Putting together investments to generate income is one of the toughest challenges, because it involves difficult tradeoffs.
Do you want to eat well or sleep well?
At some time between the ages of 40 and 80, all investors end up wanting the same thing: an income that rises at least in line with inflation and a gentle but steady rise in the value of their capital.
How have we set about achieving that for our Income Portfolio?
See our Updated Income Portfolio here
Income versus growth
The first thing to be clear about is that the more income you want, the less you can expect that income to grow, and if you insist on a level of income of 6% or more, you will also be forced to take more risks than you would like with your capital. So these are the tradeoffs:
| Lower income now | Higher income now |
| Future growth in income | Little growth in income |
| Inflation beating capital growth | Less capital growth |
When you are investing for growth, you may get income and reinvest it to boost your return, but you don’t need to focus on it.
So you can buy growth investments - like UK smaller companies - that generate virtually no income. As soon as you require a steady regular income, this changes. You have to pick investments that will reliably deliver the income you need.*
The difficulty is that rising income comes from shares and property and high income from fixed interest. So any income portfolio is a compromise. That is especially tough when, as now, the outlook for fixed interest doesn’t look great.
That’s why I’ve chosen some somewhat offbeat funds for the Income Portfolio, several of which don’t feature in our Best Buy lists.
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The £20,000 Income Portfolio
| Asset Class | Investment | Amount (£) | % of total |
| | | |
| Cash | | 2,000 | 10 |
| 60-day account | 2,000 | 10 |
| Fixed rate | | 6,000 | 30 |
| Aegon High Yield Bond | 3,000 | 15 |
| Framlington Pan European Bond | 3,000 | 15 |
| Property | | 3,000 | 15 |
| Skandia property | 3,000 | 15 |
| Equity | | 5,000 | 25 |
| Fidelity Income Plus | 2,500 | 12.5 |
| JPM Global Equity income | 2,500 | 12.5 |
| Mixed | | 4,000 | 20 |
| Invesco Perpetual Monthly Income Plus | 2,000 | 10 |
| F&C High Income | 2,000 | 10 |
| Total | | 20,000 | 100 |
Total net annual income for basic rate taxpayer at 11/4/2007: £904 (4.52%)
Fund blend for income and growth
Fixed Interest: Aegon High Yield Bond is a straightforward income-chasing high-interest fund. I am hoping its able managers will be able to dodge the effects of any rise in interest rates. Framlington Pan European Bond invests in European euro-denominated bonds, so its capital value will be affected by how the £ moves against the euro.
Property: I have selected the Skandia Property fund because it pays a higher income than New Star or M & G. Its capital performance may not be as good, but we want the 4.9% income.
Shares: I cannot include any of my top UK equity income funds because their income levels are too low, so instead I have selected Fidelity Income Plus, which has a decent record and pays 3.9%.
A good new fund is JPM Global Equity Income which aims to generate an income of 4% from an international spread of shares.
Mixed: Invesco Perpetual Monthly Income Plus has two of the most talented fixed-interest managers in the business, Paul Causer and Paul Reed. I am confident they will switch 10-20% of the capital back and forth between shares and fixed interest and make useful profits, meanwhile paying out 5% net.
F&C Higher Income, managed by derivatives egghead Stephen Dolbear, has a complex strategy for squeezing extra income out of a portfolio of UK shares and fixed interest. Don’t ask me to explain it, but it’s worked for many years and the fund currently pays 6.2% net.
The two mixed funds contain both shares and fixed interest: about 70% fixed, 20% shares for Invesco and 60% fixed, 40% shares for F&C. Add these to the pure fixed interest and equity funds and we get an overall breakdown for the portfolio of Fixed Interest 43%, Shares 32%, Property 15% and Cash 10%.
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Eat well or sleep well?
With 47% of the capital in shares and property, and assuming a long-term growth rate of around 5% in the income level, then overall we should expect an annual income gain on the whole portfolio of about 2.5%, just ahead of inflation.
If you want to improve the odds of income rising faster than that, you will need to adjust the proportions and put more of the capital into equity and property and accept that the capital value will fluctuate more. So it’s the age-old investor issue: Do you want to eat well or sleep well? Only you can decide.
*You may ask why you shouldn’t just go for growth and cash in a bit of capital each year. Indeed, some advisers with short memories are starting to recommend this, and even Fidelity is encouraging this approach with its own withdrawal scheme. But exhaustive research in America has shown that if you withdraw more than 4% in total each year from your investments you risk running out of money before you die. And I can remember investors being ruined by starting withdrawal schemes in the 1970s just before a big bear market. So this is a high-risk strategy I do not recommend if you can possibly avoid it.
How we design our Model Portfolios
See our Best Buy investment funds
Important Notice and Risk Warning
The EveryInvestor Model Portfolios are for general guidance only and do not constitute a recommendation for any investor. EveryInvestor does not provide individual investment advice. Your own personal circumstances and tax position must be taken into account in selecting investments. We recommend that you obtain advice from an independent financial adviser before making investment decisions.
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance.
