How to create a £10,000 income: three Rated Fund portfolios

After three successful years of designing portfolios to produce a £10,000 annual income, we introduce new medium- and higher-risk line-ups, plus one for investors seeking to avoid the UK.

The ability of investment funds and trusts to provide investors with a regular and growing income is often underrated. Many investors still regard them as a way of accumulating capital, rather than as a means by which they can use capital to supplement their income. Yet for many of the 2019 Money Observer Rated Funds, income generation is one of the primary objectives; and historically they have proved they can deliver.

Many funds and trusts currently pay annual income of 3-4% or more and offer the prospect of inflation-beating increases in the future, and there are many reasons to believe that our Rated Funds have the ability to deliver both income and capital growth over the medium to long term. Investment trusts in particular have established a reputation for providing long-term income growth, thanks to their ability to hold income reserves. There are more than 40 investment trusts that have raised their dividends for 10 consecutive years or more, including four which have done so for over 50 years, and the number of trusts achieving this feat is growing each year.

The investment managers of our income-oriented Rated Funds aim to select companies that they believe will pay sustainable dividends in future. Dividends have increased strongly in recent years and although the rate of increase may fall as global growth slows, FTSE 100 companies are forecast to yield 4.5% in 2019, with dividend growth of 5.5%. Dividends of companies globally have also been rising. The latest Janus Henderson Global Dividend Index showed that global dividends in 2018 (excluding special dividends) were growing at an annual rate of 9.2%. 

Choosing the right funds

We are confident that our Rated Funds with income objectives should be able to provide investors with a steadily rising income – usually paid out at either half yearly or quarterly intervals, but it is important to remember that neither the income payments nor capital is guaranteed. This is the reason that we recommend holding a portfolio of several funds, which spreads your risk across different managers and types of fund. Diversification is useful because it means that if one fund hits a bad patch, or certain assets or stockmarkets go out of fashion, other holdings in your portfolio may be able to make up the difference. It is also worth including funds that invest in other areas, such as fixed income securities or property, as well as shares.

We have used Money Observer Rated Funds to build three types of portfolios aimed at producing an annual income of £10,000. Based on current fund yields, our portfolios require initial investments of between £218,000 and £245,000. The medium-risk version contains more core funds, while the higher-risk has the lowest initial investment because it includes more adventurous and specialist funds which are liable to be more volatile.

Both portfolios include overseas-invested funds and trusts for diversification. However, for those investors who are concerned about Brexit and wish to avoid the UK market as much as possible, we have compiled an overseas income portfolio focused on globally invested funds. We have chosen eight holdings for each portfolio, though there is no magic in this number and you may choose more if you prefer. There is no lower-risk option, as many people often confuse low risk with no risk, and we want to make sure investors are aware that there is a possibility of falls in capital and income, particularly over the short term. However, we hope and expect all our portfolios to generate real returns over the medium to long term.

The medium-risk option

The medium-risk portfolio is spread roughly evenly between its eight holdings, with 25% invested in two fixed income funds. Fixed income funds are not immune from setbacks, but they are generally less volatile than equity funds. Rathbone Ethical Bond has a socially responsible investment approach, but the main reason it has been included is because of its attractive yield and good past performance record. Marlborough Global Bond’s managers adopt a cautious approach to investing in a wide spread of government and corporate bonds across the globe of different maturities, credit ratings and currencies.

Half the portfolio consists of four core UK equity income holdings – two investment trusts and two investment funds. Slightly larger than the other holdings is the stake in City of London Investment Trust, which has paid out consecutive annual dividend increases for over 50 years. It focuses on large blue-chip UK equities. The other UK investment trust is Troy Income & Growth, whose managers take a risk-averse approach, also investing mainly in quality UK companies but with some exposure to property and infrastructure as well.

The two other UK holdings are the Royal London UK Equity Income and Threadneedle UK Equity Income funds. Though both managers tend to focus on out-of-favour companies, which can cause some fluctuations, they only invest in businesses that they believe in to underpin the capital and income growth of their funds.

The final quarter of the portfolio consists of a globally invested fund and investment trust, for diversification and exposure to overseas markets. Artemis Global Income is a good complement to UK equity income funds as it is invested almost exclusively overseas. Seneca Global Income & Growth investment trust has a more flexible mandate enabling it to invest in both overseas and UK equities, and also to have exposure to other types of assets, including fixed income and specialist areas such as infrastructure.

Medium-risk portfolio for a £10,000 annual income

Constituents Initial investment (£) Yield* (%) Expected income (£)
Artemis Global Income 30,000 3.4 1,020
City of London IT 35,000 4.7 1,645
Marlborough Global Bond 30,000 3.3 990
Rathbone Ethical Bond 30,000 4.2 1,260
Royal London UK Equity Income 30,000 4.8 1,440
Seneca Global Income & Growth IT 30,000 4.1 1,230
Threadneedle UK Equity Income 30,000 4.4 1,320
Troy Income & Growth IT 30,000 3.8 1,140
Total 245,000   10,045

Note: IT = investment trust or closed-ended fund. * As at 2 January 2019. Source: interactive investor

The higher-risk option

Our higher-risk portfolio has a mixture of mainstream and more specialist funds. Half of the holdings are investment trusts, with the potential for share price discounts to net asset values to occur or widen, adding to the underlying market volatility. The portfolio has a leaning towards overseas investment, with five of its holdings investing mainly or wholly outside the UK. This diversification could help to offset possible disruption to the UK economy post-Brexit.

Its key mainstream holdings, making up 40% of the portfolio, consist of three globally invested choices. JPMorgan Global Growth & Income investment trust’s highest regional weightings are to North America and Europe. Murray International trust has significant exposure to Asia ex Japan and Latin America, with North America, Europe and the UK accounting for just over a third of the portfolio. Artemis Global Income invests almost exclusively outside the UK.

Also focusing on overseas markets is the International Biotechnology trust, which seeks to support and profit from medical advances and is chiefly focused on North America, and Montanaro European Income, which specialises in small and medium-sized companies in Europe.

The final three holdings make up around a third of the portfolio. Schroder Income Maximiser invests in a portfolio of ordinary UK company shares, but its income is enhanced by the sale of derivatives on its shares, which puts a ceiling on the capital growth the fund can achieve. Invesco UK Smaller Companies invests in a broad cross-section of small to medium-sized UK companies the managers believe are capable of self-help rather than being overly reliant on the wider economy to stimulate growth. Kames Property Income invests in a wide spread of property around the UK.

Higher-risk portfolio for a £10,000 annual income

Constituents Initial investment (£) Yield* (%) Expected income (£)
Artemis Global Income 30,000 3.4 1,020
International Biotechnology IT 25,000 4.7 1,175
Invesco Perpetual UK Smaller Companies IT 25,000 4.7 1,175
JPMorgan Global Growth & Income IT 30,000 4.3 1,290
Kames Property Income 28,000 4.7 1,316
Montanaro European Income 25,000 3.0 750
Murray International IT 30,000 4.5 1,350
Schroder Income Maximiser 25,000 8.0 2,000
Total 218,000   10,076

Note: IT = investment trust or closed-ended fund. * As at 2 January 2019. Source: interactive investor

Overseas income

Most of us have the bulk of our savings and assets in the UK – our property, our deposits and our pension are normally here. As most of our liabilities are usually here too, this makes sense – but it does mean our fortunes are linked closely to that of the UK economy. With the uncertainty surrounding Brexit, some investors may prefer to avoid adding to their UK assets. They may be interested in this overseas income portfolio option.

It consists of eight funds with global remits, managed by different managers with different investment policies and investment styles. It is not 100% non-UK, as most global funds include an element of exposure to the UK; but this may potentially be an advantage, as it does mean that in the event of a ‘Brexit bounce’ investors will feel the benefit.

Four of the largest holdings in the portfolio – the JPMorgan Global Growth & Income, Murray International and Seneca Global Income & Growth investment trusts, and the open-ended fund Artemis Global Income – also appear in our medium- and higher-risk portfolios, as we believe they provide a solid foundation. Apart from Seneca Global Income & Growth, these funds are invested 90% or more outside the UK. Seneca Global Income & Growth has one of the highest exposures to the UK, currently around 45%, but it has a flexible mandate which means that it can invest in assets other than shares. Some of its fixed income and specialist holdings include a UK element.

Further global exposure is provided by Schroder Global Equity Income and Fidelity Global Enhanced Income. Both invest worldwide in shares of companies they believe will provide sustainable dividend growth. The income on the Fidelity fund is increased by the writing of call options on a portion of its holdings.

For extra diversification, the portfolio includes Standard Life Private Equity trust, which gives exposure to non-quoted companies, particularly in Europe. Finally, Royal London Global Bond Opportunities invests in a broad range of fixed-interest securities globally, including both government and corporate bonds with different credit ratings. We expect this fund to provide the portfolio with a less volatile element.

Overseas portfolio for a £10,000 annual income

Constituents Initial investment (£) Yield* (%) Expected income (£)
Artemis Global Income 30,000 3.4 1,020
Fidelity Global Enhanced Income 25,000 5.0 1,250
JPMorgan Global Growth & Income IT 35,000 4.3 1,505
Murray International IT 33,000 4.5 1,485
Royal London Global Bond Opportunities 25,000 5.8 1,450
Schroder Global Equity 30,000 3.8 1,140
Seneca Global Income & Growth IT 30,000 4.1 1,230
Standard Life Private Equity IT 25,000 3.8 950
Total 233,000   10,030

Note: IT = investment trust or closed-ended fund. * As at 2 January 2019. Source: interactive investor

How did our 2018 income portfolios do?

This is the fourth year we have suggested how a selection of Money Observer’s Rated Funds can be used to create portfolios producing an annual income of £10,000. The portfolios have been modified each year for new investors, to reflect changing conditions and achieve the expected income.

It is important to remember that the portfolios are designed as medium to long-term investments and not just for one year. While we like to review what our portfolios have achieved over the past year, it is vital not to assume these returns will continue – for better or worse. This can be seen from the different results achieved by our portfolios in 2017 and 2018, which reflect the ups and downs you need to be prepared for when investing in stockmarket-linked investments.

In 2016 the medium and higher-risk portfolios delivered close to the target or more income than projected, as well as capital growth. In 2017 they both delivered a higher income than expected and made capital gains, with the higher-risk version coming out on top. In 2018, both portfolios also delivered a better income than expected. Our medium-risk portfolio paid out 5.6% more, and the higher risk version 6.1% more – both well ahead of inflation.

Holdings that did notably well in terms of income hikes were Invesco Perpetual UK Smaller Companies, Jupiter Strategic Bond, Kames Property Income and Threadneedle UK Equity Income. They more than made up for a few holdings where income came in under our target.

However, on the capital side, with world stockmarkets down last year, the capital value of the medium-risk portfolio was 9.3% lower at the end of the year and the higher-risk version was 12.5% down. The former’s greater exposure to bond funds helped to give it more stability last year, with Jupiter Strategic Bond and Marlborough Global Bond losing only 5% of their value. The latter’s holdings in more specialist trusts, such as European smaller companies investment trust European Assets, which fell by 28.6%, made it more volatile.

These falls will not affect the ability of these portfolios to pay out a similar or rising income in future, as they will still hold the same number of shares or units on which dividend payments are based. And we believe over the longer term their capital value will recover. (We also see no need for existing investors to make switches, as all the holdings in last year’s portfolios remain Rated Funds in 2019, even though this year’s portfolios are somewhat different.)

2018 portfolios exceed income target but capital values fall 

Higher-risk portfolio Investment Capital value Income paid* (£)
  1/1/18 (£) 1/1/19 (£)  
Artemis Global Income 32,000 27,162 1,093
City of London IT 35,000 30,636 1,431
European Assets IT 30,000 21,420 1,870
International Biotechnology IT 20,000 18,240 864
Invesco Perpetual UK Smaller Companies IT 25,000 21,592 1,000
Kames Property Income 30,000 27,863 1,587
Royal London Sterling Extra Yield 30,000 28,797 1,702
Seneca Global Income & Growth IT 30,000 27,252 1,107
Total 232,000 202,962 10,654


Medium-risk portfolio Investment Capital value Income paid* (£)
  1/1/18 (£) 1/1/19 (£)  
Artemis Global Income 40,000 33,952 1,366
JPMorgan Global Growth & Income IT 30,000 25,890 1,121
Jupiter Strategic Bond 35,000 33,156 1,083
Jupiter Monthly Income 35,000 32,085 1,633
Kames Property Income 30,000 27,863 1,587
Marlborough Global Bond 30,000 28,618 760
Threadneedle UK Equity Income 40,000 35,971 1,924
Seneca Global Income & Growth IT 30,000 27,252 1,107
Total 270,000 244,787 10,581

Note: IT = investment trust or closed-ended fund. For open-ended funds, the capital value of income units was assessed. * Morningstar and Money Observer's own calculations.

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