Don't take big bets on individual shares

"With my self-invested personal pension (Sipp) and individual savings account (Isa) I am aiming to increase capital and reinvest dividends for a pension later in life," says Henry. "I am also looking to increase the capital of my unwrapped investments, but with these I want to maximise dividends to use as income. I would like to increase the income from this portfolio, as well as preserve capital.

"Annual loss is not of concern as long as the dividends pay out - I rode through 2007 without any real effect.

"I like simplicity and clarity, and prefer only to trade when topping up. I do not watch my investments intently. I think blue-chip shares with dividends are easily understandable, for example I am thinking of investing in National Grid (NG.), but have never done well with funds. Financial advisers have generally lost me money, taken their commission and run.

"My most recent trades were the sale of some shares in Balfour Beatty (BBY), and the purchase of shares in Persimmon (PSN) and South32 (S32)."

Henry's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

The great thing about this portfolio is that it has a strong bias towards defensives, and we know that these tend to beat the market on average over the long run.

But the question is, why? One possibility is that they have what renowned US investor Warren Buffett calls "moats". These are things that protect them from competition. For example, with Unilever (ULVR) this is strong brands, with companies such as SSE (SSE) and the oil majors it is high capital requirements, and with GlaxoSmithKline (GSK) it is both.

Another possibility is that investors who want geared exposure to the prospect of rising stock markets own higher-beta shares, which leaves low-beta ones underpriced. Whatever the reason, you're exploiting one of the two strongest mispricings in equity markets - the other is momentum.

This, though, leaves us with a problem: it's hard to improve greatly upon this portfolio. You say you want more income while preserving capital. But I'm not sure this can be done.

Put it this way. Why should one share pay a higher yield than another? Why don't investors just sell the low-yielder and buy the high-yielder until yields are equalised? There can only be two reasons why they don't do this.

One is that they believe the higher-yielder has worse growth prospects. The other is that it is riskier. This common sense says you can only get more income while preserving capital by either buying stocks whose growth prospects are better than the market expects, or by taking a risk that pays off.

You're already doing the former. If Mr Buffett is right, defensives outperform because investors under-rate their growth prospects by underrating the importance of barriers to entry to growth.

The only question then is: are you holding the right defensives? Here, I'd caution that having 30 per cent of your portfolio in one stock - Unilever - is a big bet. You might want to diversify into other defensives, such as National Grid, tobacco, or food and drink producers.

Another way to seek both income and capital preservation is to take on cyclical risk, such as miners and some builders. We're approaching the time of year when this risk often pays off. But it is obviously dangerous. Whether you want to take this risk depends on your personal attitude to risk.

However, I'd urge you to ask: do I need income? It's a common mistake for investors to take income and so acquire a tax liability, while they don't take full advantage of their capital gains tax (CGT) allowance. What matters is total returns: as long as these are good you can create your own dividends simply by selling some stock. Yields matter only to the extent that they signal a stock might be underpriced - something that is often true for defensives, but not so often for others.

There's one thing you say that troubles me, that a loss is "not of concern as long as dividends pay out." A big loss is often due precisely to fears about dividends. It takes considerable confidence - or pigheadedness - to stick with a stock through such fears, and to keep calm when everyone else is panicking.

My worry about statements like these is that they are often made in good times, and the investor then discovers in bad times that they are more concerned with risk than they thought, and sell when prices are low. Please ensure this doesn't happen to you: could you really cope with, say, a 30 per cent loss - the sort of thing that's quite possible in a bear market?

If not, consider trimming your equity exposure.

Paul Derrien, investment director, Canaccord Genuity Wealth Management, says:

The dividend income from the investments outside the Sipp and Isa exceeds £5,000 a year. This will have additional adverse tax implications, especially as you are likely to be a higher-rate taxpayer. Where possible, ensure that the higher-yielding equities are held in the Isa and Sipp, keeping the dividend income outside of these wrappers below £5,000 per year. With attractive Isa allowances this is unlikely to be much of a problem: the Isa allowance for the current tax year is £15,240 and for 2017/18 rises to £20,000.

You have a reasonable spread of equities and a portfolio with St James's Place that I would expect is more of a multi-asset fund, thus providing some diversification.

The equity portfolio is already achieving your long-term income target as it yielded 4.4 per cent at time of writing, although you mention that you are looking to increase the overall yield and preserve capital. It is this latter point where I feel the portfolio needs some work.

Richard Hunter, head of research at Wilson King Investment Management, says:

You have generally well-constructed and diversified holdings, with a clear understanding that investor requirements tend to switch from capital growth to income as time progresses. That said, your other sources of income seem adequate for a comfortable standard of living without even counting the boost provided by your portfolios, unless you have any debt on top of this.

Each of your three accounts deliver on income, with yields of approximately 5 per cent for the Sipp, 6 per cent for the investment account and 5 per cent for the Isa.

For the most part, you have a solid selection of blue-chip companies. And, given the variety of markets and businesses in which they operate, you have also managed to achieve diversification not just in terms of business mix, but also exposure to foreign markets, with holdings such as GlaxoSmithKline, Unilever and the oil stocks.

Some of the stocks add a defensive element to the portfolio, which is perhaps of particular relevance at the current time.

We assume that your tax position is reviewed regularly, particularly with regard to income tax and inheritance tax, as well as CGT, which you could incur on profits made in your unwrapped investment account.

HOW TO IMPROVE THE PORTFOLIO

Paul Derrien says:

You are significantly exposed to just two companies within the equity portfolio - GlaxoSmithKline and Unilever represent around 50 per cent. You will have benefited substantially from the post-referendum rally due to the currency effect on these companies, so this is an ideal opportunity to crystallise these gains by reducing these holdings and using the proceeds to add some diversification. The yield on Unilever is 2.8 per cent, while the yield on GlaxoSmithKline of around 5 per cent is far from guaranteed, so by diversifying away from these holdings you could achieve your aim of improving the income from the portfolio and potentially preserving capital.

To improve the portfolio's ability to preserve capital you should look at alternative asset classes as well as equities. You may have been unaffected by the market swings during the credit crunch, but as you get older your circumstances could change and you might need to draw on the capital. So reducing the portfolios' exposure to equity market volatility is paramount.

I would suggest that your individual equity positions not exceed 6 per cent or around £20,000. If you followed this rule with Unilever and GlaxoSmithKline this would free up around £120,000, and I would split this between equity and non-equity investments at this stage. By doing this you will reduce the downside risk to the portfolio of another sharp fall in equity valuations, and while this is a modest sum to invest away from equities now, I would suggest increasing this over the coming years.

I would add some of the cash raised from these sales to the existing equity investments within the portfolio to rebalance the size of the holdings, including Jupiter India Fund (GB00BD08NQ14). India is one of the core geographical holdings within our current asset allocation model.

There are also a number of individual high-yielding equities that we would buy at this time such as Lloyds (LLOY), National Grid, Aviva (AV.) and Interserve (IRV).

Alongside these I would also consider the following non-equity investments with attractive return profiles:

■ NB Global Floating Rate Income Fund (NBLS), which has a yield of nearly 4 per cent.

■ Tesco Personal Finance STG 1.00% RPI-LKD NTS 16/12/19 (TS1L). The return here would come mostly as capital, and is tax efficient in the Isa and Sipp. This bond will provide some inflation protection as it is linked to retail prices index (RPI) inflation, which is likely to rise over the coming year.

■ Renewables Infrastructure Group (TRIG) has a yield of around 6 per cent. This sells renewable energy to the grid and pays out the return as income.

Richard Hunter says:

Your Sipp has 30 per cent exposure to GlaxoSmithKline and 29 per cent to Unilever. The Isa has 32 per cent exposure to Royal Dutch Shell (RDSB) and 21 per cent to Unilever, while in the investment account there is a further 20 per cent exposure to GlaxoSmithKline, 38 per cent to Unilever and 21 per cent to Vodafone (VOD).

While these exposures are not a problem in themselves, there may be an argument for rebalancing some of these weightings so as to reduce heavy reliance on individual shares.

Dividend cover is also a slight concern in certain areas of the list. Dividend cover is effectively the number of times a company could pay a dividend to shareholders from current earnings. As a general rule, dividend cover of 1.5 or above is acceptable.

But anything below 1 is indicative that dividends are being paid from reserves and are ultimately unsustainable, although by the same token the negative figure could be the result of an exceptional item that has reduced earnings, such as an acquisition.

Even so, a comparison of current and forecast dividend cover projections shows that there are very few stocks in your portfolio that exceed 1.5 on both counts. Mining stock BHP Billiton (BLT), for example, has current cover of 0.8 and projected cover of -3.6, while Vodafone has current cover of 0.4 and projected cover of 0.6.

The oils companies are also light, for example BP has current cover of -0.9 and projected cover of 0.4. The chief executives of BP (BP.) and Shell have constantly reiterated the safety of the dividend payments, but you should always consider dividend cover.

In terms of your future watchlist there are a variety of high-income funds that could potentially fit in with your overall investment objectives.