Substituting Capital Gains for Income

Moving from a "normal" ETF which holds a generalist mix of companies to a higher yield one which has a specialist mix to focus on high income payers, is one way to shift the profile of your returns towards income at the expense of gains.

However, at different parts of the economic cycle there can be a difference in total returns between specialist equity income funds (such as Vanguard's FTSE all world high dividend yield ETF or their global equity income fund, both of which yield about 3%) and generalist equity funds (such as their Lifestrategy 100 or their FTSE Global All Cap fund, both of which yield about 1.75%)

So, you might be expecting to improve your tax situation in terms of taking an extra 1.25% of income each year and having lower growth prospects... but this will not necessarily play out because in some years the total return is actually lower by using the income funds instead of generalist ones, while at other times it would be the other way around.

Really, your asset allocation is what drives your total returns over time, and although it might be a preference to avoid tax by having lower gains and avoiding the 10% CGT tax on the portion of gains that can't fit into your exemption, it won't improve your net situation if your gross profits are a little lower on the first place.

Tax effects are certainly something to be aware of and plan around, but if you let your tax planning drive all your asset allocation, it could be a case of "the tail wagging the dog". Generally the way to approach investing is to first work out what underlying investment types you want or need, and then only as a secondary thing, look how to accomplish that tax-efficiently.

Some parts of the world have companies paying a relatively higher proportion of their value as dividends, and so do some company types on an industry basis or regional basis (eg tobacco companies generate high divs, Amazon generates none but is still very valuable, others prefer share buybacks). If you focus just on companies that pay the highest divs you will perhaps be skewing your portfolio exposure away from certain types of companies and regions and towards others. A small amount of tax might not be enough compensation if one set of companies gives you twice the profit one year than the one that saves you a small amount of tax on a small part of your portfolio returns.

Tom99 wrote: »

Unless you need the extra income how does using more of your personal allowance help?

Because presumably by focussing on something with higher income (which doesn't get taxed due to bigger allowances, and then only at 7.5%) at the expense of higher growth (which is closer to getting taxed, and at 10%), one might expect a better result in terms of less tax leakage.

Whether you get that in real life however, will depend on whether the overall gross returns before and after are consistent, or differ dramatically from year to year. Compromising total return for a particular type of return might not be ideal.