Too much cash to achieve the targeted return

"I was forced into investing due to low interest rates so I was a complete novice," he says. "I subscribe to a few money magazines and I have grasped the importance of having a balanced portfolio. But I think I still have far too much in cash that is currently earning a low return - £400,000 - and if I include my building society bonds, then it adds up to over £550,000.

"But although I still have a lot to invest I am not sure where to go from here. I am just looking for a reasonable return, although did very well last year.

"I am semi-retired but still get job offers to work as a consultant and can earn over £100,000 a year. I earn more money than I invest, so the cash pot is getting bigger. My outgoings are very low and my wife and I can live quite comfortably on a 4 per cent return on my investments as they stand presently, at just over £1.1m.

"I am a very cautious investor and not happy about losing much. That said, I am down 0.5 per cent this year and okay about this. I am very pleased with the cheap corporate bonds I bought a few years ago and wish I had bought more as they are quite expensive now.

"I quite like the idea of exchange traded funds (ETFs) and corporate bonds, but don't want to buy active funds. I don't think fund managers are as good as they think they are and I want to keep the charges on my investments low. I enjoy self-investing.

"My last three trades were topping up my holdings in Vanguard FTSE 250 UCITS ETF (VMID) by £10,000 and Baillie Gifford Japan Trust (BGFD) by £5,000, and buying Diageo (DGE) shares worth £10,000.

I have the following investments on my watch list: Whitbread (WTB), Unilever (ULVR), National Grid (NG.), Victrex (VCT) and db X-trackers MSCI India Index UCITS ETF (XCX5)."

Anonymous portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

The big issue here is: are you holding too much cash? It depends what sort of total return you want.

As a rough rule of thumb, I assume that average real returns on cash will be around zero for the next few years and that average real returns in equities will be around 5 per cent. This means that if you want an average return of 4 per cent a year, you should split your money 80:20 between equities and cash. From this perspective, you are indeed holding too much cash. If you want that 4 per cent return, you need to take on more risk.

That said, there might be no great urgency to do so. History tells us that, on average, all of the outperformance of equities over cash comes during the winter months - November to April. Holding a big cash position over the summer months is often a good idea.

However, there might come a time when you do decide to shift into riskier assets. If you need to steel yourself to do this, remember three things.

First, what matters in investing is your portfolio as a whole. This includes your human capital - the earnings from your work. You can think of these as a way of spreading equity risk: if share prices fall, you can top up your wealth from your labour income.

Second, many stock market falls are temporary: the market bounces back. A genuine long-term investor, therefore, should not be worried by them. In effect, future returns hedge against current losses.

Third, research shows that, on average, people are more scared of losses than they need to be. Christoph Merkle at the University of Mannheim has found that when investors experience losses, they are not as unhappy as they expected they would be. If you're a typical investor, therefore, you might be surprised by how well you cope if you do lose money.

Nick Sketch, senior investment director at Investec Wealth & Investment, says:

You want to achieve a sustainable long-term return of 4 per cent a year, I assume after tax, with below-average shorter-term risk. Moreover, inflation is unlikely to stay this low forever, so in the long term you will need some growth of both income and capital. We can all remember when returns close to these were available from investments that had a pretty low risk profile, but that doesn't describe 2016.

I have sympathy with your views on the average active manager, but some managers are a good deal better than average. Moreover, active managers as a group tend to do better in less mature and well-researched markets.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

As for how exactly to invest in riskier assets, you're on the right lines in thinking about corporate bonds and ETFs. I'd warn you, though, that corporate bonds carry a small but nasty risk of default: returns look nice until you lose half - or more - of your money. What's more, if this risk materialises, it will probably do so when equities are doing badly, so it's hard to diversify.

Your portfolio contains little exposure to the US. You could remedy this with one of many US equity ETFs. Or consider a world or UK tracker fund.

As for your riskier assets, there are good and bad things about these.

What's good is your holdings of defensive equities such as GlaxoSmithKline (GSK), Diageo, Imperial Brands (IMB) and SSE (SSE). The virtue of these is not so much that they protect you from equity risk - they are only relatively defensive and would probably fall if the general market suffers. Instead, history from around the world tells us that, on average over the long run, defensives tend to outperform. This might be for reasons that point to future good performance - for example, fund managers avoid them because they don't want the risk of underperforming a sharply rising market.

What's not so good is that the rest of your portfolio isn't as well diversified as you might think. Correlations between Japanese equities, emerging markets and the FTSE 250 are quite high, implying that they usually fall at the same time - at least over moderate time horizons. This might be because they all carry global cyclical risk and argue for a little more global diversification.

Nick Sketch says:

Your equity exposure is tilted fairly heavily towards the UK in comparison with most relevant benchmarks, particularly to mid-cap cyclical stocks, and financials. It is tilted away from America, and healthcare, technology and industrial stocks. We would not necessarily disagree with any of these tilts per se, but there are good opportunities in most markets and sectors for the long-term investor, so you should consider broadening the portfolio.

I am pleased to see that you have some exposure to property and infrastructure, and you may well want to increase the latter area. However, you could also consider defensive, tradeable structured products. These can offer low costs, and a better trade-off between risk and return than more traditional equity or bond investments, for investors able to avoid taking too much notice of daily or annual price movements.

Even with a slightly different balance in the element that is definitely not low risk, you will need stock market performance to be pretty favourable over the next decade for your overall portfolio to meet your aims, given the low returns likely on the lower-risk part. In more normal markets, including occasional big wobbles and assuming that interest rates don't rise a lot further than most of us expect, taking 4 per cent a year after tax from your portfolio will eat into the capital value fairly quickly and inexorably.

The best solution may be to increase - perhaps gradually - your overall investment in equity investments, along with other areas that can deliver a decent return for acceptable risk over the next five to 10 years. An overall portfolio with 10 per cent to 20 per cent in cash, and 40 per cent to 50 per cent in fixed interest investments, may well be defensive enough to meet your real requirements in that direction - provided you can tolerate the inevitable wobbles in values. That would leave around half available to generate the long-term returns that you need.