How to invest £45k for £2,000 annual income

TERENCE HURST'S PORTFOLIO

Note: Portfolio valued by Investment Quorum on 12 May 2014

LATEST TRADES:

Royal Mail (buy) and Finsbury Growth and Income (buy)

WATCHLIST:

Invesco Perpetual Income because of fund manager Neil Woodford's departure.

Lee Robertson, chief executive officer and chartered wealth manager at Investment Quorum says:

You wish to supplement your retirement income with income generated from your portfolio of shares. You have previously been willing to take a greater level of risk within your portfolio but now wish for a more cautious stance. We think this is sensible as it is likely that your capacity for loss, or in other words your ability to recover from losses, is reduced as you move into your retirement years.

While we are generally happy with the content of your current portfolio it is apparent that the current holdings do not generate enough income for you to reach your desired £2,000 per year level to boost your pension income.

There is always some movement in these things but we have valued the portfolio at a little over £45,000.

The portfolio has a current yield of around 1.80 per cent and should be reset to accommodate the requirements of a moderate risk profile with both a growth and income strategy. To achieve the desired £2,000 per year we are looking at achieving a yield of around 4.4 per cent based on the current valuation.

We would suggest that this is achievable but clearly there would be a need to restructure the portfolio to increase the income stream and we would suggest that you address this situation sooner rather than later to begin harvesting the income prior to retirement, even if it is not yet required. We would suggest that you focus upon a risk-adjusted portfolio and therefore retain your exposure through funds and not direct equities as this route is a rather high-risk strategy.

Given the current portfolio and the fact that you already use funds, we would suggest you consider selling anything that does not deliver a yield of 4 per cent plus as these choices, which may be valid in general investment terms, will hinder the ability of the portfolio to generate the desired income.

Turning to investment suggestions and bearing in mind that you are looking to blend for income whilst retaining a cautious to moderate investment profile we would suggest that you consider funds such as the Royal London Sterling Extra Yield Bond Inc (IE0032571485), RWC Enhanced Income A GBP Inc (LU0539372507), Old Mutual Monthly Income Bond R Inc (GB00B1XG8Y11), M&G Global Dividend R Inc (GB00B6VRX242), Schroder UK Alpha Income (GB00B073JG03) and Henderson UK Equity Income & Growth (GB0007493033). All of these funds have good track records, excellent fund managers with strong investment processes, and have a history of delivering income to investors.

We would suggest that by switching the holdings that are not generating the required income levels and by replacing them with these suggestions, the portfolio will then be much more likely to reach your income target.

On a final planning note, depending on your tax and cash individual savings account (Isa) situation it may be worth putting these holdings in to stocks and shares Isa over the next few years to benefit from any tax advantages available.

Doug Millward, investment manager at Lowes Financial Management says:

You have taken a more adventurous approach to investing, with the primary aim of achieving capital growth. As retirement approaches, however, your reduced appetite for risk and changing investment objectives mean you will need to make adjustments to your portfolio. You should assess your current capital gains tax position before making changes to ensure you do not end up with a tax liability.

Based on your current portfolio, you will need a yield of around 4.5 per cent to produce your target income of £2,000 per year. The only holding within his existing portfolio which has achieved this level of yield is your shares in Ecofin Water & Power Opportunities (ECWO), and the first change we’d recommend is you sell these and your Royal Mail (RMG) shares, which don’t fit with your cautious attitude to risk.

Subject to capital gains tax restrictions, we would suggest the disposal of your Eclectica Agriculture and Jupiter Financial Opportunities funds, as they fail to deliver your new risk tolerance and income requirement, followed by the lower-yielding funds. We suggest you retain your holdings in the Invesco Perpetual Income (GB0033053827) and Newton Higher Income (GB0006779218) funds. Neither reaches your target yield, but they provide a reasonable level of income and offer a diversified portfolio of predominantly UK shares.

In terms of the departure of Neil Woodford from Invesco, we believe Mark Barnett is a well-qualified replacement with a track record of managing equity income portfolios. The Newton Higher Income fund has had a period of poor performance recently, as it tried to maintain its high relative yield. The performance of the fund has improved with the adoption of a more realistic yield target and a change of manager.

We believe the capital raised should be re-invested in a portfolio of funds covering different asset classes, ie property, fixed interest, and equities.

Property exposure should be through funds investing in direct commercial property, such as the Henderson UK Property fund (GB0007278590), as these benefit from rising values, generate a stable income stream from rents and don’t suffer the volatility that comes from investing directly in property company shares.

For fixed income, rather than using standard corporate bond funds, we would advise using strategic bond funds, such as the Artemis High Income (GB0006838097) or PFS TwentyFour Dynamic Bond (GB00B5LHHR01), both of which have distribution yields of over 5 per cent. While slightly more volatile than traditional corporate bond funds, they are more flexible, with most managers given the freedom to invest across the full spectrum of gilts, investment grade corporate bonds and high yield corporate bonds. They also usually can use financial instruments to manage the fund’s sensitivity to interest rate rises, which will become more important in coming years.

As well as gaining equity exposure through the retention of existing equity income funds, you could also consider enhancing your income through holding equity income funds which use a "covered call" strategy, such as the Schroder Income Maximiser (GB00B0HWJ904) fund. These effectively give away some of the potential capital growth above a certain level on all or part of their portfolio in return for a premium, which enhances the dividend income. In a strongly rising market, this can restrict the capital growth on the fund, but this can be acceptable for investors who aim to generate income.

Finally, to get the most out of your portfolio, you should ensure it is managed in a tax-efficient manner, for example by moving as much as possible into an Isa wrapper each year, until your whole portfolio is sheltered from both income and capital gains tax. If you are happy to take a more active approach to income generation, you could also consider retaining some of your growth orientated funds, such as the Scottish Mortgage Investment Trust (SMT). Partial disposals could be made from these holdings each year to 'top-up' the income generated by his other investments, and this would utilise your annual capital gains tax allowance, making income more tax efficient until your whole portfolio is sheltered within an Isa.