Align your portfolio with your risk appetite and aims

Peter and his wife have three children who are not dependent on them, and they wish to leave as much as they can to them - medical bills permitting. Peter has recently had a few health problems so is looking to leave portfolios that do not need frequent attention.

"My wife has no interest in acquiring investing expertise, although my son may be able to help," explains Peter. "I would like to buy and hold a diversified portfolio of investment trusts and equities that will produce an income that is a good deal greater than that offered by cash. I am looking for a minimum dividend yield of 4.5 per cent, and am not so concerned with total return, although look for a modest annual increase in share prices to account for inflation. I am happy to include a few direct equities to help meet that goal.

"I started to invest at the end of 2015 on behalf of my wife after she received £90,000 following the sale of her share in a property. I began investing this money in investment trusts, aiming for a yield of 4.5 per cent, but have now reduced that target to a minimum of 3.5 per cent. With her portfolio I do not so much look for total return but rather to reduce the likelihood of capital loss.

"I do consider total return as I am aware of the possibility of creating an income by top-slicing holdings, but prefer to rely more on a reasonable dividend yield.

"I would say I have a medium to (hopefully) high risk appetite and am prepared to lose up to 10 per cent without getting too concerned, bearing in mind that I have a cash safety net. I also invest with a buy-and-hold policy so I do not anticipate getting concerned by volatile markets, which initially tend to overreact to negative sentiment. I would look upon this as a potential opportunity to pick up a bargain, especially when an investment trust moves to a discount to net asset value (NAV).

"I only consider selling a holding if a dividend is cancelled or reduced.

"My holdings and investment ideas are compiled mainly from information gleaned from Investors Chronicle, in particular John Baron's Investment Trust Portfolio.

"I use my broker Hargreaves Lansdown's and the Share Centre's websites to obtain as much background information as I can.

"I am considering raiding our cash to add around £20,000 to my portfolio and the same amount to my wife's, to acquire two new holdings and top up two existing ones, although am in no hurry.

"Investments I am considering adding include Berkeley (BKG), Manx Telecom (MANX), Acorn Income Fund (AIF), Murray International Trust (MYI), SQN Asset Finance Income Fund (SQN) and Securities Trust of Scotland (STS).

"Last October I sold National Grid (NG.), Royal Dutch Shell (RDSB), GlaxoSmithKline (GSK), M&G High Income Investment Trust and BlackRock Commodities Income Trust (BRCI), and re-invested the proceeds in Bluefield Solar Income Fund (BSIF), Invesco Perpetual Enhanced Income (IPE), City Natural Resources High Yield Trust (CYN), Henderson Far East Income (HFEL) and European Assets Trust (EAT).

"In my wife's portfolio I sold one-third of City Natural Resources High Yield Trust because it had had a good run, and topped up F&C Private Equity (FPEO) with the proceeds.

"I am thinking of selling Vodafone (VOD) and CF Woodford Equity Income Fund (GB00BLRZQB71) as I am not a great lover of open-ended funds."

Peter and his wife's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

In looking for dividend yields above 4.5 per cent you are fighting against basic common sense - that you don't get owt for nowt.

A fat yield seems like a good thing so why doesn't everybody buy high-yielding assets, driving prices up and eliminating such high yields? Because many investors think a high yield comes at a cost, which deters them from buying.

There are two sorts of cost. One is lower expected growth, so what you get in current dividends you lose in future growth. The other is extra risk - very often the risk of doing especially badly in a recession. For example, in 2007 mortgage lenders and housebuilders were on big yields, but were as good as wiped out a few months later.

High yields are on average attractive if they indicate low expected growth. This is because investors exaggerate the predictability of growth and underestimate its randomness. As a result, "low growth" high-yielding stocks are often too cheap - or at least they have been in the past.

If, however, a high yield comes at the price of extra risk, it isn't a bargain. However, it might well be worth having because if that risk receded the stock would soar - think of housebuilders in 2009-10 - but such a stock isn't a bargain.

Rob Morgan, pensions and investments analyst at Charles Stanley, says:

The beginning of the new tax year is a reminder of the importance of using allowances, notably individual savings accounts (Isas). I assume all your investments are held in Isas. If not, it would make sense to migrate as many of them as possible into Isas, as well as using your tax allowances for any new investments you make.

Ben Yearsley, director at Shore Financial Planning, says:

If you are a basic-rate taxpayer it is quite efficient to top-slice any gains to produce income, as you would incur capital gains tax (CGT) at a rate of only 10 per cent - and after you had used up your annual CGT allowance which is currently £11,300, or £22,600 for a couple.

However with the annual Isa allowance now £20,000 - £40,000 for a couple - it would only take a few years for you to shelter all your investments within this tax wrapper, meaning you would not incur income or capital gains tax.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You have a lot of high-yielding assets: CQS New City High Yield Fund (NCYF) and Invesco Perpetual Enhanced Income both invest in higher-yielding bonds, which would fall if an economic slowdown increases credit risk. City Natural Resources High Yield invests in mining stocks which would be hard-hit by a global slowdown, as would probably your emerging market funds. And European Assets Trust and Chelverton Small Companies Dividend Trust (SDV) hold small-caps, which are often cyclical.

You hold some of the better defensive high-yielders such as Vodafone and GCP Student Living (DIGS), but these are a minority. And they'll become a smaller minority if you dump CF Woodford Equity Income.

This isn't to say you need to rush to re-jig this portfolio. Your high cash holdings mean that your portfolio as a whole - which is what matters - isn't especially exposed to cyclical risk. That said, if a cyclical downturn hit your shares it would also make a rise in interest rates less likely.

It's quite possible that cyclical risk will pay off for a while longer. Many of your holdings stand to benefit from momentum effects and the world economy seems to be strengthening.

But this won't continue forever, so there are two things to watch for. One is prices relative to their 10-month or 200-day moving average. When prices dip below this average you should consider selling - momentum works.

The other is the shape of the US yield curve: the gap between 10-year yields and three-month interest rates. This is the best predictor of global recessions we have. If, or when, 10-year yields dip below three-month rates, it's a sign that the probability of a recession has risen. That's a cue to dump cyclical assets. You can make good money from holding cyclical high-yielders. But you need to watch out for sell signals.

Rob Morgan says:

This portfolio is focused on providing a high income, which is an understandable priority, although it is often the case that a better long-term total return can be achieved by accepting a lower income stream that has greater potential to grow over time. CF Woodford Equity Income is a holding that falls into this category.

I am sceptical of investment trusts that habitually pay income from capital reserves, such as European Assets. This works fine when the asset class the trust invests in is doing well, but in a sustained downturn it could be forced to sell holdings if it doesn't hold enough cash. Either way, long-term returns risk being diluted. Buying this trust on a discount is potentially attractive, but if its shares are trading close to NAV I would be tempted to look elsewhere.

I generally like using investment trusts as it's often possible to buy them at a discount to NAV to enhance yield. Any structural gearing can also help, albeit typically meaning more volatility. And investment trusts allow for some useful diversification into specialist areas and more illiquid asset classes.

However, I would not exclude unit trusts and open-ended investment companies (Oeics) as there's a great deal of fund management talent that you will miss out on if you do.

A diverse portfolio should always include various asset classes, the particular ones you include determined by your attitude to risk.

You have exposure to property and infrastructure, but there are some others you could consider for diversification without compromising on income, such as high-yield bonds. Options here include Royal London Sterling Extra Yield Bond (IE00BJBQC361) or Kames High Yield Bond (GB00B1N9DY51). High-yield bonds tend to carry less interest rate risk than investment-grade bonds, but if this is a particular worry NB Global Floating Rate Income (NBLS) would offer exposure to credit while significantly reducing this risk.

Ben Yearsley says:

I'm slightly confused by your objectives and the resulting portfolio. You are looking to reduce the likelihood of capital loss, but this isn't really compatible with a fair few of your investments. For example, City Natural Resources High Yield and JPMorgan Global Emerging Markets Income Trust (JEMI) are high risk and don't fit this objective, and Henderson Far East Income doesn't either.

And much as I like Chelverton Small Companies Dividend Trust I wouldn't call it low risk - it could easily fall 10 per cent - the level where you get concerned.

You need to decide whether capital preservation or a yield of 3.5 per cent to 4.5 per cent is more important, and the overall level of risk you are comfortable with. If capital preservation is the priority then the funds mentioned above should probably be sold and replaced with more balanced and stable investments such as Personal Assets Trust (PNL) or Troy Trojan Fund (GB0034243732). And I would probably look to sell F&C Private Equity.

Chesnara (CSN) and Vodafone should be fairly stable and offer a decent yield. I've held Chesnara, a consolidator of closed-end life companies, for a while and a similar company to consider is Phoenix Group (PHNX), which is much larger and has a yield of about 6 per cent. You could also consider BT Group (BT.A).

But I wouldn't hold just a few direct equities. If you want a portfolio of these you need at least 10 to 15 to achieve diversification. An area that seems cheap is financials, banks especially, so I would add Lloyds Banking (LLOY) and life company Aviva (AV.) which has a yield of 4.5 per cent.

While I'm a big fan of infrastructure investing via funds such as HICL Infrastructure (HICL), Bluefield Solar Income and Target Healthcare REIT (THRL), it's a trendy area so watch out for premiums to NAV, which might be an opportunity for profit-taking. HICL, for example, is on a premium to NAV of more than 14 per cent.

Foresight Solar Fund (FSFL), by contrast, is on a much smaller premium of 3.7 per cent so could be one to consider.

I question your dislike of open-ended funds. Surely as an investor you want to buy the best possible investment regardless of the structure? For example, there is much more choice for bond investors among open-ended funds, and I would add M&G Global Floating Rate High Yield Fund (GB00BMP3SD68) to your portfolio.

It yields about 4 per cent and the floating rate notes it invests in mean your capital should remain fairly static regardless of the direction of interest rates, unlike with most traditional bond funds where the capital falls when rates rise and vice versa. M&G Global Floating Rate High Yield satisfies both your yield and capital stability criteria.