Getting some growth with a good dividend stream

"I am 66 and my wife is 64," says Keith. "We have no debts and I have another £250,000 in cash, loans to our children and premium bonds. I am told repeatedly that it is not safe to hold so much in equities at our age but since I only need the dividend stream - currently about £20,000 a year - why should I worry about stock market fluctuations?

We are planning on leaving the drawdown pensions intact for the time being. I have moved shareholdings into the two Isas to limit dividend tax as far as possible.

The total asset value including savings varies quite a lot from week to week. It has been as high as £1m but is now about £970,000. The loans to our two sons are recoverable - they are both successful dentists.

My hope is that you can advise me on how to retain a good dividend income without too much risk.

My investment objectives are some growth plus a good dividend stream, and I have a medium attitude to risk. I believe in buying and holding, and not speculating, however I don't think I should buy any more investments for the time being.

My last three trades were Compass (CPG), Severn Trent (SVT) and National Grid (NG.).

Compass and Invesco Perpetual Income (GB0033053827) are on my watchlist."

Keith and his wife's portfolio

Other assets (£)

Chris Dillow, Investors Chronicle's economist, says:

You say you're told that it's not safe for folk of your age to hold so much in equities. But the idea that older people should hold less equity than youngsters is in fact very dubious. Yes, older people have less time to recover from losses if the market falls. But on the other hand, younger people face the risk of decades of low or negative returns if we get trapped in secular stagnation. Net, the risks balance out. The only strong reason for older people to own less equity than youngsters is that, if you are not working, you don't have the option of saving more from your labour income to offset any equity losses. To this extent, equities are riskier because you don't have human capital to spread risk.

If, however, you are comfortable with stock market gyrations, there's nothing wrong with big equity exposure. Granted, I don't have as high an equity weighting as you. But that's because I am risk averse.

What I do question, though, is your desire for dividend income. Is this really tax-efficient? Remember that you can in effect create your own dividends by selling some shares. Such sales might well be less taxable than income. You have an £11,100 capital gains tax (CGT) allowance. Why not use it?

If you insist on getting dividends, though, consider that dividend stocks come in (roughly) two forms which are so different to each other they should be regarded as different segments of the market.

One type is cyclical stocks. Many miners now have decent yields, but this is compensation for the risk that a global recession will hurt them by reducing demand for commodities. For a retired person who doesn't need to worry about losing their job or business, such cyclical risk might be worth taking, if it is offset by holdings of cash and bonds, which would benefit from the lower inflation that could accompany lower commodity prices.

The other type are stocks that the market considers to have gone 'ex-growth'. These now include tobacco, utilities, pharmaceuticals and the bigger food retailers - which is what you're holding. On these there's good and bad news.

The bad news is that such stocks are not risk-free. Not only are they correlated with the general market - as are all shares - and so would go down if the market falls, but they also have risks of their own.

One is political risk. Utilities, for example, face the danger of tougher regulation or even nationalisation if Jeremy Corbyn becomes Prime Minister. Another risk is negative momentum. Because investors often underreact to bad news, stocks that see a decline in growth prospects sometimes don't immediately fall as far as they should but instead drift down in subsequent months. This has happened to Tesco (TSCO), for example.

What's more, big ex-growth stocks are quite rare. This means there's a danger of concentrating your holdings. In this context, be wary of funds. For example, Brunner's (BUT) biggest holdings include HSBC (HSBA), Royal Dutch Shell (RDSB), BP (BP.) and Vodafone (VOD). And Invesco Perpetual Income Fund has a lot of British American Tobacco (BATS) and AstraZeneca (AZN). But you already hold these stocks. You might not be spreading risks by holding them as much as you think.

There is, though, a big advantage to such stocks. They are big and mostly defensive in the sense that being ex-growth they are less vulnerable than other stocks to any big increase in general market pessimism. And we have plenty of evidence to suggest that such shares do well on average. This might be because their size gives them a degree of monopoly power, and investors under-rate the importance of this.

On balance, then, as long as you really are willing to tolerate the likelihood of market falls - and biggish drops in one or two of these stocks - I don't think you're doing much wrong.

How to improve your portfolio

David Liddell, director, IpsoFacto Investor

This portfolio, including the cash, loans to children and premium bonds, has about 37 per cent in unit trusts/open-ended investment companies (Oeics), 38 per cent in direct equities, 22 per cent in cash and 3 per cent in an investment trust, Brunner.

Excluding the cash, it yields about 3.4 per cent, which is not dissimilar to the yield on the FTSE All-Share. In terms of the allocation between asset classes, and assuming the loans are recoverable, as you say, this looks about right in current circumstances. But a small amount of bond or absolute-return exposure might be wise over time, particularly if bond yields start to rise, so you may wish to increase the bond exposure.

Two other things are notable: the high weighting to Invesco Perpetual Income Fund (27 per cent) and the holding in Lloyds Banking (LLOY) of about 5 per cent. Invesco Perpetual Income, managed by Mark Barnett following Neil Woodford's departure to set up his own asset management company last year, has a strong performance record: it is up 88.8 per cent over the five years to 31 July against 66.6 per cent for the Investment Association UK All Companies fund sector. But as a fan of investment trusts I can't help pointing out that Edinburgh Investment Trust (EDIN), which is also run by Mark Barnett and has a very similar underlying portfolio, has made a net asset value (NAV) and share price return of 127 per cent and 115 per cent, respectively, over the same period. Edinburgh also has a higher dividend yield, largely due to lower charges.

While investment trusts may be more volatile because of borrowing and the potential for the discount of the share price to NAV to widen, for security of income over the long term they are excellent vehicles. But given your already high weighting to Invesco Perpetual Income, I would advise reducing exposure to this fund management style rather than increasing it. I would swap the accumulation share class for an income one, at the very least. Investment trusts to consider as alternatives are Temple Bar (TMPL), Lowland* (LWI) and Finsbury Growth & Income* (FGT), although the yield on the latter is relatively low.

As for Lloyds, this is an interesting situation for income investors, since the board has signalled that over the next few years the dividend should rise from the current 1.5p to a level of something over 4p, assuming that further fines for foreign exchange rigging or other misdemeanours don't get in the way. Nonetheless, this is quite a chunky holding and you might consider swapping some of this exposure for HSBC, where a 5 per cent-plus yield is already on offer. Generally, however, to meet your objective of security of income without too much risk I would advise reducing some of the larger direct equity holdings, in particular Dignity (DTY) and Compass. Both of these have performed pretty well so lock in some profits and replace them with funds or investment trusts, as suggested above.

The main other point that stands out is the relative lack of international exposure. With emerging markets in particular having a rough time and sterling quite strong, for those long-term investors who can put up with volatility, now is a great time to consider looking overseas. Murray International Trust* (MYI), Aberdeen Asian Income* (AAIF) and JPMorgan Emerging Markets Income* (JEMI) all have yields close to or over 5 per cent. For developed markets, consider North American Income Trust (NAIT) and JPMorgan European Income (JETI).

Finally, it seems sensible, as you have been, to keep building up your Isas at the expense of the trading account holdings, making sure you use both of your CGT allowances fully.

Richard Anderson, head of pensions policy, Lloyds Bank Private Banking

The total value of your assets varies due to the high number of direct share holdings. You have just over 70 per cent of your assets in UK equities, with another 22 per cent held in cash. This leaves a minimal amount in other asset classes and, as a result, your portfolio lacks some diversification. Portfolios like yours are susceptible to downturns in the market due to the high equity content and this may mean that returns fluctuate below your desired income level.

In accordance with our categorisation, your attitude to risk is medium. However, looking at the asset mix, your portfolio is more appropriate for a higher risk category so you should consider reducing the risk.

Many of the assets you hold overlap, in particular you hold a considerable proportion of your portfolio in two Invesco Perpetual funds which invest in some of the same shares you hold individually.

Our typical medium-risk portfolios would contain all four main asset classes: cash, bonds, equity and property, with the investments spread in terms of geographical location and in a variety of sectors. By increasing the diversification of your assets, you reduce risk by not putting all your eggs in one basket. The aim is to increase the potential for your portfolio to provide a positive return in a range of market environments, so even if one holding makes negative returns in a given environment the others should help balance the effect of this, as some will perform more positively. This would also help provide a more consistent income in changing market environments.

The other factor to consider is your capacity for loss, that is, would you be able to maintain your current and future standard of living regardless of how your investments are performing? Based on the information you have provided you may be able to, however you would need to generate income from your Sipps to make up any shortfall.

Generating your income stream as tax efficiently as possible should be the main goal. Where possible, your strategy of moving the share holdings into Isas should be continued and from the next tax year you should maximise the new £5,000 dividend allowance.

*IC Top 100 Funds

*None of the above should be regarded as advice. It is general information based on a snapshot of the reader's circumstances.