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Can you earn 5% income on your savings?

A new investment aiming to pay beleaguered savers an annual income of 5% will be launched by Neil Woodford in March, arguably the UK’s best known and most successful investor.

The Woodford Income Focus fund is an equity income fund, meaning that it will look to generate a regular income for investors through investing mainly in shares.

This comes as savers battle to find a decent return on their savings. The best five-year fixed-rate savings account pays just 1.6% a year – now not even enough to outstrip inflation.

So is it worth taking some risk on the stock market in pursuit of a better return? Here, Which? Money explains how equity income funds work, and how the Woodford Income Focus fund shapes up.

Find out more: equity funds explained – how equity funds work

How do equity income funds work?

An equity fund is made up of company shares. Income is generated from these shares through dividends – a portion of company profits that is distributed to shareholders.

Equity income funds tend to invest primarily in well-established companies that pay high dividends. That can mean, however, that growth in the value of those shares is steady and modest, rather than astronomical.

The initial value of your investment, therefore, tends to grow more slowly while you generate income – something you need to be aware of if you’re going to invest in an equity income fund.

When you invest in a fund, you buy units, which are created every time a new investor joins a fund (and cancelled when they sell). Each unit in the Woodford Income Focus fund will be priced £1 at launch.

Find out more: what is a stocks and shares Isa? – tax-free investing explained

How much income will the Woodford fund pay?

The new fund aims to deliver an income of 5p per unit in the first full calendar year in 2018, after which it will aim for a more modest income target.

With each unit initially costing £1, the initial income target will be 5%. This sounds terrific, but remember that won’t be the plan after the first year.

With equity income funds, a crucial figure to look at is the fund’s dividend yield. This is the amount of dividend income you earn in a given period as a percentage of whatever you’ve paid in.

So if you invest £1,000 into the new Woodford fund and it meets its initial target, you’d receive £50 in dividends, or a dividend yield of 5%.

It’s also worth mentioning that dividend income can be subject to tax, unless the investments are held in a tax-free Isa or pension wrapper.

Find out more: dividend tax – learn more about tax on dividends and capital growth

Where will the Woodford Income Focus fund invest?

Woodford already runs an equity income fund, but this one will be a little more intense – an income espresso rather than a cappuccino.

Where the existing income fund can invest only up to 20% of its assets outside of the UK, the Income Focus fund will have no such constraint – and will therefore have more freedom to invest overseas. However, it will not invest in unquoted shares, as the existing Woodford Income fund does.

After the first year, the fund won’t target a specific yield and offers no guarantee of any specific level of yield or income over a given period of time. But reports suggest Woodford hopes the fund will outperform the income yielded by the FTSE All Share index by at least 20% over a rolling five-year period. The All Share yield has wavered around 3.5% for the last few years.

The official announcement of the fund launch will take place later this month, and the fund will open to investors in March.

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