Join our community of smart investors

74-year-old seeks sustainable 4 per cent

Our reader is in his 70s and relies on income from £400,000 he's built up in individual savings accounts and self-invested personal pensions. Three experts explain how to improve his portfolio
74-year-old seeks sustainable 4 per cent

Our reader, who wishes to remain anonymous, is 74 and has been investing for 50 years, achieving a portfolio worth £400,000.

He says: "I depend very much on the income provided since I only have the state pension plus a small private pension of £3,750 a year, which does not increase with inflation. I also have two part-time jobs which pay £7,000 each. My wife has the state pension. My taxable income is £27,000 and my wife's is £6,000 - both excluding dividends from my individual savings account (Isa). I have not drawn down any money from my self-invested personal pension (Sipp).

"I aim to achieve a high sustainable yield of about 4 per cent. The yield ought to have the prospect of increasing with inflation. Low risk would be preferable and, although I am not really concerned with capital growth, I would like the capital to increase with inflation.

"I have to look to the future and feel the portfolio needs tweaking in some way. Most of my buys have been recommended either in the Investors Chronicle or Daily Mail. However, I have recently decided that I should be getting into investment trusts, for their expertise, rather than specific companies. I am heavily skewed towards the UK market, but feel I should be investing in global income funds, America and the Far East. I also feel I have too many holdings."

Reader Portfolio
Anonymous 74
Description

Isas & Sipps

Objectives

Sustainable yield of 4 per cent

ANONYMOUS PORTFOLIO, AGED 74

Name of share or fundValue%
Isa
Bovis Homes (BVS)£4,9672
British American Tobacco (BATS)£6,9952
Compass (CPG)£5,5132
Diageo (DGE)£6,5112
Direct Line (DLG)£2,7761
IMI (IMI)£10,6204
Indivior (INDV)£2340
Invesco Perpetual High Income Fund Inc (GB00BJ04HQ93)£7,5002
John Wood (WG.)£4,4801
Legal & General (LGEN)£9,6953
Melrose Industries (MRO)£1,8331
Merchants Trust (MRCH)£10,1243
National Express (NEX)£2,8341
Neptune UK Mid Cap A Acc (GB00B3D7FD61)£11,6884
New City High Yield (NCYF)£6,8102
Primary Health Properties (PHP)£8,9983
Randgold Resources (RRS)£2,3851
Rightmove (RMV)£2,9971
Reckitt Benckiser (RB.)£7,2062
Rio Tinto (RIO)£6,2692
RPC (RPC)£3,2311
SSE (SSE)£12,5194
UK Commercial Property Trust (UKCM)£8,5213
Unilever (ULVR)£7,0162
United Utilities (UU.)£17,2506
Verizon (VZC)£2,5931
Vodafone (VOD)£3,5881
Cash£2,5001
Sipp
Babcock International (BAB)£11,4114
Elementis (ELM)£4,3541
Hammerson (HMSO)£7,4863
IG (IGG)£6,7782
Londonmetric Property (LMP)£16,3005
Severn Trent (SVT)£4,1301
Synthomer (SYNT)£4,6632
Wife's Isa
Eros Inter 6.5% bonds (ERO1)£3,4771
Balfour Beatty (BBY)£7,2302
Tate & Lyle (TATE)£3,5821
GlaxoSmithKline (GSK)£5,8152
Sky (SKY)£8,7153
Centrica (CNA)£2,8101
National Grid (NG.)£7,9833
Invesco Perpetual Monthly Income Plus Inc (GB0033051334)£7,9063
Invesco Perpetual Monthly Income Plus Gross No Trail Inc (GB00B8N47B49)£8,8893
Cash£15,0005
Total Isas & Sipps£304,182100
CASH ON DEPOSIT (not in Isa)£100,000
TOTAL PORTFOLIO VALUE£404,182

 

INVEST FOR TOTAL RETURN

Chris Dillow, Investors Chronicle's economist, says:

My biggest gripe is your attitude to income. You say you are "not really concerned with capital growth" but want a high yield.

For many investors, this is foolish simply because it means they pay income tax on dividend income while not fully using their £11,000 capital gains tax allowance. That means they hand more money over to HMRC than they need to.

For you, this doesn't seem so much of a problem because this portfolio is tax-sheltered anyway. Nevertheless, looking for yield can be risky simply because it can distort your portfolio.

This is simply because you don't get 'owt for nowt'. If a stock has an attractive yield, this can only be because investors believe it is unattractive in other ways. Most commonly, this lack of attraction lies in the belief that it offers less growth. But it can also be a sign that the stock is considered risky, in the sense that it could do especially badly in recession; many construction shares have traditionally had high yields for this reason.

What matters is total return, not dividends.

 

Sheridan Admans, investment research manager at The Share Centre, says:

You are in a similar position to many investors in their 60s and 70s. A growing income is of the utmost importance, alongside some capital preservation - at least to keep pace with inflation. You will also need your portfolio to give you and your wife the confidence that it won't let you down when you need the income most - especially when you give up the two part-time jobs you currently hold down.

With the current pension and annuity reforms, I'm sure you are giving some serious thought to what you might do to maximise income from your Sipp when you decide if drawdown, or the purchase of an annuity, is the best way to go. As annuity rates are so low it is tricky to find an income stream that is very low risk and provides you with the certainty you require.

 

David Liddell, the founder of online investment advisory service IpsoFacto Investor, says:

Investing usually involves some sort of trade off between objectives; here you are looking for a yield of 4 per cent with a preference for 'low risk'. Your current portfolio, excluding the cash, is yielding approximately 3.8 per cent.

What is available in the market? Equities (FTSE All-Share) are yielding 3.3 per cent, 10-year gilt yields are 1.7 per cent and cash is paying not a lot. Therefore, we are pushed towards equities, particularly as some form of inflation protection is desirable (in this analysis we ignore buy-to-let and we don't think corporate bonds are good value). Under the conventional view, equities would be regarded as the higher risk of the three asset classes. There may also be a trade off between high yield now and sustainable yield going forward.

There are, we assume, two elements to the question; first, what adjustments could be made to the current invested portfolio to meet your objectives. Second, the more general question of your overall asset allocation, including potentially investing the cash on deposit. In terms of the first, we think you are very much on the right lines, reducing individual equity exposure in favour of investment trusts and increasing the international element somewhat. Investment trusts can be excellent vehicles for income investors.

The bigger question may be what is the appropriate asset allocation for you; we don't have the scope to go into this in detail, but your age and other circumstances will be relevant. Given you already have a significant equity portfolio, you may be right to bide your time in investing your cash (and this may be needed for other purposes); but do consider the three-year NS&I 65+ Guaranteed Growth Bonds as a partial alternative. With the likelihood that interest rates will rise there may be better opportunities to invest in either cheaper equities or higher-yielding fixed income in the future. Don't necessarily ignore an annuity (inheritance considerations aside) as a part of your portfolio, if interest rates start rising and gilt yields increase to a more reasonable level.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your portfolio is actually weighted towards the best high-yielders: defensives such as United Utilities (UU.), British American Tobacco (BATS), and GlaxoSmithKline (GSK). There's good evidence that, in the long run and on average, these do better than they should. This is perhaps because investors penalise them too much for their lack of growth with the result that they are, on average, underpriced.

For this reason, while I'd suggest you simplify your portfolio - 42 assets is too many - I'd keep its weight towards defensives.

That said, your desire for income might be exposing you to risk in the form of your holdings of bond funds. Because these take credit risk, there's a danger of them doing badly if the economy goes into recession and so credit risk rises. You might think this risk small, but it is a circumstance in which your equities would probably also do badly; defensive stocks are only relatively defensive - they usually fall less than the market in bad times, but still fall.

You do, however, have protection against this, in the form of a decent-sized cash weighting.

I'm not sure there's a pressing need for a global income fund. First, because, as I've said, income stocks often come at a price. Secondly, such funds often have high fees. And, thirdly, you have international exposure anyway simply by holding UK equities: global markets, remember, tend to rise and fall together.

The strongest case for overseas funds is as insurance against the UK suffering localised economic troubles. This case, though, is strongest for younger investors who have invested their human capital in the UK economy as well as their financial wealth and face the (small but nasty) long-run risk of domestic stagnation. I'm not so sure it's so applicable in your situation. That said, there is nothing wrong with a low-cost global equity tracker fund.

 

Sheridan Admans says

As your risk level is low, I would encourage you to consider reducing your exposure to single companies and increase diversification via funds. I would argue that you should consider open-ended funds over investment trusts. Although investment trusts have their place in a portfolio, the management of them can be less predictable, complicated by gearing and trading at a discount or premium to their net asset value.

The current income from your investments is probably quite lumpy and this can make it difficult to know if you will receive sufficient income from month to month to cover your outgoings. There are some funds out there such as Investec Monthly High Income (GB00B8PLQH25) that pay out monthly, which are low in risk and can give you some certainty over your cash flow. The Investec fund currently yields 5.81 per cent.

There are also funds which make a point of delivering a reasonable yield and growing that income over time, such as Schroder Income Fund (GB00B5WJCB41).

Mixing your portfolio up to include a blend of equity, bond and possibly property would provide a good level of asset diversification and the regional diversification you are seeking. For equity, funds such as the CF Woodford Equity Income Fund (GB00BLRZQ620) and the Invesco Perpetual Global Equity Income Fund (GB00BJ04H253) would be advantageous. For exposure to bonds, you could consider the Henderson Strategic Bond Fund (GB00B03TP646), currently 50 per cent invested overseas, and for property, the Legal & General UK Property Fund (GB00BK35DT11).

This will also give you back some of your retirement so you are not worrying about the individual companies in your portfolio on a daily basis, as well as reduce the risk. I'm sure that you like picking individual companies and I don't wish to discourage that. However, to improve certainty and reduce the level of risk, it might be better to limit it to a handful of companies you know really well.

 

David Liddell says:

We would start with selling some of the larger lower-yielding holdings: IMI (IMI) and Babcock International (BAB) - watch out for ex-dividend dates though, as well as Neptune UK Mid Cap (GB00B3D7FD61). You might also consider trimming the exposure to utilities, perhaps by reducing United Utilities (UU.). We would try and nudge up the yield gradually, by replacing the sales with higher yielders.

In terms of replacements, you might like first to consider the iShares UK Dividend ETF (IUKD), yielding 4.4 per cent; this invests in the top 50 highest-yielding stocks from the FTSE 350 index.

For investment trusts we would start with Temple Bar (TMPL) and Edinburgh (EDIN); although these have lower starting yields than others, they may be able to increase dividends more quickly, and the former is ungeared (when cash is taken into account).

For greater international exposure, consider Murray International (MYI), although it is still on a premium and recent performance has been poor. We also like Aberdeen Asian Income Fund (AAIF) and JPMorgan European Income (JETI); although note that the latter has had a good run recently.

Mindful of sector diversification, ahead of adding to your property holdings, consider financials; for very good reasons this sector has been out of favour of late, but we may be approaching a time when some of the best dividend increases come from this area, as banks reinstate their dividends. Polar Capital Global Financials (PCFT) has a yield of 3.3 per cent, which it should be able to grow over the rest of its fixed life to May 2020.

Another approach would be to buy Lloyds Banking (LLOY) where a high yield can be expected in the future. In the same contrarian vein, you might consider a small allocation to BlackRock World Mining (BRWM).