I often wax lyrical about bargain hunting among investment trusts trading at a discount – that is, trusts whose shares trade for less than Net Asset Value (NAV).
Think buying £1 coins for 90p.
We’ve also written reams over the years on investment trusts as a potential source of steady income.
Former Monevator contributor The Greybeard had a lot to say about it – although he grew frustrated by the relentless pushback from hardcore passivistas.
More recently I’ve launched an investment trust income model portfolio for Moguls members.
I won’t rehash the whole active/passive debate with respect to income today. If you’re a passive investor but you have an open mind, I’ve written a Mavens post on using ETFs to do much the same.
But if you’re a global equities tracker and drawdown diehard, probably best to wait for the next article!
Give peace a chance
Just briefly for those on the fence – or simply confused – I’m not saying the average person would do better stock picking investment trusts to grow their capital.
I’m not even saying they would do better – certainly not that they’d see higher total returns – living off the natural yield from income investment trusts in retirement.
Rather, I see advantages to an actively managed income approach (less stress and income volatility, no planned capital depletion, lower infirmity risk) that make it worth considering. To the extent that I’ll probably go down this route myself when I do throw my portfolio into decumulation mode.
Okay, enough said. Let’s now consider where my hobby of investment trust dumpster diving could dovetail with an investor’s income goals.
Discounts and income from investment trusts
Firstly, a quick reminder about how discounts work:
It’s often the case that the share price of an investment trust trades at less than its NAV per share.
Remember, the NAV is – in theory – the best estimate of what the trust owns, minus any debts.
Clearly, buying shares for less than they are worth may present an opportunity. Price is what you pay but value is what you get, to quote Warren Buffett.
For instance, the fictitious Monevator Investments plc may trade for £1.20 a share, despite its NAV per share being £1.60.
In this case, a buyer is getting £1.60 of underlying assets for just £1.20.
Bargain! The share is trading at a discount to NAV:
The discount is (£1.60-£1.20)/£1.60 = 25%
In principle, you get more for your money when you invest at a discount. Hopefully in time the discount will narrow, pulling the share price back up towards the NAV and amplifying your returns.
So much for – fingers crossed – capital gains from discounts.
But what about income?
Yielding to the discount
The crucial thing to grasp is that any cash paid out by a trust is unaffected by the discount. 1
Let’s say Monevator Investments has a NAV of £1.60 per share, as above, and that it pays an annual 8p per share dividend.
If you were to calculate the yield based off the NAV, this represents a yield of 5%:
- Dividend/NAV = 8/160 = 5%
However this trust is trading at a 25% discount. We can buy the shares for £1.20.
Yet the dividend payout is still 8p per share. So for someone buying the shares today in the market, the yield they’ll get on their investment is:
- 8/120 = 6.7%
All things being equal, this higher yield is locked in. Provided the cash payout remains at least 8p, then this investor’s annual yield on cost of their Monevator Investments shareholding will be 6.7% – regardless of whether the share price rises or falls, or whether the discount closes.
Of course, dividends from decent income investment trusts tend to rise over time, as do their NAVs. Though sometimes dividends can be cut, too.
That’s a discussion for another day. The point is the chunky discount here has boosted the purchasers’ starting income yield, compared to if they were buying the shares at NAV – let alone a premium.
Note that in both cases – whether the shares are priced at NAV or at a 25% discount – the underlying assets (represented by the NAV) generate enough income for the trust to pay an 8p dividend per share.
When you buy for only £1.20 due to the 25% discount to NAV, you are getting the same 8p at a cheaper price. But because each share costs only £1.20 instead of £1.60, the same lump sum investment would buy more shares – and therefore more of those 8p dividends.
For example:
- No discount (£1.60): £10,000 buys 6,250 shares × 8p = £500 income
- 25% discount (£1.20): £10,000 buys 8,333 shares × 8p = £667 income
Happy days.
A striking hypothetical example of higher income returns
Generally investment trusts trading on discounts don’t draw attention to the fact. Their annual reports will wave their hands about what they’re doing to close the gap, and direct your attention to graphs of rising NAVs over time, or photos of employees from portfolio companies curing cancer or drilling for oil.
So the following illustration in a recent presentation from an investment trust I hold – Canadian General Investments Trust (LON:CGI) stood out:
Source: Canadian General Investments
For a cluster of reasons we don’t need to get into, Canadian General’s whopping 40% discount to NAV is pretty much out of its control. 2
While CGI has sometimes traded at NAV – usually during commodity booms – a big discount is typical.
Hence management has a reason to turn this bug into a feature with this table. And what it’s illustrating is exactly what I’ve explained above.
The table simplistically assumes a 10% annual return – high but less than CGI’s long-term track record – split between 7% capital gains and a 3% dividend. All the income is presumed to be paid out.
If you were to buy $100,000 of Canadian General as a hypothetical open-ended / mutual fund – that is, with no discount – then for your hundred grand you’d get $3,000 paid out as a dividend income.
- That is, 3% of $100,000 = $3,000
However at a 40% discount to NAV, your $100,000 is buying you $166,667 of Canadian General’s assets:
- 3% of $166,667 = $5,000
Your income is higher from day one, just as we’ve already seen in my example above.
From there, the company compounds NAV at 7% and holds the 3% payout (of NAV) steady. The discount stays at 40%:
By year 20:
- 3% of $602,775 = $18,083
We can also work out the ongoing yield on cost of your initial $100,000 investment:
- $18,083/100,000 = 18% on your original purchase price.
A very nice income if you can get it.
Discounts are a bonus for income investors
There’s plenty of slips betwixt cup and lip and all that. Dividends can be cut. Canada is an odd place to put a lot of your money. Canadian General’s exposure to US assets muddies the picture.
But that’s all for another discussion. Here I’m just focused on the mechanics of discounts and income.
You see, readers often ask me why I should expect a discount to close.
The simplest answer is that most usually do, eventually, at least for a time and in the absence of structural impediments such as those at Canadian General.
But the point here is that if you’re an income investor after natural yield, then it doesn’t matter. You can simply aim to buy and lock-in a high starting yield and then let the income roll in. (Touchwood!)
Buy in the sales
Unfortunately, the top flight of dedicated UK equity income trusts rarely if ever trade for anywhere near 25% discounts. Their income underpinnings, steadier investments, and decent long-term records tend to curb such extreme dislocations.
However they can reach discounts of 10% or so when out of favour, or in wider times of distress.
Still, the same income-enhancing argument holds for more specialist trusts, too, where we have seen much chunkier discounts.
For years even income seekers bought infrastructure trusts on a premium, for reasons I never understood. However as I covered on Moguls, in early 2025 they were trading on 25-30% discounts. That meant income yields of 8% or more for new money buying the likes of HICL (LON: HICL).
Such super-wide discounts have now closed, though you can still bag HICL at a 15% discount. (Disclosure: I hold.)
Property trusts and many REITs are still on big discounts to NAV, for what that’s worth.
And there remain a few – troubled – renewable trusts on big discounts touting very high yields for the brave.
Despite misgivings, I’ve dipped a little toe in with Greencoat UK Wind (LON: UKW), currently on a 22% discount and yielding 10%.
Looking to the long-term
Infrastructure, property, and even renewable investment trusts have all traded at premiums to NAV in the past. I’m not saying they will again (especially not renewables). But as we’ve seen, for braver income seekers that might not matter, just so long as the dividends keep flowing.
Still, I’m more confident about the very long-term with Ye Olde UK equity income trusts – those of the much-vaunted (and debated) Dividend Hero variety.
Anything else is a bit of a special situation when it comes to long-term income.
And yes, to belabour the point: this is active investing. Nobody needs to pipe up that a global tracker will outperform in the long run or that discounts might be flagging bigger risks or mention Neil Woodford.
I get it and I mostly agree. So should anyone who goes down this path. Do your own research!
But personally, I’m starting to think I might smooth the transition from accumulation to decumulation by opportunistically buying – and then looking to hold – these income trusts as I head towards drawdown.
That would probably be much less stressful than switching overnight from an accumulation to decumulation portfolio – albeit likely at some cost to my returns.
Indeed as I get closer to the end than the beginning, I have started making tentative stabs at building up a natural yield again. Ironically this takes me back – philosophically – to where I started as an investor.
True, I’m still finding it hard not to trade when the discounts close, or some other shiny object pops up…
But as I transition at least a chunk of my portfolio towards income, maybe that illustration from Canadian General will help me stay my hand.
Much as we love investing at Monevator, even we believe saving for an emergency fund comes first. Building a cash stash to bubble wrap you against life’s bad breaks is probably the most important financial move you can make – after clearing bad debt, of course.
Stuff happens, as they say in polite company, and that’s the starting point for why you need an emergency fund.
Why you must have an emergency fund
When you’ve got a job and good health and your income exceeds your outgoings, setting cash aside might not even occur to you.
But without savings, you’re walking a tightrope. The smallest shove can send you into the abyss.
You might not be hit by one of the life-changing shocks that kicks people on to the streets. But there are plenty of smaller things that can go wrong:
- Your income may drop unexpectedly, and no longer cover your essential expenses.
- A member of your family could get ill, and you want to hurry forward treatment.
- Something might blow up – from the archetypal boiler to a car engine.
- The roof could literally fall in.
- A far-flung relative could get married or get cancer. Either way you might want to fly out to be with them.
- Your investment platform could go bust, leaving you in need some other source of cash to live on while the administrators clean up the mess.
- Your bank might even freeze your current account for some reason.
A sudden divorce, job loss, illness, or a lurch into debt can push any of us into a downward spiral. But having a good emergency fund on standby helps ensure that you never enter that parallel universe.
At the very least, you’ll feel better just knowing your rainy day savings are there.
How much emergency fund should I have?
Save at least three to six months’ income.
Having this amount on hand is a good starting point. It’s not a magic number but a balance of considerations.
Obviously, there’s no limit on how much you could save for a rainy day. You could argue that a plumper cash cushion is best. Indeed, why not save to cover one year or even two?
Your personal situation matters here.
If you’re a single self-employed pigeon fancier, you might want to retain a few months’ more expenses than a couple with full-time roles at long-established companies.
By all means tailor your fund to match your circumstances. But be realistic about how quickly you can save your disaster-dodging dollop.
Set a stratospheric target, and you’ll be directing all of your spare cash into the Emergency Fund, rather than somewhere that does you more good long-term. (Think paying off a mortgage, or investing in higher growth assets.)
Cut your cloth
It’s better to think about your emergency fund in terms of your monthly after-tax income rather than an arbitrary and set amount of cash.
A £10,000 emergency fund is obviously superior to having £1,000 in emergency savings, but it’s your monthly burn rate that counts. If the bare essentials cost your family £5,000 a month then even a £10,000 emergency fund won’t last long.
So first, think about how much money you’d need to pay the bills for a month if you cut back on all the non-essentials you can do without in a crisis.
A budget planner can really help with this step.
Now imagine you’re out of work for several months because of unemployment during a deep recession, or due to an unfortunate illness.
Six months’ income (after tax) should get you through that kind of scrape unless you’re really unlucky.
In theory, six months’ worth of net income in your emergency fund will last longer than six months on an emergency budget. That’s because your income normally pays for life’s little luxuries, too.
But that extra wiggle room may be a lifesaver if things go from bad to worse.
Say, for example, your car conks out just before a big job interview. With enough in your emergency fund, you’ll be able to afford an immediate replacement in the nick of time.
If money is very tight, then save three months’ worth of essential expenses (as opposed to net income). That is the bare minimum you should aim to hold in your emergency fund.
Where to keep your emergency fund (UK)
Keep your savings in instant access cash
Do not be tempted to invest your emergency fund, seeking a better return.
There’s absolutely no point running the risk that your emergency savings are halved in value – just when you need them most – by a stock market slump.
Remember that stock market falls are correlated with recessions.
Covering a period of unemployment is a prime use-case for an emergency fund. That’s more likely to happen when the economy as a whole is in recession – also usually the worst time to be in equities.
Limit your ambitions for your emergency money to earning the best interest rate you can from an easily accessible accounts.
The type of emergency matters
Broadly speaking, there are three kinds of emergency you could face:
- You have an emergency – Something goes wrong with your house, health, or job.
- Your bank has an emergency – Software or other technical systems at your bank might fail, preventing you from accessing your money. Worst-case scenario they might go bust!
- Your relationship with the bank breaks – If you’re de-banked for some reason then you could find your accounts locked with no explanation for weeks or months – and ultimately even closed.
In the first scenario, it doesn’t matter much where your savings are located. As long as you’ve gone for safe and accessible banks or building societies – that is, you’ve not locked your money away somehow – then you should have no problem getting your cash when you need it.
In the other two scenarios however, the whereabouts of your money is everything.
Location, location, location
If you put your emergency fund into an unusually high-paying savings account with a slightly sketchy niche provider, you’ll obviously regret it if they go bust – but also if you’re ‘only’ unable to access your money for a time.
This isn’t a far-fetched possibility – there’s a decent chance that your own emergency and trouble at a niche bank could coincide. Think Great Financial Crisis 2.0, where a recession sees you lose your job even as it threatens smaller lenders. (Read up on the Icesave drama for a taste from the last go around…)
One practical response is to stash your emergency cash with two providers with different Financial Services Compensation Scheme (FSCS) licences.
This way you’re covered for losses of up to £120,000 per account. And even if one provider goes bust, you can access your money at the other whilst you wait for your compensation to come through.
From a debanking perspective, though, there’s a further wrinkle to consider.
Lloyds Bank, Halifax, and Scottish Widows do have separate FSCS licences, for instance – but they are all part of Lloyds Banking Group.
Put your money with any two of these institutions and you’ll be covered from an FSCS perspective, thanks to the individual licences. But if Lloyds Banking Group decides to de-bank you, then it might conceivably lock up all your money – your current accounts, savings accounts, and investment accounts – at the same time.
A belt-and-braces way to avoid this? Stash your emergency fund cash across multiple instant access accounts – split across different FSCS licences and not under the same corporate umbrella.
Principles in practice
I’ve distributed my own emergency money across three seperate accounts:
- An instant access savings account attached to my main current account. This is accessible within seconds, with no punitive limits on withdrawals. It holds one month’s spending money.
- Around three months’ spending money in Premium Bonds, backed by HM Treasury rather than the FSCS. The income is tax-free and the funds are accessible within just a few days
- Two to three months more spending money in a decent building society account with a local branch. This is totally separate from the banks I have current accounts or credit cards with.
It’s up to you how complex you want to make things. But if anything nasty ever hits the fan, you could be grateful you took such precautions in advance.
Lead us not in temptation
Ideally, your rainy day savings should be kept entirely separate from the money you’re putting towards a car, a holiday, or your dream of owning a parrot.
Of course if you’re a disciplined sort, you could lump it all together and vow that the first £10,000, say, is untouchable.
But very few of us are saints. So unless you’re expecting to get your halo in the post, keep your emergency fund separate from your other savings.
When to use your emergency fund
Spotted a delightful new fridge freezer that you simply must have when out shopping?
Come across a bargain holiday?
Those are not emergencies.
Many people – especially younger folk – are unused to having cash savings. Hence as soon as they’ve saved any money they’re tempted to spend it. It’s even harder if your partner has a different mindset to you.
So decide what is — or what isn’t — an emergency at the outset.
You might even want to write down your definition. At least that could avoid the arguments later. Then start saving for anything else after you’ve built up your fund.
We offered some suggestions for valid emergencies near the top of this article.
Review your emergency fund regularly
The money you saved when you first graduated from college won’t be sufficient when you’ve got two kids, a spouse, and a house.
Make sure you review your fund at least annually. Expenses, liabilities, and inflation all creep up at least as fast as salaries rise. Top-up as appropriate.
It goes without saying that should pay back any cash you withdraw ASAP, once the emergency has been dealt with.
Think about insurance for some emergencies
Don’t mistake emergency savings for financial invincibility.
Big hits to your property, income, or health can dwarf your emergency fund.
The best protection is a mix of cash buffer zone for smaller mishaps, plus insurance that covers you and your family from catastrophic loss to life, limb, and property.
Check out our useful articles on making the best use of insurance.
Bear in mind that insurance companies can take a while to pay out, or even fail to do so. Yet another instance in which an emergency fund can be a lifesaver.
Emergency fund UK: don’t use debt!
A lifestyle that habitually requires you to dip in and out of debt is the type most likely to get derailed by a cash call.
If you bought your kitchen on credit, there’s a strong chance that you’ll try to fend off any unexpected outgoings with your credit card or a personal loan.
But what if your particular emergency is a cut in your income? Increasing debt payments in the face of a falling income is about the worst thing you can do. Short of selling a kidney.
Avoid this at all costs, by saving cash in advance and shunning debt. Even if your salary is secure, increasing debt payments will leave you more vulnerable when fate deals you a blow.
Companies go bust due to cashflow struggles. Debt is often the multi-tentacled monster that drags them under. People are the same.
Get out of debt, and then start saving into your emergency fund.
Emergency money gives you confidence
The final reason you should build up your emergency cash reserves is because it will give you the security to (separately!) invest in the stock market – and ultimately enable you to meet unexpected expenses without liquidating your equities when they’re down.
With a sufficiently big emergency fund in place, you’ll find it easier to develop the lofty disdain necessary for long-term investing.
Marie Antoinette offering cake from within her palace walls when the rioters are at the gates should be your role model when investing. Not Corporal Jones in the BBC classic Dad’s Army, panicking at the first hint of trouble.
Cash on hand gives you that security. With an emergency fund saved to cover your unforeseen expenses, you needn’t worry when the stock market wobbles.
Start with an emergency fund
Need a last nudge to build up an emergency fund? Here you go: it gives you the bug to save and invest much more.
That’s certainly what happened to The Investor.
And I’m confident that if you’re a saving virgin, then you too will get a buzz from seeing your net worth steadily going up instead of down.
Before you know it you’ll be wondering how to start investing!