The need to focus on tax-efficiency and costs

IAN'S PORTFOLIO

Source: Investors Chronicle

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You're doing many things right here. I like your preference for passive investment. This is especially useful for a longer-term investor such as yourself. In the long run, any individual company, however mighty, can be brought down by technical change or bad strategy. For this reason it's better to back the field rather than particular horses.

I also like the fact that you're making regular monthly investments. It gets us into the habit of saving and, over time, how much we save matters more than what we invest in. Also, regular investments ensure that we buy on dips: your £395 a month buys more when prices are low.

You ask whether you should use your cash to buy and develop a flat. I would caution against this. There's a danger that the combination of higher taxes, housing benefit cuts and - perhaps later - rising mortgage rates will force some buy-to-let investors to sell up, putting downward pressure on property prices. There are also big dangers for the novice in property development, not least the planning fallacy - our tendency to underestimate how long jobs will take and how much they'll cost. And this is before we mention the fact that house price to earnings ratios are stretched by historic standards.

And remember that we want our biggest returns to be tax-sheltered, so it makes little sense to have so much cash in an Isa at the expense of equities.

Keith Bowman, equity analyst at Hargreaves Lansdown, says:

We assume that you have no significant non-mortgage debts and have considered broader issues such as the making of a will. You have not outlined any overall investment objectives, an important starting point for every investor.

Your age, 31, points to the likely pursuit of capital growth as opposed to income, with your investments signifying a medium to higher tolerance for risk. Stock market investments, as with existing holdings, should generally be acquired on a longer-term basis of five years or more.

You are missing the full benefit of Isas as you are holding a series of eligible Isa investments outside of these wrappers, while cash is being held within a stocks-and-shares Isa.

Your objective of investing in markets such as the US on a drip-feed or pound cost averaging basis offers benefits. Pound cost averaging involves investing equal money amounts regularly and periodically over specific time periods. By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high. The aim is to lower the total average cost per share of the investment, providing a lower overall cost per share purchased over time. The exercise also partly removes the critical issue of timing. Many ETFs or managed funds can be acquired on this basis. You could drip-feed the cash currently held within your stocks-and-shares Isa into such investments to fully use existing tax shelters first.

You have a stakeholder pension worth around £40,000, but could consider a switch towards a more flexible self-invested personal pension (Sipp), potentially widening the selection of investments that could be chosen, making your overall investment strategy fit together better.

Caroline Shaw, head of fund and asset management at Courtiers Asset Management, says:

You should maximise your Isa allowance each year, moving as much of your non-Isa holdings into tax efficient investments as you can. You should also consider further pension contributions: you do not say where your pension is invested but this should be looked at as part of your overall portfolio, as these benefit from tax relief and increased flexibility in retirement.

Buying and developing a flat will diversify your investment portfolio. However, property is not as liquid as your portfolio and the recent Budget introduced reductions in mortgage interest tax relief, so you should seek specialist advice.

You may wish to retain cash assets for a property deposit. Improved interest rates are usually only found if you tie up the money for a year or more which you may not wish to do. If you decide not to deploy the money into property I would consider acquiring exposure to other global equities using ETFs. You could also consider alternative assets such as infrastructure or commercial property via closed-ended funds.

HOW TO IMPROVE YOUR PORTFOLIO

Chris Dillow says:

I applaud your intention not to sell for the next two years: dealing costs mount up over time so it's better to avoid them. Which brings me to a problem. Your regular investments into ETFs are costing you one per cent of your investment each month. This is a lot. It removes perhaps the biggest advantage of ETFs - their low charges. ETFs are excellent if you have a big lump sum to invest but for monthly investments, dealing costs are a problem.

You might be able to get the advantages of passive investing at a lower cost by making regular contributions to a unit trust tracker fund instead. Their higher base charges might be offset by the lack of a monthly dealing fee.

I'm surprised that your US stocks have done well whilst your UK holdings have disappointed. This conflicts with most evidence, which shows that US equity fund managers are less likely to beat the US market than UK fund managers are to beat the UK index: perhaps the US market is more informationally efficient than the UK. For this reason, I would not infer that you have more skill at picking US than UK stocks. A track record as short as three years does not permit such an inference. Instead, it's more likely that you've been hit by the fact that some mega-cap stocks such as GlaxoSmithKline have done badly. I suspect this is just bad luck so don't read anything into it.

If you must reduce your cash holdings - and remember that cash is a very useful protection against market risk - consider shifting it into a global equity ETF.

Keith Bowman, equity analyst at Hargreaves Lansdown says:

Think about extending the diversity of your investments. Despite noted success, having a high proportion of US-dollar-denominated stocks raises your exposure not only to company-specific risk but also foreign exchange movements. Your faith in the recovery of oil and gas engineering related stocks such as Aveva may be strong, but the degree of faith given the size of these holdings relative to the overall portfolio could prove misplaced. The exact reason for the weakening in the oil price since mid-2014 is still being debated and the outlook for China's commodity hungry economy remains uncertain.

In this era of ultra-low interest rates, your dilemma with regards to cash, low returns and alternatives is a common one. For flexibility and emergency purposes, for example the loss of employment, some cash should always be held on easy access deposit.

As for potential alternatives, and considering your existing investments, managed funds such as Newton Global Income (GB00B8BQG486) and Standard Life Investments Global Smaller Companies (GB00BBX46522) are options – again, potentially using existing Isa cash first. The Newton fund looks to generate long-term capital growth investing largely in equities on a global basis, adding international diversity. And it generates a historic income yield of over 3 per cent.

The Standard Life fund targets capital growth by investing in smaller companies, a sector which historically has been profitable over the long term.

Caroline Shaw says:

Your overall portfolio, excluding your stakeholder pension and property, is suitable for an average risk investor. However, it contains a sizeable percentage in cash and without it the portfolio risk rises to that of an above-average risk investor.

You have heavily concentrated your investments into US and UK equities. This will have served you well over the past three years, with particularly strong returns from the US. However, a broader approach may now be appropriate. Increasing diversification with exposure to other global equities would benefit a long term equity portfolio. Your focus on equities appears sensible given your age, and your portfolio implies a willingness and ability to take risk. You should be aware that such a portfolio will be very sensitive to equity market shocks and is likely to be hit hard should a stress scenario such as the 2008 global financial crisis occur again.

Your focus on passive tracker funds, such as your ETFs, provides low cost exposure to the stock market. However, your exposure to select US shares will be duplicating exposure already gained in iShares S&P 500 UCITS ETF, to which you are contributing monthly. Don't ignore your currency risk either. The US dollar has been very strong against sterling but this will not necessarily persist.

Excluding your cash holdings, you have 36 per cent of your portfolio in individual UK equities. The majority is held in Aveva which is subject to a reverse takeover and profit-taking here could be opportune. But this is outside your Isa so there may be capital gains tax considerations. Whilst you appear to like stock picking this requires ongoing monitoring which you may ultimately find too time consuming, so a UK focused ETF may be helpful.

The dealing fee of £2 appears small but is over 4 per cent of your iShares Core UK Gilts UCITS ETF investment each month. In the low interest rate environment this investment may not deliver returns in excess of the dealing fee.