'How do I shift from growth to income?'

Market timing is notoriously difficult, but some investors do occasionally strike gold. Such was the case for Gary, who was fortunate enough to have invested a lump sum from a pension fund at the bottom of the market in 2020, a move that provided him with, as he describes it, “solid growth”.

However, deciding where to put profits to work can be difficult – and for Gary this is complicated by a desire to provide for himself in a time of change and to shift the focus of his portfolio from investing for growth to income generation. “I have recently separated and so need my portfolio to provide 6 per cent a year in total returns, while also making sure I can leave an inheritance for my daughter," he says.

Gary, who is 68, has only been picking investments for three years and describes his ideal investment as a “well-managed, yet undervalued, company with a reasonable dividend yield”. Some of his recent investments reflect that interest in income, and he has put money into Henderson Far East Income (HFEL), a trust that yields around 10 per cent, and miner BHP (BHP). But there is still more to do to shift this very growth-focused strategy.

In terms of other potential buys, he notes: “I invested in Rolls-Royce (RR.) as the share price drastically fell last year, and would consider further investment if it slides again.” Shares have recovered well in 2023, up 68 per cent in the past 12 months. He also recently sold a position in the Baillie Gifford Positive Change Fund (GB00BYVGKV59).

However, while Gary may have an eye for a bargain, he still considers himself risk-averse. “I am generally cautious, with a few notable exceptions,” he says. “I’m happy to make modest capital gains each year and similarly averse to immodest losses.”

Dividend income is the priority from Gary's £76,000 portfolio, with 6 per cent providing around £4,500 a year. He does have some other forms of income, and receives £11,511 a year from the state pension, and around £6,500 from workplace pensions. He also earns £13,200 from part-time work.

To boost his income down the line, he plans to add to his pot. “My mortgage-free three-bedroom home is worth around £350,000,” he says. “I plan to downsize and buy for around £200,000 and set aside the £150,000 to invest. I also receive 3 per cent a year on £35,000 of cash savings.” The additional £150,000 would take his annual investment income to £13,500.

The portfolio ranges from energy and mining plays, such as BP (BP.) and Gulf Keystone Petroleum (GKP), to financials, a few investment trusts and a sector fund – Legal & General Global Technology Index (GB00BJLP1W53). As the table shows, the portfolio already has certain income credentials, with yields of a number of holdings exceeding 5 per cent.

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

Rory McPherson, chief investment officer at MFDM, says:

You have done well by buying good equity investments at good prices. However, I think it would be helpful to drill into your stated aim to be a “cautious” investor as this doesn’t tie in with a portfolio that is nigh on 100 per cent in equities. That being said, your investment aim of a 6 per cent total return with a bias towards income is certainly achievable.

By not owning bond investments you avoided massive losses last year and can now buy in from a position of strength. Many bonds are trading with yields not seen for 15 years: 6 per cent for what are highly rated investments.

You might want to look at having some “stabilisers”. Funds such as the Axa Global Short Duration Bond Fund (GB00BDFZQV30) and Vontobel TwentyFour Absolute Return Credit (LU1368730674) are yielding around 7 per cent and 6.5 per cent, respectively, and have potential for growth too.

These funds own bonds that are within five years of maturing, which are unusually attractive at the moment having sold off following the fastest pace of interest rate rises since the late 1980s. This means they're yielding more than longer-dated bonds.

These sorts of investments can provide a nice ballast to your growth-focused portfolio, as the lion’s share of the return is derived from income. Alongside this, you might want to have a look at other bond funds such as the BlackRock Corporate Bond Fund (GB00B4T5JV79), yielding around 7 per cent, and the Artemis Target Return Bond Fund (GB00BJXPPJ80), which yields around 6 per cent.

This should be complemented by some global equity funds, such as the Royal London Global Equity Diversified Fund (GB00BF93WF36) and TB Guinness Global Equity Income (GB00BNGFN669).

Given you want income, it may be worth pairing these with the FTF Clearbridge Global Infrastructure Income Fund (GB00BMF7D779), which yields 4 per cent, and the Pacific North of South Emerging Markets All Cap Equity (IE00BD9GKZ43), which yields around 4.5 per cent. 

The primary port of call is nailing down what your attitude to risk is and then building a robust and diversified portfolio that matches that. This probably involves more bonds. But the good news is that now is a really fantastic time to be looking for that.

Alex Brandreth, chief investment officer at Luna Investment Management, says:

There is a mismatch between your risk tolerance and your portfolio. The reason why your portfolio is high-risk is because it is mainly invested in equities with some smaller companies, for example Gulf Keystone Petroleum has a market capitalisation of just £270mn. You can manage 6 per cent a year from your investments but it would be better achieved from a diversified, balanced portfolio that includes bonds, alternatives and cash, especially given interest rates are at their highest level for 15 years. Although I note your separate £30,000 cash savings earning 3 per cent.

Moves in interest rates over the past 18 months have repriced most investments, with government and corporate bonds offering attractive yields. This means a 6 per cent return is achievable. 

The yield on a corporate bond index is now 6.6 per cent and the duration 6.2 years; compared with from a 2 per cent yield and 8.5 years duration at the start of 2022. These assets should be the bedrock of an income-generating portfolio, and they de-risk it at the same time.

A portfolio for a medium-risk investor, which is how you have described yourself, should have roughly 60 per cent in stocks, 20 per cent in bonds and 20 per cent in alternatives. Around half of the equity part should be in UK stocks as valuations are attractive and to manage currency risk. The remaining should be spread across the US, Asia, Japan, emerging markets and Europe.

Within bonds, you should own government and corporate bonds, but favour shorter-dated bonds as they are less volatile in the current backdrop of high inflation and rising interest rates. Alternatives should include property, absolute return and a small allocation to private equity.

Another issue is concentration: you only have 13 individual companies, which is not diversified enough. To solve this, add more funds and investment trusts. You have the Henderson Far East Income and Legal & General Global Technology Index funds, but there is scope for more. Using funds introduces another level of costs, but the diversification benefits outweigh the cost.

There are also other asset classes you may want to consider. I notice that you already have some holdings in infrastructure, which we would class as alternatives, but some exposure to real estate may also be appropriate. Real estate in particular has been hit hard by the recent changes in interest rates and presents an interesting buying opportunity.