Expecting to make regular withdrawals from a fund to provide the income you require can make huge demands on your investment, especially in the early months.
Many investors have come a cropper when anticipated growth in a fund has not met expectations, while income has continued to be drawn. The result is that the income payments eat into the investment to such a degree that capital shrinks as the fund struggles to maintain regular payouts.
Indeed, many experts point out that the best performance is seldom found in an income fund. "Recently, UK growth funds have generally outpaced UK income funds on the basis of overall return," says Geoff Rollin, director at Devonshire Wilson Financial Services, a member of the Financial Options Group.
"Income funds have a specific risk in that the fund deducts its annual charges from capital. This means the income is higher than would have otherwise been the case, but growth in capital is constrained."
Despite the drawbacks, income funds remain popular. But investors face dilemmas, says Graham Bates, an independent financial adviser with Leeds- based Bates and Partners. "The age of the investor is important," says Mr Bates. "Someone looking to generate an investment income in early retirement, say mid-50s, will need to ensure that growth potential also exists. But the priority for older investors may be getting the maximum immediate income, with growth being a secondary consideration."
In order to achieve income growth, investors will need to have some capital appreciation in their fund. Mr Bates says: "The key is to look at the sector most likely to meet your investment objectives. Funds in the UK Equity Income sector will give you a low starting yield but the best prospect of long-term capital growth. Funds in the UK Equity and Bond sector offer a slightly lower risk and a higher initial yield, but less potential for growth. Those needing the highest level of income should look at the UK Fixed Interest sector."
It is also important to bear in mind the level of charges on all funds as they will further reduce the potential for capital growth.