Fixed interest OEICs are often touted as secure investments if you are considering investing for income. We show you how to find the best income paying OEIC.
The best income funds can offer more regular payments than standard funds, effectively providing you with a second income.
Coupled to this, they are often seen as relatively secure investments; but how do income OEICs work?
What are fixed income OEICs?
Fixed income OEICs (Open Ended Investment Companies) work in the same way as standard OEICs, using their investors’ pooled funds to trade in a specific market.
Fixed income OEICs aim to limit the risk of their fund losing value by purchasing fixed interest products such as bonds and gilts, rather than buying equity on the more volatile stock market.
When you invest, you're buying shares in the overall fund rather than with individual companies directly, which then represent your portion of the fund’s total worth. This means when the fund grows in value your shares are worth more; similarly if the fund loses money, your shares lose value too.
These assets offer a regular income to the OEIC, which means they can pass on more regular payment to investors than a fund relying on share growth. Profits are paid to your bank account as income, rather than re-invested for more shares in the fund (accumulation).
What do fixed income OEICs invest in?
Fixed income OEICs only invest in products that pay the fund a fixed return, such as government and corporate fixed rate bonds, and government gilts.
Bonds are loans issued by either a government or company, at an agreed interest rate and for a set period of time. When an OEIC buys a bond they are paid interest-only for the duration of the loan, and then the balance in full at the end of the term (maturity).
Gilts are similar to bonds but are only issued by governments. Investors essentially buy a portion of a state’s debt, with fixed interest paid on the gilt until it closes - when the balance is paid in full.
As with all investments, some bonds and gilts are more risky than others and so offer higher fixed rate returns. This usually happens when a company or state is in financial difficulty, so are seen as more likely to default.
They usually have to offer higher interest rates to convince investment funds to purchase their bonds or gilts, so high income funds may look to take advantage of these.
What are the advantages of fixed income OEICs?
Fixed income OEICs are able pass on a regular and reliable payment to their investors according to the number of shares they hold in the fund.
This is because the fund's investments each has a fixed income that other OEICs and Unit Trusts can’t rely on.
OEICs are also considered to be less risky than going-it-alone trading, because a pooled OEIC fund is likely to be larger than any one individual’s savings and allows them to spread their risk by investing in a more diverse range of products.
Additionally, the fixed interest products that this type of OEIC invests in are seen as safer investments than buying equity (shares) on the stock market as businesses and particularly governments are less likely to default on repayment than a company’s value is to drop.
Finally, you can improve even the best fixed rate investments by using an investment ISA to make your gains tax free; deposits in your ISA buying shares in the OEIC. In the 2013/14 tax year you can deposit up to £11,520 (less up to £5,760 invested in a cash ISA), with any income you earn coming tax-free.
What are the disadvantages of fixed income OEICs?
It is important to note that with fixed income OEICs, it’s the income of each investment that’s fixed (not their investors’ income).
Bonds and gilts bought directly from the issuing body are often sold on through trading on the stock market, so OEICs can make big losses if they buy or sell investments at the wrong time.
This risk is offset somewhat by the fact that even bad investments still pay a fixed income unless they are defaulted on completely; although you could receive lower payments as a consequence.
However, this means that like all investments, you could end up losing some or all of your investment if the OEIC’s share prices drops.
The extra security of bonds and gilts also means that the returns OEICs can expect from their investments tend to be lower than the returns available on the stock market, which goes for investors too.
How to compare income OEICs
As with all investments you need to decide the level of risk that you want before you can compare income OEICs for things like performance, prices and charges. OEICs usually state the level of risk they take, so it is a good idea to narrow your search down to suitable funds immediately.
Once this is done, you can start to compare fixed interest OEICs based on their past performance (it is a good idea to check the current fund manager’s track record, too), and fees and charges.
Shares in an OEIC fund are the same whether you want to buy or sell (unlike Unit Trust investments) and are usually updated on a daily basis. This means the only deposit costs you need to consider are any administration fees added to the transaction.
The final charge you can expect to pay for investing via a fixed interest OEIC is an annual management charge (AMC). This fee generally hovers around 1.5% of your interest, used to pay the fund manager’s salary.
The best fixed interest OEIC for you will be the best compromise between the level of risk you’re comfortable with and your expected returns once the fund’s charges are taken off.