How can I create an income of £60,000 a year?

Stephen is age 57, lives in the United Arab Emirates and earns £78,000 a year tax free. He owns five buy-to-let properties which in total general an annual rental income of £83,800.

Stephen has two grown up children.

“I would like to retire at about age 65, probably in the United Arab Emirates but possibly the UK, depending on my family situation," he says. "So I want my assets to be able to generate an income of £60,000 a year starting within the next 10 years. I intend the income to come from a mixture of equity investments, rental income and cash. 

"I would also like to pass the assets from which I generate this income, intact, to my children at some point during my lifetime or when I die. I don’t expect to sell my properties but rather pass them to my children. I had already built up savings within lifetime individual savings accounts (Isas) and regular Isas to contribute towards deposits for their first homes. They have now used these funds.

"I can tolerate risk and the value of my investments falling by up to 30 per cent in any given year. I would be prepared to invest cash in such a situation because I have been investing for 40 years and over time this appears to have been the right strategy. I did this, for example, in 2008-2009 and in early 2020.

"I hold most of my liquid investments in a self-invested personal pension (Sipp). I prefer low-cost passive funds which I hold alongside some active funds, although nothing too complicated.

But I enjoy trading a small portion of my investments – not life changing sums of money – dipping in and out of markets. For example, I have recently bought International Consolidated Airlines (IAG), Avation (AVAP) and Avon Protection (AVON). I hold these in a trading account. Information sources such as Investors Chronicle and trading websites have given me hours of fun over the years. 

"My property portfolio adds diversification, and rental income and asset appreciation over time. So I am thinking of investing in another buy-to-let property."

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS INVESTOR'S CIRCUMSTANCES.

Chris Dillow, Investors' Chronicle's economist, says:

Your investments are mainly invested in buy-to-let properties, so carry three risks.

If or when when interest rates rise, you will have higher mortgage payments, albeit not necessarily immediately if they are fixed-rate mortgages. And there’s also a danger that rising interest rates will reduce property prices.

There is also liquidity risk. In hard times, property becomes difficult to sell – at least for prices that you think are acceptable. Even if the market withstands the higher interest rates we could see in the next couple of years, there will be a downturn at some time in the next 10 years.

And there’s exchange rate risk. When the UK property market falls, the US dollar tends to rise. This, for example, happened in the early 1990s and 2008-2009. This is a global phenomenon because downturns in the world property market result in investors becoming more risk averse and dumping risky currencies in favour of US dollars.

This is a big issue for you. As a resident of the United Arab Emirates, your living expenses are tied to the US dollar because the dirham is linked to this. If you have sterling assets – whether property or equities – you have a currency mismatch between your assets and liabilities. And this could be detrimental to the overall value of your portfolio in a global recession, or property or equity bear market, because the value of your sterling assets would fall relative to US dollars and dirhams. So I suggest addressing this issue. Although it’s very wise to hold a lot of cash, given your interest rate and liquidity risk, it might be better to have this in US dollars.

Your attitude to trading is sensible. Very few investors get rich by actively trading, unless they are lucky, because short-term price moves are largely unpredictable. So you should indeed regard trading as a bit of fun – gambling with slightly better odds. But keep a diary of your trades and your motives for making them as, over time, this will highlight whether you make systematic mistakes or good decisions. Doing this will help you learn about trading and your decision making process generally.

Also be careful of buying after falls in the market, of which there’ll be many more over the rest of your investing career. An old saying, 'never try to catch a falling knife', exemplifies the danger here of wishful thinking. This is because it’s easy to see falls as mere dips and hence buying opportunities when in fact they are the start of longer bear markets. When over-valuations correct themselves, the process can be long and deep. For example, after the 2000 bubble the Nasdaq Composite index lost more than 60 per cent over three years. And momentum works both ways: it can drive prices down further than you think, as well as further up.

So don't rely on unaided judgment when deciding when to re-enter markets. Instead, consider some version of the 10-month rule – buying assets when their prices are above their 10-month average. This never gets you in at the bottom but does save you from catching a falling knife.

Jason Porter, business development director at Blevins Franks, says:

Your portfolio is heavily invested in equities which is commensurate with a high-risk investor. This asset allocation is suitable given your aggressive attitude to risk. And because you have been investing for 40 years you are likely to be knowledgeable and have a proficient understanding of the associated risks.

Your portfolio's equity exposure is higher than a 'lifestyle approach' to investing would advocate, which is understandable given your stated risk tolerance. A lifestyle approach would involve moving to a higher weighting in safer assets such as fixed income and bonds as you approach retirement. But this would not help you meet your objective of generating income from your assets because fixed income yields are very low.

Your portfolio makes good use of passive funds which provide liquid exposure at a low cost. However, iShares S&P 500 GBP Hedged UCITS ETF (IGUS) and iShares S&P 500 Information Technology Sector UCITS ETF (IITU) are likely to have a significant number of the same holdings as each other (see tables). This results in high correlation and low diversification benefits.

Your portfolio also seems to have a growth bias which results in it being overweight to US companies versus companies in the rest of the world. So you could introduce regional equity funds and a value investment style to improve diversification. Although growth style investing has outperformed in recent years, it would be prudent to have some exposure to other styles so that your portfolio is not reliant on a single style or geography for its returns. Vanguard LifeStrategy 80% Equity (GB00B4PQW151) is a good example of a well-diversified holding that provides broad equity exposure (see chart).

Your portfolio's high allocation to cash will act as a drag on its performance in a rising market. This may impact the asset value from which you have to draw an income when you retire. Given your relatively long investment time horizon and capacity to bear risk, you could invest more of the cash to benefit from additional time in the market, rather than retain a large cash weighting for optionality.

In its current form, your portfolio is insufficient to help meet your income objective, as I estimate that it has an income yield of less than 1 per cent. So consider gradually switching it towards income producing assets before you retire and combine what they produce with the income generated from the net rental income yield of your properties. As you have significant exposure to real estate via your buy-to-let properties, there is no need to hold listed real estate in your Sipp.

While your trading account is not financially optimal, it is important to keep this portion of your assets small and to let the remainder of your assets provide the bulk of your long-term capital return.

A UK Sipp falls outside of your estate for inheritance tax purposes. This is beneficial, given your objective of passing assets to future generations of your family. But further wealth planning for this is necessary.