How to boost your portfolio income

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In a world of high inflation and high market volatility, income-hungry investors are casting around for steady returns on their money.

Those in the UK, at least, can scarcely hope to beat the rate of consumer price rises, currently running at an annual 8.7 per cent. But mitigating their impact can do much to forestall the need to tap into capital or scrap purchases. 

This is where wealth managers can help, devising income-boosting tactics or introducing their clients to ideas they might not previously have considered. 

Where are the pressure points on income?
In uncertain times, putting a dividend in your pocket provides a valuable element of predictability in a portfolio. But investors may need to rethink their traditional choices as economic circumstances change. When inflation is high, some businesses are better able than others to keep their costs down or pass them to suppliers or customers without putting their profits in peril — and keep the dividend train rolling. 

Broadly speaking, as household budgets have come under pressure, companies offering consumer discretionary goods or services appear increasingly vulnerable. Defensive stocks, by contrast, might include companies producing consumer staples — mundane items that are nonetheless regarded as essential, such as washing-up liquid, detergent or medicines. 

So what returns can these sorts of investments deliver?
The FTSE 100 in aggregate currently offers 4.2 per cent on a forward dividend basis — in other words based on estimated earnings over the next 12 months, according to Jason Hollands, managing director of investment platform Bestinvest. It falls far short of UK inflation, but he adds: “It obviously has the potential for capital returns as well over the longer term.”

A key consideration when picking dividend stocks is not simply to opt for the one with the highest yield but to consider the sustainability of payouts and their ability to grow over time. The important measure is the dividend coverage ratio, which indicates the number of times a company can pay dividends to shareholders from its earnings. 

A company with a very high yield can sometimes indicate the market is sceptical about its ability to maintain its dividend and demands a higher return for the risk of holding the stock. “I would sooner be in a company with a well-covered dividend that has the potential to grow from here rather than just picking the shares with the highest yields,” says Hollands.

What about tax? 
Wealth managers note that the old-school approach to income — taking interest in dividends and leaving the capital to grow — has changed in response to economic shifts, especially the rise of low- and no-dividend tech stocks. Investors over-reliant on income stocks were missing out on the biggest growth opportunity of recent years.

“It is much more likely that somebody is withdrawing funds in the form of capital and the yield is being rolled back into the portfolio,” says Christine Ross, client director at Handelsbanken Wealth and Asset Management. “People tend to pay less heed to income versus gain as far as their portfolio returns or withdrawals are concerned.”

Many wealth managers are loath to overload a portfolio with dividend-producing shares, as it can skew it towards particular themes or factors. Also, capital growth attracts lower rates of tax than income. 

David Henry, investment manager at Quilter Cheviot, says: “For clients who have assets in unwrapped [non-tax protected] accounts, going down the route of maximising income yield can be a little bit tax inefficient for them if they’re a higher rate or additional taxpayer.” 

Others highlight the need for flexibility in investment choices. John Moore, senior investment manager at Brewin Dolphin, warns clients against being “hung up” on income or growth. “We want to be balanced because we want to develop the risks we want to take as the investment narrative changes and those dark clouds disappear.”

Should I be thinking about bonds? 
Bonds are back on the radar for a new generation of investors after years of dismally low yields under the policy of quantitative easing and ultra-low interest rates. The function of gilts within a UK portfolio has been revived, since for the first time in over a decade they offer a reasonable rate of return at a very low risk. 

Henry at Quilter Cheviot says appetite among clients for gilts — currently yielding around 4.5 per cent — has jumped, in spite of a painful “reset” for bond investors in 2022. He cautions, however, that fixed income should be an element among a range of assets rather than a major constituent. 

“With gilts yielding around 4.5 per cent, people with 20 or 30 years of retirement left need a sizeable engine in the car to try and protect the real value of their capital. So they don’t want to have too much in fixed income.” 

How much is safe to take out to cover my needs?
Ross at Handelsbanken Wealth says the biggest danger today is that clients withdraw either a fixed amount or percentage from their portfolio, regardless of the wider circumstances in the market. This can lead them to eat into their capital, putting their long-term plans at risk.

“You need to consider whether you need to keep some capital back and give the portfolio a chance to grow in times of adverse market conditions,” she says. As a starting point for discussion, she suggests limiting withdrawals to an annual 3 per cent.