Use tax wrappers efficiently to hit objectives

1. To produce a small income of around 3 per cent and generate some growth to achieve an annual total return of around 4-5 per cent.

2. To preserve wealth so that his wife can continue receiving a good level of pension if he dies before her, and to be able to pass something on to his family.

"My wife and I have a reasonable income from our combined pensions, which gives us a comfortable standard of living, so the extra income is to provide us with some good holidays and enable us to enjoy our retirement and hobbies," he says. "We have our NHS and small BBC pensions, both of which are linked to retail prices index (RPI) inflation, two small level annuities and our state pensions. We also have other small investments in joint names, mainly in stocks and shares, worth just over £200,000, with just over half of that invested in US stocks. The only other asset we have is the house we are living in, which is worth around £1m and does not have a mortgage.

Until recently I had been taking a rather high-risk investment approach, but since attending Investors Chronicle seminars in September and October 2015 on investing for growth and income I have decided to become more moderate/conservative in my approach.

I haven't altered my portfolio yet as the market has been so volatile since, but my risk profile has changed and I would like to lose as little as possible - even in a bad year.

I think I take too much investment risk for my age. The investments that have influenced my approach are technology stocks, especially Apple (AAPL:NSQ), and to some extent Google (GOOGL:NSQ) and Microsoft (MSFT:NSQ). I have also been influenced by the collapse of commodities and mining shares, and the effect these have on developing markets.

My last three trades were the purchase of 300 Greene King (GNK) shares worth £2,789.19, 10 Amazon (AMZN:NSQ) shares worth £4,413.17 and 100 Apple shares worth £7,130.95.

I have the following investments on my watch list:

Tesla (TSLA:NSQ), Moneysupermarket.Com (MONY), Daily Mail and General Trust (DMGT), WH Smith (SMWH), 4imprint (FOUR), Dart Group (DTG), Marlborough UK Micro Cap Growth Fund (GB00B8F8YX59), Alibaba (BABA:NYQ).

Yusuf's portfolio (Isa and Sipp)

Yusuf's wife's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You don't need me to tell you that this portfolio is rather sprawling. One way to try to understand and simplify it is to ask: what factors am I exposed to, and what do I want to be exposed to?

It seems to me that you have big exposure to three particular factors. One is domestic cyclical risk. If the UK economy does badly - or looks as though it is going to - smaller stocks and housebuilders would probably suffer. The opposite of this is that they'd be the main winners from increased optimism about the economy. I suspect that Standard Life Investments UK Equity Unconstrained Fund (GB00B1LBSR16) falls into this category: one reason for its poor performance over one year, after sustained good returns, was that it was hurt by growing fears about an economic downturn.

The second factor is defensives. IC Top 100 Fund CF Woodford Equity Income (GB00BLRZQB71) and CF Lindsell Train UK Equity Fund (GB00BJFLM156) both have a bias towards defensive stocks. I suspect that Apple and Amazon also fall into this category now: their size and brand power give them what Warren Buffett calls economic moats - the power to fight off threats from competitors.

Thirdly, you've got some growth stocks - most especially within your biotech funds.

There is some diversification across these factors. Circumstances in which growth stocks do well, for example improved sentiment, are likely to be ones in which defensives underperform. In this sense you have a closet tracker fund.

However, you are only diversifying relative returns. In bad times, all your stocks and equity funds would probably fall together simply because all of them are correlated with the global market. This portfolio does not, therefore, satisfy your desire to "lose as little as possible even in a bad year". To achieve this, you need more non-equity assets such as cash, gold or bonds, which would hold up well if shares fall.

In this context, though, you face a sharp trade-off. You cannot lose as little as possible in a bad year and at the same time achieve a 4-5 per cent total return. Reducing risk requires that you sacrifice returns by holding lower-returning assets.

That said, there are two ways in which you can mitigate this trade-off.

One is to have a strong bias towards defensive stocks: on average, these achieve the twin goals of decent long-run returns and fall less than the market in bad times.

The second is to use some form of moving average rule. History tells us that we can improve long-run returns and reduce risk by following this rule: hold equities when prices are above their 10-month or 200-day moving average, and sell when they are below. One drawback with a portfolio as sprawling as this, is that it makes it difficult and expensive to change asset allocation in response to this sort of rule.

James Baxter, partner at Tideway Wealth, says:

Your objectives look entirely reasonable and conservative, however, as I think you have identified from the Investors Chronicle workshops, your and your wife's portfolios don't match these objectives.

There is too much speculative growth, and not enough income and certainty of return. On top of this there is a somewhat random use of the various tax accounts: self-invested personal pensions (Sipp), individual savings accounts (Isa) and your wife's general investment account. Left unchecked, these are wasting the valuable tax breaks. You may well have put a lot of research into each investment selected, but there seems to be a lack of high-level planning.

A sensible strategy for the Sipp accounts would be to separate out at least 15 years' worth of any potential withdrawals you might want to make into a combination of cash deposits and fixed-income securities. This would mean that no equity investments would need to be sold just to meet income needs in the coming years. The balance of the Sipp accounts could then be invested for longer-term growth, with dividends reinvested. A long time horizon and dividend reinvestment have proved to be the best way to invest in volatile equity markets.

With the new rules on death applying to personal pensions, these are probably the most tax-efficient of the three accounts to preserve and grow assets for the next generation.

High-level planning like this will help you decide which investments to hold in which accounts, and to generate your income requirement tax-efficiently and ensure you never have to sell investments at a loss to fund income.

Creating a secure and reliable income stream from a combination of gross fixed-income coupons and equity dividends, topped up by secure funds set aside for a number of years, will make you largely impervious to any future market downturns. Over time, it could also help you separate out capital that's not essential to your income needs and with which you could comfortably take more speculative risk, or potentially pass on as gifts to reduce inheritance tax and put to good use elsewhere in your family.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

I would suggest really simplifying this portfolio, using a FTSE All-Share or global tracker fund as a core, and adding exposure to other factors, such as defensives, if you really want them.

I have three other suggestions. First, don't be scared to let go. It's difficult to sell, partly for fear of missing out if stocks rebound. However, it is inevitable that even the best investors miss out on many opportunities. The facts tell us that we lose by holding on to shares that have fallen, because we expose ourselves to adverse momentum effects. Be ruthless in selling losers.

Secondly, be aware of an overlap between stocks and funds. For example, the biggest holding in Standard Life UK Equity Unconstrained Fund is Crest Nicholson (CRST), which you also hold. It may be a good stock, just be aware that you're holding more of it than you think.

Thirdly, try to minimise funds' fees. One problem with a very diversified portfolio such as this is that funds don't bring anything to the party in terms of significant outperformance or risk reduction, but do cost you money. Only hold such funds if you are confident they are doing something. I'll concede, grudgingly, that this might be true for defensive equity income funds. But it might not be true for the other types of fund so these should be the first to go when you prune this portfolio.

James Baxter says:

I suggest you plan your investments as follows.

A 4-5 per cent return target can be met by quite a few listed fixed-income securities issued by blue-chip companies, with complete certainty of returns and an extremely small risk of default. By keeping to relatively short-dated maturities, say under 10 years, the risk of interest rate rises can also be mitigated. This is by far the simplest and most certain way of meeting all three objectives of total return target, distributable income and capital preservation. A combination of collective fixed-income funds and individual bond securities, correctly sized, can make for an ideal combination, just as you have blended individual equity holdings with professionally managed collective equity funds.

If you and your wife focused your combined Isas on fixed-income securities and gross distributing fixed-income funds you could reasonably expect to generate around £22,000 a year, or 4.5 per cent, tax-free income from these accounts without excessive risk. This is equivalent to £27,500 a year of pension withdrawals taxed at 20 per cent. This would be a far better use of your Isas than holding equities and equity funds that generate capital gains and dividends taxed at lower rates.

Equity funds and individual shares are still tax-efficient when held directly, despite the new tax regime for dividends. Couples can use their annual capital gains tax (CGT) and dividend allowances, and CGT and dividend tax rates are lower than general income tax rates. If you and your wife focused your joint and individual general investment accounts on income-generating equity funds and individual shares, it would be possible to generate, say, another £14,000 a year, or 3.5 per cent of dividends. £10,000 of this would be tax-free and £4,000 would be taxed at 7.5 per cent, amounting to £300. This would be equivalent to drawing £17,125 income from the Sipp accounts taxed at 20 per cent.

Generating the bulk of your income this way versus larger pension withdrawals has the propensity to save you around £8,600 a year in income tax payments. It would also leave a very modest annual shortfall of income to come from the pension accounts, which could be withdrawn as needed.