Selecting funds: Income vs Growth?

Fri 01 Apr 2022

By Brian Dennehy

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Generating income

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If investors want long term income, where growth in that income is vital, they MUST embrace equity income. But one reader rightly pointed out that our ratings for growth funds don’t tally with our income fund selections. This deserves an explanation and here it is.

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In a nutshell selecting income funds requires a different mental approach AND a different process to select outstanding funds.

Investing for income requires a different approach

Income investors wanting to achieve long term growing payouts, to combat inflation, will need to move away from an obsession with day to day moves of the capital value, and focus more on the relative predictability of the income.

Think of the income portfolio like your heart pumping out blood - the heart continually changes shape as it pumps out a steady stream of blood. The capital value of your income portfolio will also vary from day to day, but there will be a steady flow of income, growing income. As an example, two UK funds with this kind of focus are Vanguard FTSE UK Equity Income Index and Janus Henderson UK Equity Income & Growth.

Why are income recommendations sometimes marked as a SELL on our rating system?

Our fund rating is designed to highlight outstanding funds for growth (or strictly speaking total return, as any reinvested income is part of the “growth”). This rating immediately tells you whether a fund should be bought or sold based on the probability of superior returns going forward. The rating is based on Dynamic Fund Ratings, explained here in more detail.

Our Dynamic Fund Ratings use a form of momentum investing, which means buying an investment (in this case a fund) performing well today in the likelihood that it will continue performing well tomorrow. This is shorthand – by “today” we actually mean performing well, outperforming its peers, over the last 6 months.

In contrast, if you are investing for income, we judge whether a fund is good or bad over a much longer time period, where there is clear evidence of a commitment to providing a steady, and growing, income stream.  This is the basis of the Consistency of Payout Growth figures used in the Income Tool.

The result is that a top class fund for generating income in the long term may not have much correlation with a growth fund selected for its shorter term potential.  From time to time there will be overlap but there is not necessarily a direct relationship.

Hopefully this explains the differences between the two approaches:

  • one targeting consistent income growth,
  • the other focussed on shorter term momentum.

ACTION FOR INVESTORS

How do you identify the best income funds?

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Generating income

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