Investment funds for a £10,000 income: three simple Rated Fund portfolios

We update our three 2019 Rated Fund Isa income portfolios for 2020.

An increasing number of people rely on their savings to generate extra income, particularly in retirement.

In the past, bank, building society or National Savings accounts would probably have played the key role in their portfolios, but the low interest rates currently on offer mean these accounts generate minimal income.

Nowadays, one of the best ways to enhance your income is to put part of your capital in investment funds and trusts – although that does mean upping your risk profile. These funds provide better immediate income – many pay yields of 3% or more. What’s more, they offer capital growth potential over the medium to long term, which can protect against inflation.

Some investors are still nervous of stock market investments, but it is important to bear in mind when investing for income that dividend payments in general are more stable than share prices. Share prices often fluctuate because of factors beyond companies’ control, but dividends are set by the companies themselves.

- 10 shares to deliver a £10,000 annual income in 2020
What are Rated Funds and how are they chosen?

Over the years, average dividend payouts have grown steadily. Although some businesses may cut back payments if their earnings decrease, other firms will increase their dividends as their profits grow. Investing through the right funds and trusts means your money is in the hands of managers who can seek out the companies best-placed to maintain their dividends.

Indeed, many funds and trusts have long records of increasing their income payments in all stock market conditions. Investment trusts in particular are well placed to smooth out their dividends, as they can hold back some of the income they receive in the good times to underpin their dividends when the going gets tough. More than 40 investment trusts have paid out an increasing income for 10 years or more.

At least a quarter of Money Observer’s Rated Funds describe themselves as income funds or list paying an income as one of their primary investment objectives. They normally distribute income at half-yearly or quarterly intervals, although some funds pay monthly. But the amount of income paid is not guaranteed, so while we expect our Rated Funds to perform well and pay investors regular and, in many cases, increasing income, we would recommend holding a portfolio of several funds, as this spreads your risk across different managers and fund types.

The two main Rated Fund categories of dividend-paying funds are UK Equity Income and Global Equity Income, which invest in higher-yielding UK and overseas shares, respectively. There are also geographical income specialists that focus on the shares of specific countries or regions, as well as funds that invest in other income-producing assets such as bonds and property. Multi-asset income funds consist of a mixture of assets such as shares and bonds.

11 investment trusts for a £10,000 annual income

Investment options

To demonstrate how you can combine our Rated Funds into income portfolios, we have devised three investment options: medium-risk, higher-risk and overseas income portfolios. Each aims to produce income of around £10,000 a year. Based on current fund yields, they require initial investments of between £220,000 and £240,000.

The higher-risk portfolio, which focuses on higher-yielding and more specialist funds, requires the lowest investment, but its returns are likely to be relatively volatile. It would, of course, be possible to achieve a £10,000 income with even less capital if greater use were to be made of higher-yielding funds, but we believe it is important to have a more balanced portfolio.

The medium-risk portfolio contains more core funds than the higher-risk option. Both portfolios include UK- and overseas-invested funds for diversification.

For investors who would like specifically international exposure, we have compiled an overseas income portfolio that focuses purely on globally invested funds.

All three portfolios consist of an exchange traded fund (ETF) plus a mixture of funds and investment trusts. We have spread the investment fairly evenly across eight holdings in each portfolio, although there is no magic in this number and you can include more funds if you prefer.

The same ETF, the Vanguard FTSE All World High Dividend Yield ETF, has been included in all three portfolios to give broad, low-cost, passive exposure to the largest higher-yielding companies in developed and emerging markets.

There is no low-risk portfolio. Investors in funds and trusts need to be prepared for the possibility of fluctuations in their capital and income, particularly over the short term. It is important to regard all the portfolios as medium- to long-term commitments, and to keep adequate cash available to meet your short-term needs.

Medium-risk option

This portfolio (see table below) has a bias towards the UK. Investors are usually advised to have a good foundation of holdings in their domestic market in order to reduce currency risks. The portfolio has 50% in mainstream UK funds and trusts, including City of London investment trust, one of the largest UK investment trusts. It focuses mainly on large, blue-chip UK equities and is very diversified across about 100 holdings. It has been increasing its dividend for more than 50 years, the longest record of increases for any investment trust.

The other three core UK equity income holdings are the Royal London UK Equity Income fund, the Threadneedle UK Equity Income fund and Troy Income and Growth trust. All are run by very experienced managers who focus their investments on quality companies and are regarded as safe pairs of hands.

The three remaining holdings, like the Vanguard ETF, all have exposure to global markets. They include a pure fixed-income fund, Royal London Global Bond Opportunities, which helps boost the portfolio’s income thanks to its high yield, and provides greater asset diversity. A spread of assets is also provided by two globally invested mixed-asset funds: TB Wise Multi-Asset Income and Seneca Global Income & Growth investment trust. Both have UK exposure, but they can go anywhere they see value.

TB Wise Multi-Asset Income invests both directly in shares and in funds in order to access specialist sectors overseas, private equity, property and alternative assets. It also has the advantage of paying a monthly income. Seneca Global Income & Growth is highly diversified both geographically and in terms of assets. It aims to keep its dividends growing at least in line with inflation.

Medium-risk choices are better bets for shorter-term investors

  Investment
amount (£)
Yield*
(%)
Expected
income (£)
Vanguard FTSE All World High Div Yld ETF 30,000 3.5 1,050
City of London IT 35,000 4.3 1,505
Royal London Global Bond Opps 25,000 5.6 1,400
TB Wise Multi-Asset Income 25,000 5.0 1,250
Royal London UK Equity Income 35,000 4.5 1,575
Seneca Global Income & Growth IT 35,000 3.7 1,295
Threadneedle UK Equity Income 30,000 4.0 1,200
Troy Income & Growth IT 25,000 3.2 800
Total 240,000   10,075

Notes: *As at 2 January 2020. IT= closed-ended fund or investment trust. Source: interactive investor

Higher-risk option

This portfolio has the largest number of higher-yielding funds. Six holdings currently have yields of more than 4%, thus reducing the initial investment required.

The three UK-focused holdings are very different from one another. In our Rated Fund categories, Merchants Trust is classed as an adventurous UK equity income choice. It has one of the highest yields in its sector as well as one of the highest gearing levels. It has a relatively concentrated portfolio. The Schroder Income Maximiser fund also has a high yield, thanks to the natural yield generated by its portfolio of UK company shares and the sale of options.

Our final UK-focused holding is BMO Commercial Property Trust. It pays an attractive monthly income, but its capital value has been hit recently by the uncertainty caused by Brexit and the difficulties facing the retail sector. However, we believe there is scope for recovery, thanks to the trust’s experienced managers and an expected return to greater certainty when the outcome of post-Brexit trade negotiations between the UK and the EU becomes clearer.

The remaining five holdings in the portfolio invest globally. Broad diversification is provided by Vanguard FTSE All World High Dividend Yield ETF, while the managers of the JPMorgan Global Growth & Income investment trust focus on picking the best stocks worldwide rather than on geographical allocations. The managers of the Schroder Global Equity Income fund are value-oriented and look for companies with sustainable earnings globally.

The Murray International and BlackRock Frontiers investment trusts give this portfolio an exposure to emerging markets. Murray International has holdings in developed markets, but it also has a higher-than-average exposure to Asia and emerging markets. This has held back its performance in recent years, but we think this may be about to change. BlackRock Frontiers invests exclusively in less developed countries such as Indonesia, Egypt and Pakistan. Although this entails obvious risks, the trust’s dividend has grown every year since its launch in 2010 and its manager says prospects for several of its markets are looking good for 2020.

Higher-risk options can deliver outstanding returns

  Initial amount
(£)
Yield*
(%)
Expected
income (£)
Vanguard FTSE All World High Div Yld ETF 30,000 3.5 1,050
BlackRock Frontiers IT 20,000 4.3 860
Merchants IT 30,000 4.8 1,440
JPMorgan Global Growth & Income IT 30,000 3.8 1,140
BMO Commercial Property 30,000 5.2 1,560
Schroder Global Equity Income 30,000 4.0 1,200
Murray International IT 25,000 4.2 1,050
Schroder Income Maximiser 25,000 7.1 1,775
Total 220,000   10,075

Notes: *As at 2 January 2020. IT= closed-ended fund or investment trust. Source: interactive investor

Overseas option

Much as some income investors may prefer to choose their own shares, this is difficult in overseas markets. For such investors, we have constructed the overseas income portfolio – although it is worth noting that most global funds will have some UK exposure.

Some Rated Fund income funds focus on particular markets such as Europe, Japan, Asia and the US, but our portfolio consists of global funds. It could be argued that there will be overlaps, but all the funds are somewhat different, and we believe this gives the portfolio the broadest possible scope and longevity.

Six of the eight holdings also appear in the medium- and higher-risk income portfolios. The Vanguard FTSE All World High Dividend Yield ETF acts as a basic diversifier. The Royal London Global Bond Opportunities fund helps improve the overall yield and provides exposure to another asset class. Seneca Global Income & Growth holds some fixed-income securities, as well as UK and overseas equities and specialist funds.

The various management teams adopt different investment approaches. The team at JPMorgan Global Growth & Income has a ‘global focus’ strategy while the team at Schroder Global Equity Income is value-driven. Murray International is differentiated by its high exposure to Asian and emerging markets.

The two holdings unique to the overseas portfolio are the Fidelity Global Enhanced Income fund and the Standard Life Private Equity investment trust.

The Fidelity fund generates its income from a conventional portfolio of shares in firms with good track records of increasing dividends and preserving capital. Income is supplemented by selling call options. The Standard Life fund has been included to give the portfolio more diversification through exposure to unquoted companies. It invests in private equity funds as well as directly in private companies.

Overseas option provides the broadest scope and longevity

  Investment amount
(£)
Yield*
(%)
Expected income
(£)
Vanguard FTSE All World High Div Yld ETF 35,000 3.5 1,225
Fidelity Global Enhanced Income 35,000 4.6 1,610
JPMorgan Global Growth & Income IT 30,000 3.8 1,140
Murray International IT 30,000 4.2 1,260
Royal London Global Bond Opportunities 35,000 5.6 1,960
Schroder Global Equity Income 35,000 4.0 1,400
Seneca Global Income & Growth IT 25,000 3.7 925
Standard Life Private Equity IT 15,000 3.7 555
Total 240,000   10,075

Notes: *As at 2 January 2020. IT= closed-ended fund or investment trust. Source: interactive investor

2019 Rated Fund Income portfolios’ performance

This is the fourth year in which we have combined Rated Funds to create portfolios aimed at producing an annual income of £10,000. The portfolios have been rebased and modified each year for new investors, to  reflect changing conditions and achieve the target income.

However, nothing is guaranteed, and it is important to emphasise that investments are intended to be held for the medium to long term. The performance – good or bad – achieved in previous years is not necessarily a guide to the future. Your capital and income are likely to fluctuate, so you should always have sufficient cash to draw on if necessary to supplement your income or for capital expenditure.

Market movements over the past three years exemplify the type of fluctuations you can expect, especially over the short term. On the income front, in 2017 and 2018 the medium- and higher-risk portfolios delivered more income than predicted. However, in 2019 the picture was more varied. Best for income was the overseas portfolio – a new addition to the range – which delivered £10,858 of income, some £800 more than expected. Every holding paid out more than predicted.

The medium-risk portfolio paid out about £200 more than our target. Although two holdings paid out slightly less than we had projected, the difference was more than made up by others that paid out higher incomes. However, income from the higher-risk portfolio fell more than £300 short of the £10,000 target. Payouts from three holdings were lower than projected, and slightly higher payouts from other holdings were insufficient to make up the difference.

On the capital side, the higher-risk portfolio more than made up for its income shortfall in 2019. An investor in this portfolio would have seen their capital grow by 13.6%, or nearly £30,000 in value, during the year. This illustrates one of the potential benefits of investing in the stock market for income: where capital growth is achieved, it can be drawn on to top up income. However, growth is less predictable than income – for example, although our higher-risk portfolio made a gain in 2019 and 2017, in 2018 it fell by 12.5%.

In 2019, the capital value of our medium-risk portfolio grew by 12.8%. Like the higher-risk portfolio, it had dropped in value in 2018, having made a gain in the previous year. Our new overseas income portfolio gained 11.2% last year.

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