Annuity dilemma and individual share portfolio tidy

ANONYMOUS SHARE PORTFOLIO (MOSTLY HELD IN ISAS)

Other investments:

Cash savings: £51,000

Equitable Pension pot: £160,000

Stakeholder Pension pot: £235,000

Last three trades:

Infinis Energy (buy), Merlin Entertainments (buy), Al Noor Hospitals (buy)

Watchlist:

Songbird Estates, Rio Tinto

Chris Dillow, the Investors Chronicle's economist says:

How long do you expect to live? I know this seems a brutal question, but it is the key to your annuity choice.

You’re considering buying a 3 per cent escalating annuity. These currently give you an income of £3,900 per £100,000, whereas a flat rate annuity would give you £5,900. Why, then, prefer the former?

This is where life expectancy enters. The longer you are likely to live, the more attractive is the escalating annuity than the flat rate one, simply because you get more 3 per cent rises.

Two other factors should affect your choice. One is your likely health. Opting for a higher income now at the expense of a lower one in 20 years' time - that is, for a flat-rate over escalating annuity - might not be irrationally short-termist. It might be better to spend money in your 60s while you’re healthy enough to enjoy it; what’s the point of being able to afford holidays in your 80s if you don't have the mobility or eyesight to enjoy them?

The second factor is: how concerned are you by inflation? The more you are, the less attractive is the flat rate annuity relative to escalating or RPI-linked ones.

Here, there are two complications. One is that while inflation isn’t likely to be a problem in the near future, we can’t be sure whether this will remain the case over the next 20-30 years. For flat-rate annuity holders, inflation is a genuine uncertainty with the small chance of a high cost.

The other complication is that our attitudes to inflation are unduly influenced by our formative years. As economists Stefan Nagel and Ulrike Malmendier have shown, people who saw depressions in their youth remain risk-averse in later years, while those who saw inflation remain inflation hawks. Could it be that you are overweighting the danger of inflation because you saw so much of it in your impressionable 20s?

Many readers might wonder: why annuitise at all, rather than just use drawdown? Here, I sympathise with your choice. Annuities protect you from three risks, which can interact nastily. One is longevity risk - the danger (or hope) that you'll have a long life and so outlive your wealth.

Another is equity risk. Drawdown schemes - which, remember, can (and perhaps should) be as simple as selling a few of your own shares every so often - should give you a higher income than annuities on average because, for younger folk average equity returns should exceed annuity rates. But there is big risk around this. If share prices fall a long way, a decent income would make huge inroads into your capital. And there is a roughly 10 per cent chance of shares losing 20 per cent or more over a three-year period, which means such an event is odds-on during a 25-year retirement.

A third risk - which applies to self-administered drawdowns - is a psychological one. You might be tempted to spend too much early in your retirement. One overlooked argument for annuities is that they act as a precommitment device, saving us from our own impetuosity.

On balance, then, I reckon your annuity choice might be more or less right.

As for the composition of your equity portfolio, you’re right - it is the sort of sprawl which a buy-and-hold investor can easily end up with after years of investing. But as you’ve steered clear of actively managed funds you have avoided the biggest problem with closet tracker portfolios, that you pay high fees merely to track the market. My one caution here would be that this seems to have a slight cyclical bias. This is no problem at all whilst the economy grows well, but it might become one - albeit slightly so - when the economy cools off.

Gavin Haynes, the managing director at Whitechurch Securities, says:

Although the cash held outside the portfolio reduces the overall risk, with less than 10 per cent of the investment portfolio in bonds and the rest in direct UK (and a couple of overseas) shares we would classify this as high risk portfolio due to the high equity exposure.

Given that one of the requirements of the portfolio is to possibly provide for long-term care you may wish to consider diversifying the asset allocation away from UK equities. We suggest increasing the weighting into income producing areas including fixed income and commercial property while moving equity exposure further into safer, higher-yielding stocks.

You are averse to investing in funds due to poor performance in the past but should perhaps reconsider this as a means of gaining some international diversification to an otherwise very UK centric portfolio. Your two overseas holdings while in quality developed large caps offer limited exposure. Artemis Global Income (GB00B5V2MP86) and Newton Global Higher Income (GB00B5VNWP12) are both funds that we rate highly for providing globally diversified exposure to yielding shares.

As time progresses you may also wish to review the exposure to more speculative stocks in favour of other assets. It may also be worth revisiting how you define 'safer' shares as you still have a high exposure to a lot of small and mid-cap stocks which can by their nature be higher in risk.

The portfolio contains shares in 35 companies. You have acknowledged that your method of buying shares over the years may have led to a random mix of shares, but actually the investments are spread across a range of sectors providing good diversification.

However, several of these holdings are very small (although you acknowledge one of these is sentimental) and at well under 1 per cent of the portfolio they are adding very little. It would be worthwhile reviewing these holdings and deciding if you have conviction in them in which case it may be worth increasing the size of the holding to something more meaningful or if not selling out completely to use the funds to reinvest in a stock that you have more conviction in.

One of the stocks on your watch list is Rio Tinto (RIO). This is a large cap, diversified miner with a good well covered dividend yield which would fit well as part of the move towards to safer, higher yielding stocks. However, when considering these stocks it would be worth looking at them as part of the overall portfolio as there are already two mining stocks held. Although these are much smaller, more speculative mining stocks very different to Rio Tinto overall sector exposure should be considered as underlying trends will affect the sector in the same way.