investing in different types of assets. Those assets can include cash, equities and bonds. However, multi-asset fund managers may also choose to invest in alternative assets. These include real estate, commodities and a wealth of investments outside traditional cash, bonds and equities.
Investors are often attracted to multi-asset funds due to their inherent diversified structure. While by no means a complete form of protection, investing in different assets protects you from falls in the market. That's because different asset classes perform differently in varying economic environments. So, if the value of the stock market falls one day, you still protect your initial investment because the alternative assets in the underlying fund have not fallen at all.
To earn an income from these funds, managers look at the same factors as they would for individual asset-class funds. So if they invest in an equity, it needs to pay a high dividend. If it's in a cash deposit, it needs to earn a high interest rate. If it's in a bond, there must be a large coupon payment.
We spoke to John Kingham from the UK Dividend Stocks Blog, who told us: "Dividend stocks are popular with income seekers because they can offer higher yields than savings accounts and the potential for both income and capital growth. Dividends can be lumpy though, so if a monthly income is required, moving dividends to an instant access account once per year can make sense."
We've broken out this type of asset class all on its own as, while it can provide an income, it's such a diverse category that it demands its own attention. Alternative assets, as alluded to above, can include real estate and commodities, but they can be as diverse as investing in whiskey or expensive cars.
Of course, there's plenty of choice between these more traditional investments and innovative ones - all that can potentially pay you an income each month in return for your initial outlay.
Private Equity is one good example. This is when you give your money to a firm to invest in private companies (not ones listed or traded on an exchange). Those investments don't have to be income-bearing, so you need to target the private equity funds looking to generate income. This can be a high-risk asset class, but the returns can also be very high.
Or, you could use your money to buy private debt. This is like buying bonds, but instead, you give your cash to private companies, much like private equity investing. Again, you earn your income through interest payments on your loan.
One idea for an alternative investment is to look at crowdfunding websites. Investments here are deemed to be far riskier than many other options you have available in the investment universe. Remember that losing all your money could happen, so doing your due diligence and research is crucial before transferring any money. Peer-to-peer lending is another type of crowdfunding where your capital is at risk too. But, again, the return could be higher than in traditional markets. However, your research must account for any income or capital gains tax liabilities you may incur. Plus, you should also consider the fact that you won't have FSCS protection.
Finally, another option is to invest in a fund solely targeting alternative investments. If you do not think the income-bearing space in the traditional investment markets is yielding enough for you, either due to your income needs or simply because you do not believe you would get enough back to compensate you for your risk, these funds could solve that problem.
Each alternative fund will have a different investment objective and target, with its own parameters. Those parameters will stipulate what it can and can't invest in, so it's imperative to read these over to ensure you are comfortable with the level of risk you are taking on.
Financial advice for the best investments
Realistically, optimally investing your money is challenging to do on your own unless you have in-depth experience with the financial markets and making investment decisions. There is no 'one-size fits all' response to investing. Everyone's circumstances are different, and everyone's financial goals vary. As a result, it is impossible to copy another person's investments in the hope that they will help you reach your aims. They won't. That's why it is hard to do it independently without previous knowledge.
And that's why using a financial adviser is often a good idea. They'll look at your financial situation and consider your short-term and long-term goals to structure your investment portfolio in the most appropriate way. They will tailor an investment strategy so that you can be comfortable with the level of risk you are taking on and consider how much risk you can take on. It could be that some income investments are more suitable for you than others, which your advisor will highlight. It could be that you could invest in high-risk cryptocurrency or that your situation dictates that you should invest in far safer Government bonds.
Whatever your situation is, an adviser will have only your interests in mind when suggesting what investments you should make and when. They'll know how to create a series of investments that gives you that much-wanted monthly income.
Investing for an income
Investing so you get a return in the short term and capital growth in the long term can be a great way to earn a passive income - alleviating pressure on you now to make all your income through a salary. However, do remember that taking an income from your investments is at the cost of reinvesting it, which could have led to a more significant return in the future. Your cumulative gains will therefore be diminished - especially if you are still a few years off retirement and saving for a pension.
However, given the cost of living crisis, with inflation increasing the prices of everything we buy, supplementing your income is now, more than ever, worth looking into.