Investing to pay off my buy-to-let mortgages

Mark's Isa portfolio

Last three trades:

Dixons (Buy), Diageo (part sell), Unilever (part sell)

Shares on watchlist

IG Group, Jarvis Securities, Barratt Developments

Chris Dillow, the Investors Chronicle's economist, says:

Ordinarily, I wouldn't advise people to use equity investing in the hope of paying off an interest-only mortgage. Equity returns, even over quite long periods, are too volatile for us to rely upon share prices rising sufficiently to do so. However, as your equity portfolio is already quite big relative to the size of your mortgages, and you have 15 years in which it can grow, you can get away with doing this.

One of the first questions to ask about our financial position is: what risks do I face? And you face interest rate risk. For many of us, a quicker or sharper rise in interest rates than expected would be a blessed relief. For you, though, this would mean higher outgoings. It might also mean a fall in the value of your buy-to-let investments, if house prices fall as a result. (Remember, people - house prices can fall.)

In this context, I'm a little surprised by your equity holdings. A fair chunk of them add to your interest rate risk. If rates do rise a lot, Bovis, the banks and Rightmove might be especially hard hit. While many people can afford to take this risk - as they would benefit from higher rates - you are less able than them to do so. In this sense, your equity portfolio seems to add a little to your background risk.

How big a problem is this? The futurologist in me thinks not; rates might not rise much for a long time. But nobody should base an investment strategy upon a vision of the future. What also makes me relaxed about your position is that you are saving a decent sum already. If rates do rise, you might be able to adjust by reducing your savings. (Again, I wouldn't ordinarily advise this, but as you have a good company pension, one powerful reason why the rest of us have to save doesn't apply to you.)

But is this margin of adjustment sufficient protection? If it's not, you should consider alternatives. One possibility might be to pay off some of the mortgage - assuming that early repayment charges aren't too onerous. Another possibility is to hold cash. Yes, I know it pays a negative real rate. But it has the attraction not only of protecting us from stock market falls, but from interest rate risk; what you lose from higher mortgage payments, you'll gain from higher cash returns.

A further interesting issue here is the composition of your portfolio between buy-to-let and equity investments; the latter seem to be the smaller part of your portfolio, but you are rebalancing towards them.

Is this wise? Personally, I suspect that, overall, the risks and long-term returns on equities and property are roughly the same; it's just that equity risk is more obvious and quantifiable than buy-to-let risk. And the two risks, over periods of a few years, are only lightly correlated, which means that one is a good diversifier against the other.

Why, then, might a big position in buy-to-let be a bad thing? There are three types of investor for whom it could be:

■ Those who might require cash quickly. It's far easier and cheaper to sell equities than houses. If your circumstances are likely to change so that you need quick cash, equities are therefore better than buy-to-let.

■ Those exposed to local economic risk. If you own houses near where you live, you're taking a double bet on the local economy - that local conditions will be good enough to support house prices and keep you in your job. If a big local employer closes, you could lose on both counts.

■ Those saving for retirement; contributions to equity pension funds usually get better tax treatment than buy-to-let investments.

If these factors don't apply to you, then a big position in buy-to-let isn't so bad. For some others, though, it would be questionable.

Helal Miah, an investment research analyst at The Share Centre, says:

Before looking into your portfolio, some consideration should be given to paying off the mortgages and the potential benefits that reduced monthly mortgage payments may bring. This would be a lower risk option and it is my general preference to minimise debts before thinking about investments. While interest rates and inflations levels may currently work in your favour, the market expects to see rate rises before too long.

Excluding your properties, your current investment portfolio is roughly equally split between direct equity holdings and fund investments. The allocations of the funds are well balanced between blue chips, small caps and international equity exposures; however, they tend to focus towards income, which doesn't always go hand in hand with a target for growing your capital with a medium level of risk. However, I understand that these are all in accumulation units and, as studies have shown, reinvesting the income over the long term should generate bigger returns.

Looking at your direct equity holdings, the largest exposure is to the banking sector through Barclays and HSBC. These are our preferred stocks in the sector as they are lower risk than some of the other banks and are paying dividends. HSBC is less exposed to the indebted developed world, relying on the high-growth emerging markets for 85 per cent of its revenues. Barclays, despite setbacks related to several scandals, looks like it is in better shape as new strategic plans takes effect, including major cost cuts. However, let's not forget the sector is not totally out of the woods yet and so we would expect some volatility. While the European debt situation is not looking as bad as it did 12 months ago, banks will still be prone to any resurfacing of debt problems among the peripherals and there could easily be another Libor-type scandal yet to rear its ugly head.

The overall yield of the portfolio is circa 2.85 per cent on a historic basis, with the direct equity holdings contributing about 1.5 per cent of this. However, we are doubtful whether Man Group's indicative yield of 16 per cent will be maintained and a fairer view would therefore be in the region of 2.5-2.6 per cent. For a growth-focused portfolio this is a reasonable return and, as mentioned earlier, reinvesting the income will certainly help boost the capital return over time.

Your equity investments have a good balance of large blue-chip income stocks and higher-risk growth stocks and among these your two property-related stocks, Bovis and Rightmove, have performed well. The property and construction sector has a very positive outlook for the next few years, supported by government policies.

In terms of sector exposures, consider buying some energy and commodities as you have no exposure to these. The big oil companies haven't been the best of performers recently but they provide a very good yield and we would expect energy prices to remain elevated in the future, given the lack of significant conventional oil finds. The mining sector could also offer good value given how weak commodity prices have been. We would suggest focusing on the less risky large-cap diversified miners, such as BHP Billiton (also see page 58).

The £450 a month that you contribute into the portfolio means that you're a employing a pound cost averaging strategy, where you buy more shares when the price is low and fewer when it is high. This, along with reinvesting the dividends, should result in the capital growth you are looking for over your investment term.