Equities have tended to fall between 30 per cent and 50 per cent during severe downturns. An income investor with a large allocation to equities risks losing significant wealth during a protracted fall in markets, which can last two to three years. 

While it is tempting to assume that income investors can avoid risk all together by hiding out in bond allocations, this too produces a suboptimal outcome as returns are hampered by low expected returns in safer asset classes. In addition, bonds can also be hit severely during periods of high inflation. 

Mitigate risk of pound cost ravaging

The key is to have a dynamic asset allocation approach that steers income portfolios away from equities as they start to show increased vulnerability.

Something as simple as a trend-based approach can significantly improve outcomes for clients as research by Andrew Clare, professor of asset management at Bayes Business School, has demonstrated. This involves reducing the allocation to equities based on the 10-month trend of the equity market.

While no system is ideal in this regard, any system at all can help mitigate the risk of pound cost ravaging and/or suboptimal long-term returns by varying the exposure to equities through the economic cycle

Income investing is a uniquely challenging endeavour because, unlike growth investing, it exposes investors almost exclusively to the downside consequences of asset price uncertainty.

Income investors face a variety of challenges that industry experts have rarely prepared them for. It is important to seek help, adjust and avoid the temptation to use higher-risk allocations as a solution. 

Fahad Hassan is chief investment officer at Albemarle Street Partners