Portfolio Dilemma: what kind of income investor am I?

Stephen asks: I’ve finally reached the point where I’m looking to generate an income from my portfolio, but am not sure on the best way to do this. 

I have tended to buy shares and funds for growth rather than dividends. How much of the portfolio should now focus on yield?

Income-paying assets, from FTSE 100 shares to UK income funds and even some esoteric investment trusts, are popular for good reason. 

They tend to pay out a good level of income fairly reliably and should, in theory, serve as stable investments – although this certainly isn’t always the case.

• Invest with ii: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

It can definitely make sense to put money into such investments if you want a regular income stream without too much hassle.

Here, one approach might be to work out how much income you need, and then work out how you need to deploy in a given set of holdings, based on their yield and how much they would be expected to pay.

As always, it makes sense to diversify well – by region, sector, asset class, and by yield. 

A high yield (of, say, 7% or more) can sometimes indicate that the given investment is risky or investors fear for the sustainability of its payouts.

The FTSE 100 is well known as a home to dividend stalwarts, while funds give access to many a different income play.

That’s especially evident in the investment trust space: income plays popular with ii customers range from UK income play City of London Ord (LSE:CTY), which has increased its payout for 60 consecutive years but has a relatively moderate 3.8% yield, to the very high-yielding Henderson Far East Income Ord (LSE:HFEL), renewables funds like Greencoat UK Wind (LSE:UKW) and Renewables Infrastructure Grp (LSE:TRIG), and, recently, property funds such as Schroder Real Estate Invest Ord (LSE:SREI).

• City of London raises dividend for the 60th year in a row
• Tips and tricks on how to generate a sustainable monthly income

Should I care about dividends?

Income investing does, of course, have its critics. 

There’s an argument that a focus on dividends can lead you into sectors viewed as “ex-growth” with their best days behind them, be that tobacco or energy.

Some might dispute this point but it has certainly been more growth-focused companies, in particular the likes of the US tech names, dominating by returns over the last decade. 

And investors might rightly not want to focus purely on dividends and miss out on these gains.

One alternative approach that income-hungry investors can take is simply to invest growth and then take profits on winning positions to free up the cash you need. 

In an ideal scenario this might leave you with better performance, and backing more promising stocks.

We see a version of this in the investment trust space, where many vehicles have adopted a so-called enhanced dividend policy.

As with names such as JPMorgan Global Growth & Income Ord (LSE:JGGI) this can involve paying out a set proportion of net asset value (NAV) each year, leaving the investment team to buy what it views as the best companies and then bank gains where needed, rather than obsessing over yield.

Taking this approach, or blending it with a more conventional income strategy, might appeal to some. 

• UK Budget latest
• Case study: managing a £1.25m pension and ISA portfolio in midlife
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

But it does have risks: growth investing does invite volatility, and leaves you dependent on the portfolio performing well so you can generate cash without eroding your savings. 

Having to sell holdings in a falling market could substantially eat into your pot.

Investors might therefore want to have some cash on the side to rely on when markets are falling, and to have some defensive investments too (be it bonds, gold or wealth preservation funds to name a few options). 

They might generally need to be more hands on if taking this so-called total return approach.

As mentioned before, it could make sense simply to hold growth investments alongside income-paying ones. 

This may inadvertently give you a good level of diversification, given that growth and income investors can end up fishing in different parts of the market.

Finally, if you do look for an equity income fund, it can make sense to check how they are invested and whether they do in fact bet heavily on growth stocks.

An analysis we published in summer found that some of the best-known growth stocks featured prominently in such funds. 

That raises questions about how much they differ from growth funds.

If you have a question you’d like to be considered in our Portfolio Dilemma series, we’d love to hear from you. Please contact: editorial@ii.co.uk