Building a portfolio to provide for a spouse

"It has been a fascinating learning experience which I have greatly enjoyed and which continues to absorb me," says our reader. "But my wife does not share my interest in investing, so my aim is to create for her a hands-free, to have and to hold portfolio of quality investment trusts, with the possible future addition of exchange traded funds (ETFs). This is to provide for her old age without the need for her to make any adjustments to it. After all, isn't this what we pay our fund managers to do?

I take a bullish view of my wife's potential longevity, if not my own, so the investment timescale is potentially three decades.

I wish to protect our wealth from erosion by inflation, which will undoubtedly become an issue again at some stage. And I would like to think that when my wife dies a worthwhile pot will remain for the benefit of our grandchildren.

The construction of this portfolio is still a work in progress as it contains some short-term speculative components that, with hindsight, I rather wish I had not bought. I intend to liquidate these and replace them with investment trusts and/or ETFs at some stage.

When choosing investment trusts, I greatly prefer those in which the directors or fund managers have significant skin in the game, and I tend to be dismissive of those in which neither directors nor managers have a material stake.

I'm not too keen on investment trusts that charge a performance fee, although I would make an exception in some cases.

I am rather prejudiced against open-ended funds because of the failure of many of these to disclose their portfolios in full and their general level of charges.

Increasing our incomes is not currently a major consideration, and our portfolio yield of around 2.5 per cent added to our pensions more or less covers our outgoings.

We have dry powder in the form of uninvested cash that I hope to deploy in the market at some future time, if and when prices fall further. Around three-quarters of our assets are invested, with the rest in cash.

Although cautious by nature, I am always prepared to take a view on future outcomes and, when convinced, invest accordingly.

Both my wife and I have stocks-and-shares individual savings accounts (Isas), which we top up annually by the maximum allowed. The portfolio outlined below incorporates these Isas.

My most recent purchases were Scottish Mortgage Investment Trust* (SMT), City Merchants High Yield Trust (CMHY) and iShares Physical Gold ETC (SGLN).

I have Personal Assets Trust* (PNL) on my watchlist.

Our reader and his wife's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You desire to protect your wealth from erosion by inflation, but this is not an issue in the near term. In fact, any pick-up in inflation from current levels might raise share prices, in so far as it betokens stronger global economic activity and reduces the risk of deflation. But it might become one sometime over the next 30 years.

How to protect yourself from inflation depends on the source of that inflation. If it is purely UK-driven inflation caused by, say, a fall in the pound, the solution is to hold assets denominated in foreign currency.

If it is mild inflation, which the Bank of England tries to suppress through orthodox monetary policy - remember there is an inflation target - then cash is protection as in theory higher inflation should lead to higher real interest rates. If inflation results from higher commodity prices, your resources investment trusts offer protection. If, however, inflation arises from general wage militancy in developed economies, you have less protection.

I say all this to make a key point. The only reliable protection against inflation is index-linked gilts. You already hold these indirectly via your investments in Ruffer Investment Company* (RICA) and Capital Gearing Trust* (CGT). But are these really the best way of doing this? I suspect a direct holding might be better.

This, though, poses another question: is the certain real capital erosion that comes from holding assets with negative real rates really a price worth paying for a risk that seems distant right now? Only if you attach a high priority to capital protection rather than growth is the answer yes.

My second issue is whether a collection of investment trusts really is the easiest portfolio to leave to your wife. Why not follow Warren Buffett and simply leave her an index-tracker fund? Sure, this might be too risky on its own, but the answer to that is to leave her cash as well. It might not protect her from inflation, but the solution there is to hold some index-linked gilts alongside it. You have to be pretty confident about these managers' abilities to prefer this portfolio to a truly hands-free alternative.

Colin Low, chartered financial planner at Kingsfleet Wealth, says:

You have clearly identified the key matters that are pertinent to your financial circumstances. Not only is it very important that any investor establishes the objectives they are seeking to achieve, but also to record the risks they need to mitigate as part of their financial planning.

The key issues that I can see you are seeking to address is a shortfall in your income requirements from your pension to meet your standard of living. This is a concern your wife will also need to address should you die before her, even though she has a lower risk appetite and doesn't have the same inclination to take an interest in investments as you do.

Other considerations I would raise are inheritance tax planning and using your annual capital gains tax allowance, either to draw funds as a tax-efficient way of supplementing your income or as to switch funds on a regular basis.

I would question whether anyone should hold investments without making any adjustments to them. The very nature of long-term investment arrangements is that, even like the best motor vehicles, they require regular servicing, reviewing and changing. It may be that multi-asset fund ranges could be the solution your wife is looking for, but it would take away the enjoyment of your fund selection and research while you run the portfolios. Perhaps have some of these in reserve for when they may be required.

A chartered independent financial adviser could be useful to your wife if you die before her.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

There are three things I like here. First, your aversion to fund managers' high charges is well justified, especially if you have a long time horizon. An extra percentage point of annual charges could cost you £1,000 over 30 years for every £1,000 of investment.

Secondly, your wising up to the pitfalls of speculative stocks is sound. History tells us that such stocks underperform on average over the long run. If in May 1997 you had invested £100 in the alternative investment market (Aim), a gauge of speculative shares would have lost you £20 by now, whereas the same sum invested in the FTSE All-Share index would have grown to £285.

This is partly because investors pay too much for the small chance of big quick returns - just as they bet too much on outsiders at race meetings - and partly because they are overconfident about their ability to foresee future growth. Long-term investors should steer clear of such stocks.

Thirdly, you've done a reasonable job in avoiding the pitfall of investing in a portfolio of investment trusts, which is to end up with a closet tracker fund.

Ruffer and Capital Gearing have big exposure to index-linked gilts, which spreads equity risk. And you've got a spread of exposure to global stocks, some unquoted assets and UK defensives.

I would warn you, though, that your diversification is limited. RIT Capital Partners (RCP), Monks (MNKS) and Scottish Mortgage are likely to rise and fall together because they all hold general global equities. And BlackRock World Mining Trust (BRWM) is, for now at least, quite highly geared to the general world market - commodity stocks are more like stocks than commodities.

Tom Dawson, investment manager at Redmayne-Bentley, says:

When constructing a portfolio it is key to ensure you understand your investing time horizons and how these could be subject to change.

You own two direct stocks: Vermilion Energy (VET:TOR) and Pan African Resources (PAF). In addition, you hold iShares Physical Gold ETC, City Natural Resources High Yield Trust (CYN) and BlackRock World Mining Trust. These investments account for 8 per cent of your portfolio.

As you rightly point out, investment managers are paid to look after your investments, and if you are not comfortable selecting your own shares, a good starting point would be to sell Vermilion Energy and Pan African Resources. I would also consider selling the other investments exposed to these potentially volatile and cyclical sectors, as you can buy investment trusts whose managers can tactically switch in and out of the gold, mining, energy and any other sectors as and when required.

Temple Bar Investment Trust (TMPL) is focused on UK-listed equities and has an accomplished manager in Alastair Mundy. However, to capture the upside in the UK market from a broader range of market conditions, it is worth considering a further investment trust focused on UK equities, but which has a different strategy to complement Temple Bar.

I would suggest Henderson Opportunities Trust (HOT), managed by James Henderson, which has a bias to mid- and smaller-cap companies. But this would be a higher-risk investment over short timeframes.

Another option, more skewed to income, is Diverse Income Trust (DIVI) managed by Gervais Williams. This trust has a small- and mid-cap bias, but has an income strategy with a target to maintain and grow its dividend in terms of pence per share over time. With this you could reinvest income to grow capital.

If you want to move towards a more defensive strategy, in line with existing investments such as RIT Capital Partners, Capital Gearing Trust and Ruffer Investment Company, then Personal Assets could be a sensible choice. Should you decide to retain your investments in gold, it is worth highlighting that Personal Assets Trust has approximately 10 per cent of its assets in gold.

If you wish to increase your allocation to global equities then other suitable investments that merit consideration are Witan Investment Trust (WTAN) or F&C Global Smaller Companies Trust (FCS). All of the investment trusts highlighted are run by managers who have substantial shareholdings in them.

Colin Low says:

You are concerned about inflation, and I believe as you do that investing in real asset classes is the only way to hedge against this for the long term. You are obviously mindful of the volatility that long-term investments can carry, but your focus is on the income yield they provide and you are permitting the capital to fluctuate in the background - irrespective of the income yield that is being provided.

I would concur with many of your investment trust purchases, but would suggest that you consider open-ended funds as well, as there are a number of very successful and consistent fund managers who only run these kinds of funds. For example, we have used Artemis Global Income* (GB00B5N99561) and Fundsmith Equity* (GB00B4MR8G82) for some time, which employ managers who do not also run investment trusts.

*IC Top 100 Fund