Want to earn an income on your savings of 7% or more?

If this return looks too good to be true, there are plenty of other opportunities to earn 4% or more on your money net of basic rate tax. No, these are not some dodgy Ponzi schemes or savings accounts with unsustainable introductory bonuses, these are the yields currently available on highly respectable investment trusts. There are plenty of UK equity income funds paying average yields of 4.6% too.

These investment trusts and funds normally invest in the stock market so there is some risk to your capital. But with share prices at comparatively low levels, Richard Wadsworth of Glasgow wealth manager Fitzallan says: "The likelihood of further steep falls in the stock market is relatively low and if you are investing for income your main priority is income. Dividend income is normally more stable than share prices and tends to rise so there is also some protection from inflation."

Loading article content

Among the investment trusts Richard Wadsworth would recommend for first-time investors are Temple Bar, Murray Income and Murray International – the latter a winner at the recent Investment Week awards along with the Lindsell Train and Finsbury Growth & Income trusts.

The Association of Investment Companies (AIC) has recently highlighted the yields of up to 11% which are currently available on investment trusts. However, many of the top paying trusts are invested in property, where the average yield is 7%. John Newlands, head of investment companies research at Brewin Dolphin in Edinbugh, cautions people against investing in this sector at present. He says: "I think people should be wary about commercial property funds while there is still a clear over-supply of property." This means capital values could fall further.

Jeffrey Deans of Glasgow-based financial adviser Save & Invest says clients looking for income are becoming more prepared to consider investment funds. He says: "With interest rates low, clients who need income face a dilemma just now. Equity funds capable of providing a stream of income are being viewed by many clients as potentially suitable for the longer term, and they are now becoming less worried about the short-term capital fluctuations."

Funds focusing on higher yielding company shares are looking increasingly attractive. David Thomson, chief investment office at VWM Wealth Management in Glasgow, explains that it is usually larger, more secure companies which pay dividends – which can increase over time. "Shares should provide some protection against inflation," Thomson says. "Companies have scope to put their prices up. The value of their physical assets can also go up in value. A good example is Tesco. It is currently earning 7.9%, it reinvests 4% back in the company for growth, and pays a dividend of 3.8%. People still have to eat, and historically supermarkets have been pretty adept at raising prices even ahead of inflation."

However, investing in individual shares can be risky, as holders of BP and the banks have discovered in the last few years when their dividends dried up completely. But funds spread their risk by holding portfolios of 50 or more shares. Among those favoured by Save & Invest are Artemis Income, Invesco Perpetual High Income, Schroder Income, and Standard Life UK Income Equity.

Thomson believes it is a good idea for investors to spread their nets even wider. He says: "Investing in high yielding companies in the UK can result in a fairly concentrated portfolio so we prefer to invest globally in funds such as M&G Global Dividend which has a yield of 3.61%, and Newton Global Higher Income where the yield is 5.09%. Both enjoy a good longer-term track record with the Newton fund typically being a little on the defensive side."

The growing ability of overseas companies to pay reliable dividends is reflected in the establishment by the Investment Management Association of a new fund sector from January 1: global equity income. The move follows a review by the trade and to qualify a fund must have at least 80% of its assets in global equities.

Payments from income funds are generally made half-yearly or quarterly and most fund managers aim to raise their income payments on an annual basis. With dividend payments from UK companies expected to have risen by an average of nearly 17% this year and 10% next year, according to Capita Registrars, it shouldn't be difficult for fund managers to lift their payouts.

Investment trusts have an advantage over other investment funds in their ability to keep increasing their dividends as they can retain up to 15% of the income they receive each year and transfer this to their revenue reserve. Known as "smoothing" dividends, this is one of the defining characteristics of the sector. Another advantage is that they appear to perform better, according to recent research carried out for F&C Investments.

It found that investment trusts outperformed open-ended funds (Oeics or unit trusts) in seven out of eight major sectors over both one and five years, in six out of eight cases over three years and in all eight sectors over 10 years. The figures, produced by Winterflood Securities, compared share price total returns across equivalent IMA and AIC sectors (UK equity income, global growth etc).

Some popular Scottish investment trust yields*

Shires Income 7%

British Assets 5.1%

Dunedin Income Growth 4.9%

Murray Income 4.6%

Edinburgh Investment Trust 4.5%

Standard Life Equity Income 4.3%

Murray International 3.9%

Securities Trust of Scotland 4.1%

(*at 07/12/11

source AIC)