Where should I invest £100,000 to generate income?

If you would rather go it alone then you need to realise that with inflation in excess of most savings account rates the real value of money on deposit can be quickly eroded.

Typically the only way to earn a higher rate of interest from a savings account is to lock your money away for a longer fixed term. You can use our table of the best savings rates on instant access accounts to help guide your choice of savings account, although these rates usually fall woefully short of inflation.

Check out our regularly updated article ‘Best savings accounts in the UK‘ for a full roundup of the best savings accounts in the UK.

An alternative is to consider the best fixed rate savings bonds available on the market which can provide inflation-beating interest rates and the good news is that they can be held in a cash ISA, so returns can be tax-free.

But one word of warning. These bonds will either restrict access to your capital during the term of the bond or impose penalties if you wish to withdraw your money early. It is therefore worth keeping an eye on the Bank of England Base Rate (which influences rates on savings and mortgages) because if interest rates changed you could find yourself stuck with a deal which isn't as competitive as rates offered on ordinary easy access savings accounts. Something to think about.

One of the best free tools out there is the savings account rate tracker. You simply enter the details of the savings accounts you currently have and then not only will the system tell you if you are getting a good deal, but it will monitor the market for you and email when there are better deals out there than your existing account. Make sure you put in the current balance for each of your savings accounts.

If you do decide to put your money into a savings account then you may wish to limit the amount held with any financial institution to £85,000 (£170,000 for a joint account) per banking licence. Bear in mind that banks can share banking licences. This will ensure your savings are covered by the Financial Services Compensation Scheme should your chosen bank go bust. Of course, National Savings and Investment bank accounts (NS&I) are 100% backed by the Government so represent no investment risk, however, the return can be poor.

3. Peer-to-Peer lending

If the interest available on cash is unexciting enough for you then one way to get a better rate is through peer-to-peer lending. When savers deposit money into a normal savings account the bank can and does lend that money to other people in the form of loans. The profits that the bank makes help pay the interest you earn on your savings account.

Peer-to-peer lenders cut out the middleman (the bank) and allow you to lend your money to borrowers directly in return for a higher rate of interest. The way this works is that when you deposit your money the peer-to-peer lender will parcel it up into smaller loans to manage risk (much like a bank). The reason why you get a much better interest rate is because without the middleman (the bank) you keep more of the profits as there are no bank branches etc to pay for.

At present, use of a peer-to-peer lender is not covered by the Financial Services Compensation Scheme (FSCS), so be aware. The first £1,000 of interest from peer-to-peer lending is now tax-free for a basic rate tax payer, however, in line with ordinary savings accounts, plus peer-to-peer savings can now be held within certain ISAs.

That all being said, peer-to-peer lending has seen a steep decline in revenue growth in recent years thanks to a number of factors including greater investment choice and an increase in defaults fuelled by the pandemic. Two of the biggest peer-to-peer lenders – Ratesetter and Zopa – have withdrawn from the market and only a handful of niche companies remain.

4. Equities

It is possible to invest for income directly in shares and hopefully receive an income stream via regular dividend payments along with a bit of capital appreciation (for which you can use your annual capital gains tax allowance to receive tax-free, or at least in part). Well, that’s the theory. Direct equity holdings carry much higher investment risk and hopefully rewards. The problem is that if you get your timing or research wrong you can swiftly find yourself sitting on a huge loss and no income stream. (that’s exactly what happened to people who invested in banks in 2008). According to the Barclays Equity Gilt Study equities have produced an annual return of around 5.4% over the last 50 years but this does mask huge crashes and market rallies.

In terms of generating income, shares can produce regular dividend payments. Companies can choose to pay some of their profits to shareholders in the form of dividends. In theory, if you held a portfolio of shares that paid regular dividends you could use that income to live off. The added benefit is that currently the first £1,000 of dividend income is tax-free, however, this will reduce to £500 for the tax year 2024/25. Building a portfolio of shares that generate a growing and dependable income is tricky but later in this article, I describe a better method, using funds.

5. Bonds

Corporate bonds are essentially loans to companies paying you an interest payment (a coupon) and your original loan amount back at an agreed date. The riskier the company the more likely they are to default, so the greater your potential return by way of compensation. But as ever, with greater risk comes the potential for greater loss.

At the safest end of the spectrum, we have Gilts (which are loans to the UK Government) through to investment-grade bonds (companies with good credit ratings) through to non-investment grade and high-yield bonds (loans to companies with poorer credit ratings). Like equities, it is possible to hold bonds directly and a number of companies (such as Tesco) have even marketed their bonds directly to the public.

Bonds are deemed lower risk than equities and their typical annual return (income and capital growth) over 20 years has been around 4.37%. But as ever past performance is no guide to future returns. From an income-generating perspective, bonds tend to produce an income that doesn't grow over time, i.e it is fixed at outset. If you want your income stream to keep pace with inflation that typically means investing in equities (shares).

The above are just a few of the main investment asset classes. There are others such as commodities and hedge funds but I don’t wish to bamboozle you. The main point being you have a wide choice of assets which can produce income.

But up until this point I have talked about holding assets directly. Placing all your money into a single asset (such as one company’s shares) is akin to putting all your eggs into one basket. However, most people invest via an investment wrapper or product into a number of investment funds which invest in a range of assets.

Wrapper/product

When you invest, two things to consider are ‘how’ you invest and ‘what’ you invest in. The ‘how’ is whether you invest via a pension, investment bonds, collectives etc. While the ‘what’ is usually the underlying investment itself, such as equities, bonds, property etc.

Without trying to oversimplify investing, try and think of it like a car. In order to get from A to B (ie your current situation to your desired stage in life) you need to choose a car. The car that best suits you will depend on the journey you plan to take, your current budget etc. Every car will have different running costs, tax etc and not one car suits all. Think of this as the investment wrapper (pension, Stock and Shares ISA etc).

Once you have chosen a car you need to put petrol in it to get you to your desired destination. This is akin to the underlying investment choices. Clearly, the petrol drives performance but the car can enhance it. But obviously it’s no good buying a Ferrari if all you plan on doing is going to the shops and back each day. It’s a similar thing with investment – excessive costs can wipe out any benefit.

General Investment Account

This is effectively buying funds (Unit trusts/Investment trusts) outside of any investment wrapper. I explain funds in more detail later in this article, but they represent lots of investors’ money combined into a pool which is run by an investment manager with a certain brief. This can be based on the asset type such as bonds, property, shares, a geographical region or a theme such as cautious managed. The fund manager will buy and sell a much larger range of holdings which will hopefully reduce exposure to a single company’s share for example. If collective investments are held outside of a wrapper (in a general investment account) then they are subject to income and capital gains tax.

Stocks and Shares ISA

This is simply a tax wrapper and can hold cash, shares and collective investments (funds). The benefit of investing for income via an ISA is that income and capital gains are tax-free but you have a limited subscription each tax year which is currently £20,000.

Pension

Defined contribution or personal pensions are another tax wrapper to consider when investing for income as income and capital gains are tax-free. Again you can invest in the aforementioned assets and collectives (but not residential property). If you are looking to generate an income from your pension then see our article ‘How much income could I get from a £100,000 pension pot?‘

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Investment Bonds

These are products that are offered by life insurance companies that are subject to income tax. Their investment flexibility is usually limited to a range of investment funds.

If you simply want to invest for income with no access to capital then it is possible to buy an annuity (called a purchased life annuity) which will provide you with a guaranteed income stream. The level of income will depend on your age and possibly health but once purchased you lose all access to the capital.

Conclusion

So is property the best way to provide income? Not necessarily and in my opinion I'd be wary of putting all my eggs in one basket. Buy-to-let yields vary wildly and the costs involved are often unforeseen.

Diversifying the assets you invest in not only reduces risk but also diversifies the source of your income. The greater the investment risk you take the greater the potential loss. Can you afford to lose any money? If not then you may need to be realistic with your income targets for any investment and settle for safer assets.

Growth – How to invest £100,000 for the best return

Investing for growth is very different from investing for income. That is why I have produced a separate article detailing how to invest £100,000 for the best return.