Insights from ISA Millionaires: How to generate £100k of annual income from your ISA
We are fortunate at Stockopedia to have a community of successful investors who have built portfolios worth more than £1m in their ISAs and kindly agreed to share their insights. In this series of articles we will explore their investment strategies and key lessons learned on how to pick stocks and manage risk when building a portfolio. Whether you are an experienced investor or just starting out, we hope that these interviews will provide valuable insights and inspire you to achieve your own investment goals.
Profile
Name: Jack (not his real name)
Job: Retired
Number of years as a private investor: Over 30
Portfolio Size: £1.1m
Investing Background: Jack worked for FTSE 100 consultancy firm Computer Management Group where he joined his company’s share scheme. When he retired in 1995, CMG was his one and only stock. The rest of his portfolio was in VCTs and EIS funds managed by professionals. Since retirement he has become a full time investor.
Investing Goal: To generate £100,000 of dividends from his ISA every year to boost his income and reduce the amount of time it takes to manage his portfolio.
Getting Started
There is no denying that building a portfolio of stocks and shares worth over £1m requires a certain degree of good fortune, whether that comes in the form of a well-remunerated job or a series of successful stock picks. But getting started early is key.
Jack says, “I’d been investing since 1972 in an employee share scheme - that was my original one and only share and it set me up.” While still working, he left the management of his portfolio to specialists where it was mainly invested in Venture Capital Trusts (VCTs) and Enterprise Investment Scheme (EIS) funds.
Then in the early 1990s when the Personal Equity Plan (PEP) - the predecessor of the ISA - was introduced in the UK he started contributing annually. Around the time he was thinking about retiring, one of the private companies he had shares in went public, cementing a gain which left him a good starting portfolio to build on in retirement.
Insight 1: It is never too early to begin building your portfolio
Hunting for growth
Jack’s approach to growing his portfolio might seem slightly haphazard. He has invested in funds and individual stocks as well as the VCTs which got his portfolio started in the first place. He says that when he first started investing his focus was “small-cap-ish”, but now those small caps have grown.
With an income provided by his investments outside of his ISA, Jack has been able to take more risk with the assets in his ISA - picking stocks in innovative sectors that were just in their infancy (like new energy companies) and investment trusts with stakes in early stage enterprises (like Gresham House and JLEN).
But despite the wide ranging field of assets he has added to his portfolio, the overall focus has remained on growth stocks. Jack’s success in building his portfolio provides a valuable lesson in the importance of setting targets before making big investment decisions. As a recent retiree with a decent income which covered personal expenses, he knew he could afford to take some risks with his growth portfolio and so he picked companies in geographies and sectors which could provide that growth.
Insight 2: Focus on assets which will help you reach your goal
How to reduce risk
Jack has diversified across many different sectors and geographies and believes that over his investment career he has owned more than 280 individual assets, most of them stocks.
Jack’s approach to diversification stretches to the accounts he uses to manage his portfolio. “I have a boutique firm to look after a portion of my assets, another company with another portion of my assets,” he said. “I set up another account in America. In addition to diversifying my assets I was diversifying with my brokers, to decrease risk.”
Insight 3: Diversify
How to generate income
Jack maintained his focus on growth until about two years ago when, “I decided because of my age I should invest for income.” “I now hunt the money,” he said. “What I am targeting is £100,000 out of my ISA every year. At the moment I am generating a 5% return on £1m.”
With a portfolio of over £1m, Jack knew that to generate an income of £100,000 a year he needed to buy high yielding stocks - a task that is complicated by the fact that Jack’s portfolio is so broad.
Indeed, Jack admits that part of the reason for switching his focus to lower risk, dividend paying stocks is to reduce the maintenance of his portfolio. He remincises that during the Covid-19 pandemic, he didn’t mind spending a lot of time managing his money, but now he doesn’t have time for much else.
Now that his strategy has shifted to income stocks, Jack maintains his focus and the new strategy is proving fruitful. Last financial year the portfolio generated £50,000 in income and next year it will be up to £60,000. Jack is confident that he’ll hit his £100,000 target before long and after that “I don’t know what I’ll do.”
There is no denying that Jack continues to benefit from good fortune. Although his ISA strategy has now switched to income generation, he doesn’t actually need that income for himself - the money from the VCTs and EIS investments continues to take care of that. Instead the cash he makes from his ISA can be reinvested: “As I’m hunting the money for income, I’m not taking any income out, so that income is being reinvested at a higher rate of knots.”
Insight 4: Set targets and refresh those targets if your personal circumstances require it
How to deal with times of turbulence
Jack’s portfolio isn’t on a continuous upward trend. It peaked at around £1.6m before the pandemic and has fallen to £1.1m today. But Jack isn’t phased, “it will come back, I’m not a panicker.”
That’s a mindset which he says has persisted throughout his investing career: “My mindset has stuck,” he said, “but the strategy unconsciously has changed - not [because of] my personal circumstances but [because of] the market”.
And therein lies an important but oft-forgotten lesson of successful stock market investing: don’t panic. Markets fluctuate, but as long as investors are confident that their portfolio has been built to help them reach their target, there is no reason to veer off course.
Insight 5: Don’t panic
Update: This article has been updated to improve clarity around the income generating capacity of the portfolio. Jack's portfolio currently yields around 5% generating an income of roughly £50k. He is targeting £100k by increasing both the size and the yield.
Disclaimer
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17 comments
Thanks for sharing but to me you may be captive to your environment and experience set. I too have more than 20years investing experience and believe the market is a great way to keep liquid assets working for you. I believe returns are a combination of dividends and capital movements which can be up and down. As John Maynard Keynes said in the long run we are all dead. But while you are here, you have to protect and grow your capital else it will degrade to nothing. Suggest a target of 25% return, less stocks to manage, the fallacy of diversification protecting you is just that a fallacy. You are not the Market, or a market maker. Time to manage the portfolio is a normal non lazy process. I still have time to play golf 4 times per week at 71 and make time for family. To achieve 5% return and 50,000 in cash income is great but not it your capital has gone down by 50,000.
“What I am targeting is £100,000 out of my ISA every year. That’s a 5% return on £1m.” Wrong: that would be a 10% per annum return on £1m.
He said: At the moment I am generating a 5% return on £1m.
Well done Jack and best of luck with your income shares. In contrast to your approach, my investing style has remained the same regardless of my age or whether I am retired. I always invest in what I hope will provide the best total return over the medium to long term.
Interesting article and I too have been thinking about what I would do when I reach retirement age and switch my portfolio to a more passive income strategy. I'm 26 years away from when I can access my SIPP, but plan to compound my savings in small cap growth during this time (fingers crossed!).
My initial thought was to put are large portion of my equity portfolio into a dividend ETF. That's when I researched about £IUKD - a 50 stock ETF, selecting the highest dividend yielding stocks in the FTSE 350 - and yields around 6% (at current prices), but has historically achieved a yield of 5%... sounds perfect!
However...
The ETF's inception date was in December 2005 but has only produced 3.61% annualised return during this time. This is with dividends reinvested! (chart below).
If you were to take your dividends as income, with no re-investment, the annualised rate of return is -2.44% annualised! (chart below). This is fine if the only thing you care about is the income, but I think capital growth is still important to keep with inflation during retirement.
So in my personal opinion, being too passive with your income portfolio or 'buying for yield' will lead to underperformance. As a result, I've done some more digging into how I can achieve a high yield portfolio but with 'momentum'. Taking a look at the VM rank's performance over the last 10 years and producing an annualised rate of return of 16% as of writing, I selected the top 20 stocks and found the average dividend yield to be around 4.76% - not bad.
I then decided to optimise this further for yield and created a screen which is:
Mkt Cap: >= £50m
Rolling 1y Yield >= 1 x market median
VM Rank >= 95
Dividend Cover Rolling 1y >=1
Sort by descending VM Rank
Rebalance annually (to capture the full dividend yield) in a NAPS style or sell when the VM rank falls below 85 (to ensure you keep momentum).
By selecting the first 20 stocks, I have increased the forecast yield to 7.99% and I hope to capture the upside momentum which a VM portfolio can bring.
It would be great if anyone has done this before, and tell us what the performance of this is like. But my two cents on this, is that you will always need to be "active" at least once a year to ensure your performance doesn't drift downwards over time.
Not done that specifically, but if you are doing it for the income might be worth using a higher dividend cover of say at least 1.5x to rule out the highest yielders with the greatest risk of cutting their dividends. You could also exclude the top quintile / quartile by yield as the 2nd quintile / quartile by yield have tended to do better than the highest yielders. This would obviously mean a lower starting yield, but might afford more growth and less risk perhaps, hope this helps.
Excellent process, I will investigate further.
Thank you.
Michael
Of course, the approach taken by “Jack” in this article is pretty meaningless without knowing his age. If he retired in 1995 then even if he retired early in his 40’s that means he is maybe in his 70’s now. If so, then I can understand why dialling down risk is important, but buying equities that yield above the market average is not the way to do it IMHO.
He may also want to look at the fees charged by his boutique broker! The cost of charges and fees is important in maximising returns over 30 years. High fees can really hit long term returns. Personally, that’s one of the main reasons I started investing for myself 25 years ago. That and the fact I knew I couldn’t do any worse than the professionals…
Surely what Jack is targeting is drawing 5% from an ISA valued at £2m rather than a return of 5% on a portfolio valued at £1m?
I do the same (target drawing 5%) all be it on a smaller portfolio size. I also acknowledge the inherent risks in targeting a particular drawings figure and a figure as high as 5%, when in general the literature would indicate that a 4% withdrawal rate is the very maximum safe level. And, though I wish (oh wishing) otherwise, I acknowledge that my portfolio is unlikely to double in all but the very long term at this withdrawal rate.
I would also question whether it is possible to draw 5% from a stock portfolio worth £x and at the same time grow that portfolio so that it becomes valued at £2x in a meaningful amount of time. This article:
https://www.hartfordfunds.com/...
points out that “Going back to 1960, 69% of the total return of the S&P 500 Index1 can be attributed to reinvested dividends and the power of compounding..”
One could invest the lot in Legal & General (LON:LGEN) and Aviva (LON:AV.) and other high yielding large caps and boost the dividend income to £85,000 (on a portfolio of £1m) but I am not sure that would be a strategy for the long term.
Regards
Michael
Hi Michael,
I agree. I found the maths in the article quite confusing and 5% sounds over ambitious, particularly when the pot has already shrunk by £500k. I have read that 4% is a Safe Withdrawal Rate but this relates to US based investments only. If you invest purely in the UK market the SWR is considered to be less (3-3.5%) because the FTSE has less growth historically.
However, my biggest issue with the article is that it states shares with a 5% dividend yield are less risky. I’m sorry, but that’s nonsense.
All the best, Si
Hi Michael,
Your withdrawal rate of 5% may be risky (which you acknowledge) in terms of you running out of money if the capital growth of your portfolio is not sufficient to make up for it or sequencing risks. Unless that is your intention as we can't take it with us after all!
Interestingly you linked to the Hartford Funds research which not only shows the benefits of Compounding dividends but also the benefits of targetting Companies growing thier dividends for higher returns & lower risk. If you could afford to live with a lower income a safer way to go may be to target Companies & investment trusts which can grow their dividends consistently over time (ideally ahead of inflation). Then just take the natural yield (3 to 4% or more perhaps) as it comes which might then grow in line with or ahead of inflation if the Companies & funds you choose are successful in that regard.
The capital side should then take care of itself and you should then be able to live with the volatility in the capital without worrying about it. Obviously the main risk to this is a 2020 Covid type situation where there are widespread dividend cuts & suspensions. Hopefully that will prove to be a one off situation, never to be repaeated, but in any event dividends did bounce back pretty quickly. So as long as you have some emergency funds too then it should be manageble.
Any way that's how I do it personally, but obviously not possible or desirable for everyone depending on their circumstances / tax postion etc.
Regards,
Jamie
Compound Income
Twitter:jamie@compoundincome
Hi Jamie
Mine was a quick reply (rather than an in-depth heavily researched treatise) to what I found a (very) confusing article, with muddled logic. But reading between the lines he seems to think that having shifted to income stocks, to yield the magic 5%, these stocks will still grow at a sufficient clip to take his portfolio from £1.1m to £2m. I just don't think that is realistic.
I suppose what I am trying to say is I didn't find the article very helpful. Goldfinger said "You would like to hear another of my aphorisms [Mr Bond]?’ ‘Yes.’ ‘Well, Mr Bond.’ Goldfinger gave the rich man’s thin smile. ‘The safest way to double your money is fold it twice and put it in your pocket.’"
While that might be a little conservative, the most likely solution to being able to draw £100,000 out of your ISA at age 60 is save £400 a month for 40 years, and hope with a following wind you mind mange 10% growth but expect 8% and up the savings rate as you get older. Then draw 4% from your savings.
One of the many things I have learnt since I started investing, is that most people, including myself, are far too bullish on expected returns, rates of inflation and drawdowns we are likely to suffer along the way.
If I had set my investing goals much lower at the outset, I believe my outcomes would have been much better for it.
Regards
Michael
Surprising as the top stocks pay very little in dividends, Microsoft (NSQ:MSFT) pay 1%, Apple (NSQ:AAPL) pay 0.62%, the other top 4 pay nothing, not much compounding there. What is the growth is from reinvested dividends in the last 10 years? I think it has changed with the top companies paying low or no dividends recently. The S&P 500 yield in the 70s and 80s was around 4-5%, now it is only around 1.7%. The index is up 4x in the last 10 years.
I assume you are referring to the Hartford Funds Research. Worth noting that in the small print is said it was in comparison to an equally weighted S&P 500. The same outperformance it not I believe seen against the regular S&P 500 weighted by market cap as you allude to as investors / indexers increasingly chased / gravitated towards the big tech stocks etc.
That 5% on one million is NOT £100,000……..
There is a mistake in this sentence: "What I am targeting is £100,000 out of my ISA every year. That’s a 5% return on £1m"
I thought that as well, but later it clarifies this is a target that hasn't been achieved yet. Last year it was £50k, and on track for £60k this year.