'I've ditched buy-to-lets – can I invest and earn £30,000 a year?'

With costs and complications on the rise, quitting the buy-to-let market has become an increasingly logical choice for small landlords. But deciding where to put the proceeds of a sale is a much trickier decision, especially for those who still need a good level of income.

Jake finds himself in such a dilemma. He was fortunate enough to retire from a well-paid career eight years ago, aged 45, having amassed enough money to “invest and live off the income”. He bought two buy-to-lets that generated around £20,000 a year, and invests in shares that paid an additional £6,000 a year.

But now, a shift away from the property market requires a change in tack. “Earlier this year, I decided to quit being a landlord, both because of the hassle factor and likely reduced capital growth going forward,” he explains. He has sold his properties, which left him with nearly £800,000 to invest.

He has started the process, with £150,000 invested across JPMorgan Global Emerging Markets Income Trust (JEMI) and Vanguard’s FTSE Emerging Markets UCITS ETF (VFEM), FTSE Developed Europe UCITS ETF (VEUR), US Equity Index fund (GB00B5B71Q71) and Active UK Equity fund (GB00BK1XR392). On top of this, there is nearly £250,000 invested across 25 stocks, typically reliable dividend payers and mainly London-listed companies (see table below)

Another £300,000 is sitting in fixed-term savings products and bonds waiting to be invested, but given rising interest rates, even this is paying 6 per cent a year in interest for the moment. Then there's another £130,000 of cash in NS&I Premium Bonds and easy-access accounts, plus a mortgage-free £400,000 residence.

At 53, Jake is focused on generating income until his pensions kick in. “From 65 I'll receive £15,000 a year from final-salary pensions and two years later will receive the full state pension, around £11,000 in today's money. Both are index-linked," he says.

“My goal is to generate around £30,000 a year until then, and protect my capital to a reasonable degree.” This would require a yield of 7.5 per cent of his current £400,000 investment pot, or 4.3 per cent if you include the £300,000 currently sat in savings bonds. Jake is also due an inheritance of around £130,000, which would reduce his required yield should it be added to his investments. His two final-salary pensions could also be taken early but with reduced benefits.

Jake has a mixture of different investments: he started picking stocks around 15 years ago and tends to avoid funds due to their perceived high charges. That focus on cost is also reflected in the fact that three of the funds he does own are passives.

Of his investment style, Jake notes: “If a share has a sustainable dividend of 4 to 5 per cent that attracts me. I’ll take it and consider any share price growth as a bonus.” He has a fairly high tolerance for volatility, noting that his portfolio halved in value during the dark days of the pandemic. "It didn’t overly worry me, although I’d prefer it not to happen again," he adds.

His previous focus on property has caused one other complication, which may affect how much Jake has to withdraw from his savings. Many of the investments are outside tax wrappers, with only around £92,000 of his shares held in an 'individual savings accounts (Isa).

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

Rob Morgan, chief analyst at Charles Stanley, says:

Your target level of income is achievable, especially given current yields. It is therefore possible to construct a well-balanced portfolio that offers a high and sustainable level of income, with some potential for that to grow over time. But with pension income payable further down the line your situation is slightly different to that of many people in that you need to front-load your income.

The fact that investors don’t have to reach for yield is demonstrated by the investment-grade corporate bond market, where you can enjoy yields of 5 to 6 per cent with modest credit risk. Unlike cash rates, that level of return is effectively locked in for far longer and capital values should be far more stable than the stock market.

On a risk-adjusted basis, that is attractive and should not be ignored in an income-producing portfolio, especially given the chances of an environment where inflation decelerates faster than monetary policymakers adapt. This scenario would increase the risk of recession and hit corporate profits. This affects share prices in the shorter term. I note your aversion to holding funds owing to charges, but some corporate bond funds, such as Vanguard Global Credit Bond (IE00BYV1RG46) and Morgan Stanley Global Fixed Income Opportunities (LU1699749930), could be well worth using to provide good diversification and yields that match what you need.

Given that you only need to generate an average yield of around 4 per cent, a comparatively high level of income from bonds would also allow you to diversify your portfolio, and have a more conventional geographical spread. You are tilted markedly towards UK stocks with relatively little US exposure. I have my reservations about the higher valuations in the latter market, but I would still allocate more there to create a better-rounded portfolio in terms of sector exposures and types of business.

You could look to rebalance geographically while maintaining a bias to income generation through funds such as the Fidelity Global Quality Income UCITS ETF (FGQD), Fidelity Global Dividend (GB00B7778087), M&G Global Dividend (GB00B39R2R32) and Trojan Global Income (GB00BD82KQ40). These offer a decent level of income that appreciates over time with long-term capital growth, complementing higher-yielding, lower-growth investments.

Currently, you have more than half your assets excluding your home in cash, some of which you will and should invest over time. With the recent increases in interest rates, I can see why it is tempting to turn to cash and collect a risk-free return. Although cash on hand is important to cover you in case of emergencies, parking too much there over a long period is costly. It usually guarantees a loss of purchasing power after the effect of inflation.

No doubt you already plan to use your £20,000 a year Isa allowance to maximise tax efficiency, but using a ‘flexible Isa’ is one extra trick that may help.

Any withdrawal amounts (including in the form of income) can be added back to the Isa account before the end of the tax year, and this could allow you to gradually shelter more of your money from tax than a standard Isa that you are taking income from.

Relatively few providers offer flexible Isas, but it's worth looking around for the ones that do. Finally, you could also look to make personal pension contributions of £2,880 net, equivalent to £3,600 after tax relief credited each year despite having no earned income to help maximise tax efficiency.

Peter Hargreaves, consultant at EQ Investors, says:

Your financial circumstances are healthy and your objective of generating £30,000 a year seems feasible. Your attention should be focused on producing this income in a tax-efficient way and improving the asset allocation and diversification of your portfolio.

Your investment portfolio is heavily skewed towards UK stocks and a significant portion consists of individual companies. This level of concentration exposes you to higher risks due to the potential volatility of the UK market. And while direct equities offer the potential for high returns, they also carry a higher level of risk due to their sensitivity to company-specific factors. Diversification across different types of assets, such as bonds, funds, and exchange traded funds (ETFs) can help reduce the overall risk in your portfolio, without adding significant extra cost.

I would suggest using a ‘top down’ investment approach. This means focusing on the macro factors of an economy, such as gross domestic product (GDP), before examining micro factors such as specific sectors or companies. This will result in a more diversified approach to better manage risk and potentially enhance the stability of your investment strategy.

Fund costs are a concern for you so passive funds may be more attractive. Because passive funds track indices they tend to be well diversified in terms of the number of stocks and sectors. You would also like a 4 to 5 per cent dividend per year; however, it is important not to base stock selection on the dividend yield because sometimes the reason for a high yield is a drop in the share price caused by trouble in the business.

Some passive equity income strategies include quality screens which attempt to rule out companies with unsustainable dividends. For example, the objective of the iShares MSCI World Quality Dividend ESG UCITS ETF (WQDS) is to provide investors with a total return, taking into account both capital and income returns, which reflect the return of the MSCI World High Dividend Yield ESG Reduced Carbon Target Select index.

You have 12 years before your final salary pensions income commences; however, you can take these early with a reduction. It is worth looking into taking these from age 55, because although the income amount will be reduced, you will receive the income for a longer period. There will be a point at which you break even having chosen one option over the other. I would recommend a cash flow modelling exercise to explore your options.