An unusual way to boost your income

Enhanced income funds can earn investors higher income without taking on added risk. Sarah Moore explains how they work.

As yields on bonds and stocks continue to decline, investors are looking for other ways to earn a higher income without taking added risk. One approach that may sound tempting involves "enhanced income funds". These are able to pay out higher-than-average dividends (up to 8% or 9% in some cases) to investors by giving up some of the potential capital gains on the shares they hold, using a derivatives strategy called "covered call writing". In effect, they are converting capital gains into income.

This isn't as complicated as it sounds. Essentially, the fund sells an "option", which gives a buyer the right (but not the obligation) to buy a stock from the fund at a prearranged price (known as the strike price) on a specified future date. For this, they receive a payment, known as a premium. If the stock ends up being worth less than the strike price, the fund simply keeps the premium (which it can use to help fund a higher payout to investors).

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Sarah is MoneyWeek's investment editor. She graduated from the University of Southampton with a BA in English and History, before going on to complete a graduate diploma in law at the College of Law in Guildford. She joined MoneyWeek in 2014 and writes on funds, personal finance, pensions and property.