Jean is in her early 60s and has acquired through divorce a typical old stockbroker's portfolio of over £1m. There is a small amount of income from fixed-interest stock.
The whole portfolio is pregnant with gain and Jean requires a higher income (say, £50,000 as opposed to the £22,000 she currently gets). She is also concerned about stockmarket volatility.
Jean's portfolio is currently divided between conventio-nal blue-chip equities (70 per cent), a handful of foreign shares (10 per cent) and fixed interest (20 per cent).
Of the UK equity element, around £80,000 is in Peps and Isas. We will aim to reduce direct equity exposure, increase income and minimise the tax liability by the following steps:
Peps and Isas will be adjusted to hold fixed-interest investments.
A quarter of the portfolio will be allocated to with-profits investments.
A quarter will be allocated to cash and investment trusts as an income generator.
The residual equity portfolio will be allocated to lower-risk higher-yielding equities.
A small element will be used to shelter capital gains in venture capital trusts.
Ideally, we will put together a portfolio of investments (trusts and some of the existing direct equities) to generate a gross yield in the region of 3.5 per cent.
Inevitably, some further capital gains will be crystallised but we should be ableto shelter these gains by creating a VCT portfolio.
The rearrangement can be effected cautiously over the next year or so as the market (hopefully) recovers from its current malaise. The overseas holdings are yielding very little and, although a portfolio of this size should certainly have international exposure, we prefer to achieve this via collective funds and investment trusts.
The Pep and Isa portfolio needs some rearrangement. This will not cause a tax liability but it is important that this element of the portfolio begins to throw out some worthwhile yield. Ideally, we will seek a yield of 7 per cent or so from a fixed-interest and corporate bond portfolio.
Venture capital trusts are collective investments providing income tax relief at 20 per cent on the amount invested. They also secure capital gains tax deferral if you realise a chargeable gain during the period of 12 months prior to and/or 12 months following the allotment of shares. Dividends, usually around the 2 per cent level, are paid free of income tax. Furthermore, the capital gain made upon disposal of the VCT shares themselves is free of tax.
The underlying investments do tend to be higher risk than conventional blue-chip shares so exposure must be limited and we will look for a broadly diversified portfolio to spread the risk.
While those who are investing solely for growth can afford to ignore short-term market fluctuations, they can be problematic for income investors who want their investment returns to arise in a steady and consistent manner. We will address that problem by putting together a combination of investments, splitting funds between short-term income and long-term growth elements.
About a quarter of the total portfolio will be divided into two portions to produce two investment funds – one made up of cash (about £90,000) and one exposed to a wider range of growth investments (about £180,000).
From the cash funds, Jean can draw an income of, say, £20,000 a year. Clearly, at this rate of withdrawal, the deposit of £90,000 will be whittled away over five years. However, over that same term, the balance of the portfolio will have time to ride out the peaks and troughs of the normal stockmarket curve and, assuming the usual pattern continues, it should replace the cap-ital expended as income from the deposit funds.
The sort of investments we use for the growth fund need not be particularly aggressive or speculative. A combination of investment trusts and zero-coupon shares should enable us to achieve sufficient growth to replace the capital expended as income. The target is around 8.5 per cent a year.
Ultimately, the use of this combination of deposit and growth funds is simply a way of using cash to buy the time for the stockmarket-exposed investments to work. It is also very tax-efficient as much of the “income” is capital. In this way, the overall tax liability can be minimised very effectively.
Finally, about £250,000 will be invested in with-profits bonds from a number of leading providers which will increase the ability to draw a tax-efficient income from a lower-risk, low-volatility fund.
Five per cent as a net yield from £1m or so could be quite a tall order. However, by greatly reducing the tax liability, the fund can be made to work more efficiently, reducing the overall yield required.