How do I maximise income from my Isa?

Stephen's Isa portfolio

Source: Investors Chronicle, as at 2 August 2013

Last three trades

Rio Tinto (sold some holdings)

Premier Oil (Buy)

Rambler Metals & Mining (Buy)

Watchlist

Wolf Minerals

Invesco Perpetual High Income Inc

Chris Dillow, Investors Chronicle's economist, says:

If you were to retire now, this portfolio would buy you an annuity of only just over £5,500 a year. This suggests you might indeed have to wait until 65 to retire. Doing so would raise your retirement income in many ways: it would give you time to save and top up your retirement pot; annuity rates rise with age; it would allow your portfolio to grow as share prices rise; and it would give time for annuity rates to rise because it's quite likely that bond yields will rise in the next few years.

However, there's a problem here. For you, these last two possibilities conflict with each other. Some things that might cause annuity rates to rise might hurt your portfolio.

I say this because you have a high weighting in emerging markets and resources companies. This gives you less diversification than you might think, because in recent years resource stocks and emerging markets have been highly correlated.

This is because they face (at least) two common risks to which other stocks are less exposed.

First, there's the likelihood that Chinese economic growth will slow down in the next few years, and shift from being an export-oriented economy to a more consumer-oriented one. This isn't wholly bad for investors of your age, because it would reduce China's savings and hence the buying of western bonds that has reduced yields in recent years. This would help raise annuity rates. However, slower Chinese growth might weaken the country's massive demand for commodities and, at best, create uncertainty about other economies in the region. This could hurt both emerging markets and commodity stocks.

Secondly, we will eventually see an ending, or even reversal, of quantitative easing (QE) in the US and the UK, and rising interest rates. This would push up annuity rates. But the less loose monetary conditions might hit commodity prices and the speculative inflows into emerging markets (these, remember, are to a large extent a play upon US monetary conditions). Your portfolio is unusually exposed to this danger.

How worrying are these risks? Three things mitigate my concern. First, the market might now be pricing them in. You could read this year's fall in mining and emerging markets as a sign that investors are now bracing themselves for these dangers.

Secondly, what you lose on your equity holdings you would gain on your retirement income, to the extent that annuity rates do rise.

Thirdly, the Federal Reserve will only reverse QE once it is confident that the US economy is strong enough. In this situation, share prices generally would be higher than they are now.

In this sense, your portfolio isn't disastrous. But you might want to consider trimming your exposure to emerging markets and resource stocks, in favour of general equities.

There is, though, a more general point here. Although our portfolios should be shaped by our idiosyncratic needs and circumstances, they are also vulnerable to moves in the global economy, and sometimes the connections between those moves and our own portfolios are not immediately obvious. This doesn't mean you should think much about the future of the global economy - you can save that job for futurological windbags - but it does mean you should ask: how might global changes affect me?

There's something else I'd advise. You say you like to make a quick profit and move onto other stocks. I'd caution against this, for two reasons.

First, one of the strongest quirks of the stock market is the momentum effect - the tendency for past risers to continue rising; this might be especially true for smaller and middling stocks. If you quickly take profits, you are denying yourself this nice source of profits.

Secondly, moving onto other shares is risky. We all have limited cognition, and underpriced shares are rare. These two facts mean it is unlikely that we can regularly spot good stocks. Most fund managers have only a handful of good ideas, and I suspect the same is true for retail investors. So why not stick with your winners?

Lee Robertson, chief executive officer of Investment Quorum, says:

I note that you are now 59 years of age, have a wife and no dependants, and would like to retire within the next six years. Therefore, it is time to address a few issues that are apparent from your attitude towards risk, your keenness to generate as much income as possible, and what makes you different to the average investor.

We agree with the assets being held within Isas with the attaching benefits of generating a maximum tax-free income from your portfolio. However, we do feel that the overall structure of the portfolio seems very risky considering your stated six-year time horizon. We would prefer to see more of a strategic and tactical asset allocation, overlaid with a portfolio that can maximise an annualised income stream for you and your wife on retirement, but still give you some risk-adjusted capital growth.

Primarily, the portfolio should deliver you an income by investing in a wider range of asset classes. I suggest you increase the number of fund holdings rather than the current mixture of direct equities and funds, as this will allow you to further diversify portfolio risk while taking advantage of a tax-free capital gains and income environment. The objective of the portfolio would be to harvest the income pending your distribution requirements, therefore giving you the flexibility to consider retirement sooner than 65.

By using more funds in this way you can capture both a UK and global equity income exposure, which should give you both a capital and income return and enable you to include some bond funds, such as strategic bonds and monthly income bond funds. You may also wish to consider some exposure towards UK commercial property, given that yields once again look fairly attractive.

Obviously, your portfolio does have some exposure to both growth and income funds, but we would be inclined to sell the direct equities, and possibly some of the growth funds, to boost the overall yield on your portfolio. Generally speaking, you might like to consider having a current asset allocation split of approximately 80 per cent in global high-yielding equities, 12 per cent in bonds or cash and 8 per cent in property, which should deliver reasonable levels of yield while reducing the current risk inherent in your portfolio.

Given that growth over the global economy in the next few years could remain low, with benign interest rates, a total return strategy seems sensible, especially if you are considering retiring sometime over that time horizon. Certainly, it would seem sensible to generate a risk-adjusted total return strategy over the next few years, especially if inflation and interest rates were to begin to rise over that time frame.

Finally, while you already have some excellent funds that create both growth and income, we would suggest the following funds for consideration, the M&G Global Dividend Fund, Threadneedle Global Equity Income Fund, BlackRock Continental European Income Fund, JOHCM UK Equity Income Fund, Cazenove UK Equity Income Fund, Old Mutual Monthly Income Fund and Ignis UK Property Fund.