Gilts do not offer your desired level of income

“I would like to withdraw about a £1,000 a month from my investments to supplement my pensions income,” says Robin. “I have other assets that are probably enough to cover care fees, if that is ever necessary. So I think that I could tolerate a fall in the value of my investments of up to 20 per cent in any given year. But I am risk averse in terms of the overall value of my assets.

"I have been investing for more than 30 years but my approach is not very systematic. I know that the value of an asset is the capitalised value of the expected income stream – plus or minus a few other factors. I also know that I should hold more government bonds probably via an exchange traded fund (ETF). But I am unsure as to whether to add another ethical fund.

"I have recently invested in WisdomTree Physical Gold (PHGP), and sold holdings in Tremor International (TRMR) and Stobart (STOB).

“I have also been keeping cash worth £100,000 (on top of what I have in bank accounts) to cover the cost of some work on my roof. But I might just get the planning permission, and move to a home that is more suitable for someone my age and maybe cheaper, so raise some cash in the process. 

“I also have about €100,000 (£84,848) in a bank account from the sale of a property.”

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You 'know' that you should have more government bonds but it isn’t at all obvious to me why this is the case. In real terms, yields are strongly negative, meaning that unless something unexpected happens you will lose 2 per cent a year in real terms. What you are getting in return for this loss is insurance against the types of stock market falls that are caused by investor loss of appetite for risk or an increased chance of recession. This insurance, however, is expensive.

And you already have a lot of insurance, in part from your holdings in Lyxor FTSE Actuaries UK Gilts UCITS ETF (GILS) and Rathbone Ethical Bond (GB0030957137) because better quality corporate bonds are correlated with gilts. Also, your substantial allocation to gold is, in effect, like a gilt in that gold tends to rise when gilt yields fall.

Another good form of insurance against recession or heightened risk aversion is cash denominated in euros. Sterling tends to fall when global investors become nervous or expectations for the UK economy turn down. For example, sterling took a dive in late 2008 and 2016 for these reasons. So if there are heightened fears of a UK downturn or greater nervousness among investors you might enjoy profits from your euros, gilts and gold. This and the fact that you are retired means you are well placed to tolerate cyclical risk from holdings such as your China fund and direct share holdings. When the economic risks of the coronavirus have passed such cyclical risk might pay off.

But this doesn't mean that you should dump your cash holdings. Your home and land are illiquid – it could take some time to sell them for a decent price. Cash gives you liquidity that these assets don’t have.

So you are also in a position to consider an ethical fund, although I think that the case for these is ambiguous. Theory suggests that ethical funds should underperform the main market because some of the returns you get are the non-financial satisfaction of doing the right thing. But it’s possible that carbon stocks will face increased political risk while green stocks benefit from a 'bandwagon effect' [more and more investors piling into them]. So environmental investing might not be a terrible idea.

Rob Burgeman, senior investment manager at Brewin Dolphin, says:

As we get older we often need to look to our savings and investments to produce income, and this can necessitate some changes to our investment strategy. It needs to evolve to reflect these changing demands and our greatly diminished ability to rebuild savings [as a result of being retired].

You want to draw around £12,000 a year from your investments to supplement your pensions income. Your situation appears to be good in that you have plenty of assets although a lot of these are tied up in property, which cannot be classified as liquid. You also have cash, but have not made it clear whether the £100,000 reserved for the building work on your home is in these figures. 

Assuming the cash shown is not going to be used for work on your home, your savings and investments are worth about £325,000 [excluding the land, cash in euros and £6,000 in a UK bank account], so a drawdown of around 3.6 per cent is achievable. If you exclude the cash, the requirement rises to 5.47 per cent, which is unsustainable. However, your current investments will not produce anything like either these figures with an estimated income yield of little over 1 per cent.

A more disciplined income-orientated approach and a broader geographical spread would make a lot of sense, as it would reduce the volatility and the capital and income risk of your current, relatively constrained allocation. You could adopt the same kind of approach within your UK and other major markets allocations. 

The right risk profile for you is not just the one that you are happy to take on, but also what is going to meet your investment objectives and – most importantly – the one you can afford to take. It seems that so far capital appreciation has allowed you to bridge the gap between your £12,000 annual income requirement and the natural income produced by these investments. But at this end of the economic cycle a more circumspect approach may be prudent – we cannot rely on markets rising forever.

If the natural income produced by the investments covers your monthly requirements you could tolerate a degree of volatility in their capital value. If not, the only other safe option is to retain cash reserves so that if there are sharp market falls you can give your investments some time to recover [see last week's portfolio clinic for more on this]. A very good approach to investing is to hope for the best but plan for the worst.

Rachel Winter, associate investment director at Killik & Co, says:

If you wish to withdraw £1,000 per month from your investments you will need a yield of 3.7 per cent. This is feasible but will require some risk. This era of low interest rates has forced investors to take on more risk to get a particular level of return.

Adding more government bonds to your portfolio is a good idea in terms of diversification and risk management, but they do not offer your desired level of income. Although government bonds are viewed as safe assets because governments could print money to pay back bondholders, if necessary, they make low returns. A 10-year UK government bond currently yields just 0.52 per cent a year, and that’s before you’ve paid fees to buy and hold it. UK inflation is currently in the region of 1.3 per cent so these government bonds will not keep pace with it even if you reinvest all of the income.

Some bond funds invest in very long-dated bonds which can be sensitive to changes in interest rates. For example, Rathbone Ethical Bond's largest holding doesn't mature until 2032. If interest rates rise, in theory, the prices of long-dated bonds such as this will fall.

Gold also doesn't meet your need for income. Although gold has historically offered protection against inflation it does not pay any income, so I would question as to whether such a large allocation to it is a suitable strategy for you personally.

While yield is a consideration, you are right not to have simply selected assets that yield the most. Investors who take this approach can end up with portfolios that are highly concentrated in certain areas of the market, in particular oil companies, miners, and UK banks. These sectors have not performed well over the last decade and there is always the possibility of dividend cuts.

As you say, the value of an asset is a function of the income stream, so the sustainability of the income stream is critically important. Therefore it is good that you have some growth orientated investments such as Polar Capital Automation & Artificial Intelligence Fund (IE00BF0GL543). Although it does not offer a yield it should rise in value over the long term, meaning that you should be able to take profits from it periodically and extract cash from your investments in this way.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

I would suggest selling L&G FTSE 100 Super Short Strategy (Daily 2x) UCITS ETF (SUK2), which is designed to rise when the FTSE 100 index falls. It is suitable for a punter wanting to bet on a near-term drop in the market – although it is silly to do this as markets are mostly unpredictable. It is also suitable for someone who holds lots of equities that they are unable to sell quickly. But it is NOT a long-term investment because the FTSE 100 will probably tend to rise over time, meaning that it will tend to fall.

I would also sell BMO MM Lifestyle 4 (GB00B83XVS65), which mostly invests in bond and equity funds. A fund of funds has a double layer of fees: the ones you pay for the fund itself and those of the funds that it invests in. So you might be able to get a similar result but more cost effectively by getting exposure to bonds and equities via a tracker fund and bond ETF.

Rob Burgeman says:

A double short FTSE 100 tracker is a leveraged bet that the FTSE 100 Index will fall. But it is unlikely to fall enough to offset the decline in your overall investments' value. And L&G FTSE 100 Super Short Strategy (Daily 2x) UCITS ETF produces no income.

Gold has a potential role to play, but holding around 10 per cent of your investments in assets which produce no income is not suitable for your income requirements. And while Augmentum Fintech (AUGM) and Polar Capital Automation & Artificial Intelligence (IE00BF0GL543) may be worthy from an adventurous investment point of view these are speculative investments, and mean that in total over 18 per cent of your investments produce no income.   

Your investments also have an allocation of around 11.5 per cent to Asia and emerging markets, which produce very little income, but do produce a great deal of risk and volatility. 

BMO MM Lifestyle 4 Fund is your largest holding, accounting for just under 10 per cent of the investments. This has over 40 per cent of its assets in equities, around 37 per cent in bonds and 6.5 per cent in cash – an odd investment to hold in a portfolio like this. You also hold the accumulation rather than the income units. 

Around 10 per cent of your investments are in bonds and while these should provide some ballast to your overall return [if there is volatility] your funds do not provide a great deal of income. GAM Star Credit Opportunities (IE00BYZXFP13), for example, would provide more income.

You have little US exposure, but could get exposure to the biggest and deepest capital market in the world with some income via SPDR S&P US Dividend Aristocrats UCITS ETF (USDV), a passive fund that only invests in US companies that have increased their dividend every year for 20 years or more. Another option is Fidelity US Quality Income ETF (FUSI). 

Alternative asset investments also offer some interesting income opportunities. Investec Diversified Income (GB00B7700K18) produces a decent yield of around 4 per cent and iShares Developed Markets Property Yield UCITS ETF (IWDP) offers exposure to global real estate. 3i Infrastructure (3IN) and Renewables Infrastructure Group (TRIG) are expensive at the moment [because they are on high premiums to net asset value], but offer decent yields and exposure to asset classes that should be less volatile than global equity markets.