DIY Investor Diary: how I’m aiming for £10,000 annual income from my ISA

In our DIY Investor Diary series, we speak to interactive investor customers to find out how they invest in funds and investment trusts, what their goals and objectives are, current issues and concerns regarding their portfolio, and what they’ve learned along the way. The premise is to try and provide inspiration for other investors, and we would love to hear from more people who would like to be involved. We do not require those featured to be named. If you are interested, please email our collectives editor directly at: kyle.caldwell@ii.co.uk

For many investors thinking about using ISAs or SIPPs to help fund retirement, the aim will be to secure a reliable and regular income from their investments without inflicting too much harm on the capital.

This is the plan of the latest DIY Investor to feature in our series showcasing how interactive investor customers invest. The 61-year-old mining engineer is aiming to generate £10,000 of income from his ISA to help fund retirement, including trips abroad to watch cricket.

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He also has a SIPP, which is currently a smaller pot than his ISA, and he will receive both a defined benefit pension and defined contribution pension on retirement.

He says: “I’m looking to generate £10,000 a year from the ISA, of which I have around £200,000 invested. I’m aiming to take just the natural yield, so I’m looking for the ISA to yield around 5%, which is what it’s delivering at the moment.”

Drawing only the income produced by funds or investment trusts’ underlying investments – the natural yield – is a prudent way to reduce risk during retirement. This is because in a scenario where stock markets fall sharply, it is more difficult for a retirement fund’s capital value to recover after if you are withdrawing more than the natural yield.

Our investor’s ISA has 11 holdings made up of 10 investment trusts and one fund. The investment trusts span a range of countries, sectors and asset classes to provide diversification, which helps to reduce risk.

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Two UK equity income funds, Merchants Trust (LSE:MRCH) and City of London (LSE:CTY), account for a quarter of the ISA. Both trusts have yields of just over 5% and are solid income payers, with long track records of consistently increasing dividends year in, year out. City of London has increased payouts every year since 1966, while Merchants Trust has upped payouts for 41 years in a row.

Around 30% is held in three global equity income funds: Murray International (LSE:MYI), Henderson International Income (LSE:HINT) and Bankers (LSE:BNKR).

One thing to bear in mind with global income funds and trusts is that some have low yields, of below 3%, due to having a large exposure to the US stock market, which is more growth than income-focused. However, two of the three trusts held by this DIY investor, Murray International and Henderson International Income, buck the trend by being less wedded to the US. Both trusts have dividend yields of around 4.5%.

Our investor says: “Rather than picking countries or themes myself, I prefer to pick investment trusts that are ‘dividend heroes’, due to them having longstanding track records of growing their dividends every year.

“One area I do not have too much exposure to is the US. To me, everything seems a bit too rosy, and I am cautious on whether the US technology stocks can continue their strong run of performance.”

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He adds that investment trusts’ ability to “retain money for rainy days is a good feature and I like the accountability to shareholders”, which is why he prefers trusts over funds.

Under the investment trust structure, 15% of income generated each year from the underlying investments can be held back to be used in future years. Due to this, 20 investment trusts have raised their dividends for more than 20 years. In contrast, funds do not have this “get-out-of-jail-free card” and have to pay all the income generated back to investors each year. Therefore, when there’s an income shortfall, such as during the Covid-19 pandemic, a dividend cut is pretty much inevitable for funds.

The rest of the DIY Investor’s portfolio has exposure to property, bonds and infrastructure. This includes two defensive strategies: Capital Gearing (LSE:CGT) and Royal London Short Term Money Market. As well as holding both to reduce risk, our DIY Investor views the duo as cash-like investments and, therefore, they will be the first to be sold if he needs to dip into his ISA ahead of retirement.

The SIPP’s smaller size may change in the coming years, as there is the option for the DIY investor to top it up if he takes the 25% tax-free lump sum from his pension. If it is topped up, he will also look to generate £10,000 a year from his SIPP.

Eleven investment trusts are in the SIPP, which he says are “a bit more riskier” overall due to his plan to take money out of the ISA first. This makes sense from an inheritance tax (IHT) perspective, as ISA money typical forms part of an individual’s estate for IHT. Whereas, pension assets aren’t usually subject to IHT. Another attraction is that pension money passed on from those who die before 75 is tax-free. For those who die at 75 or later, the beneficiaries will pay income tax on withdrawals. 

The asset allocation of the SIPP is similar and some of his favourite trusts from the ISA also appear. However, there are some differences, with Balanced Commercial Property (LSE:BCPT), JLEN Environmental Assets Group (LSE:JLEN) and Scottish American (LSE:SAIN) all in the SIPP, but not in the ISA.

While the focus is now on using the ISA and SIPP to help fund his retirement, he had previously invested to help fund property purchases. At this point, he invested in funds as he was not aware of investment trusts. However, he became more familiar of trusts from reading Money Observer magazine and interactive investor’s editorial content. One piece of particular interest is the yearly £10,000 investment trust income challenge.

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He says: “As part of my research, I’m looking for ideas and pointers to narrow down the vast number of funds. I only invest in things I understand, which is why I wouldn’t invest in cryptocurrency.”

His top tips for fellow investors include doing your research, investing monthly and being patient.

He says: “Drip-feeding on a monthly basis means you haven’t had the money available to spend elsewhere, which means you learn to live without it. And if you do it for long enough, you’ll see the money grow.

“Being patient is also very important. After all, investing is for the long term – it is not a football accumulator. I’ve seen a few ‘bumps in the road’ since I’ve been investing. However, they usually present investing opportunities if you have a cash buffer to deploy.

“I would also add that it’s important to have a clear objective about what you are seeking to achieve from investing. Doing so, will make clear which types of investments to focus on.”