Reduce and rebalance to be retirement ready

"My wife and I already have around £150,000 in cash, much of it in Isas, so the tax-free lump sum will effectively be reinvested while retaining a similar degree of overall liquidity," says John. "This means I need to allocate around £350,000 in total. I have considered some form of spread bet on the MSCI World or FTSE 100 indices to offset the market risk while the providers transfer the cash, but I don't know how to do this.

"My portfolio comprises my Sipp, our Isas and what remains of my deceased father's will trust, which is notionally earmarked for the benefit of our son who starts university later this year.

Our investment objective is to produce an income return broadly in line with the UK market, while maintaining the income and capital value in real terms.

"I want to rebalance the portfolio, but am not sure in what proportions. Since the FTSE 100 is particularly international, investing in the likes of Prudential (PRU), HSBC (HSBA), GlaxoSmithKline (GSK) and Unilever (ULVR) gives global exposure while leaving the companies to manage exchange rate issues. And a FTSE 100 exchange traded fund (ETF) does this at minimal cost while avoiding stock-specific risk.

"Should I invest my new monies only in the investments I already have or what seem to be the best current options - even if that increases the total number as I tend to buy and hold? Or should I invest in the best current options but also rationalise some of my existing holdings?

"There seems little point in holding bonds at the moment, with an almost certain capital loss likely over the medium term. I am, however, wondering about putting £20,000 into very long-term index-linked gilts. I have a real concern over the medium-term inflation risk and these could increase in value significantly.

"We currently have £8,000 in peer-to-peer loans via Ratesetter, paying 3.9 per cent interest on a monthly basis. What would be a reasonable proportion of cash, which by definition is risk-free, that could be allocated to peer-to-peer lending?

"I prefer investment trusts to funds because as a long-term investor it's much more cost-efficient to pay a dealing fee than a percentage of the assets I hold. I regard controlling cost as one of the main determinants of the overall return and my target here is 75 basis points maximum, ideally 50, achieved through a combination of ETFs and active funds.

"I am interested in the various new factor ETFs and wonder whether one that combines lots of different elements is a good way of getting the best of all worlds, or just an expensive way of achieving the average. As one inclined to value and contrarian investment styles I am frustrated with the apparent success of momentum strategies, although ETFs seem to succeed here.

"Within my non-Sipp pension pot is £50,000 in Standard Life GARS Fund (GB00B7K3T226) and £30,000 in the Standard Life property pension fund and I'm inclined to leave these.

My watch list includes smart-beta ETFs including iShares Edge MSCI World Momentum Factor UCITS ETF (IWFM), iShares Edge MSCI Multifactor International ETF (NYSEARCA:INTF) and iShares Edge MSCI World Quality Factor UCITS ETF (IWFQ).

I am also considering CQS New City High Yield Fund (NCYF) as I probably need some bonds.

THE BIG PICTURE

Dan Burnham, chartered financial planner, Helm Godfrey, says:

Before considering your portfolio composition you need to determine how much risk you are willing to and - maybe more importantly - need to take. Retirement usually involves a change in investment philosophy as income generation, and the sustainability of such an income, becomes more important.

Your defined-benefit pension will provide a sustainable base income, which can then be supplemented by the portfolio. While your objective is to produce an income return broadly in line with the FTSE, is such a return required?

Between 2000 and 2015 the FTSE 100, on average, has yielded marginally less than 3 per cent a year once both capital appreciation and dividends are considered. Based on a portfolio of £950,000, a 3 per cent return equates to an income of £28,500 before taxation. Such an income, together with your defined-benefit pension, would provide a pre-tax income of £43,500 before any state pension entitlement is included.

However, given that by the end of 2015 the FTSE 100 index had fallen almost 10 per cent from its starting point of 6930 in the year 2000 the annualised return of 3 per cent has been entirely provided by dividends. This poses a problem as, without capital growth, the income provided by dividends will fall in real terms in an inflationary environment.

In such a situation the only way income can be maintained in real terms is by drawing on capital as well as dividends.

Whether a 3 per cent return is sufficient is dependent on your lifestyle and future plans. A good financial planner would provide an invaluable asset to you at this stage, helping you to better visualise your financial future and determine what yield you require to enjoy your retirement. While you treat your portfolio as one, the different elements are each subject to diverse tax legislation. A financial planner will be able to take advantage of these differences, and structure the portfolio and future income withdrawals in a way that minimises taxation, such as phasing tax-free cash over a period of time.

Investigate the possibility of transferring your defined-contribution pot to your Sipp in-specie rather than in cash. This will keep you in the market while the transfer process is completing and forego the need for any spread betting arrangement.

Treat the will trust as your son's and invest the monies based on his risk tolerance and needs.

Ben Wattam, investment manager at Mattioli Woods, says:

There are several holdings in the portfolio, the costs of which are offset by some plain vanilla low-cost trackers. But there is no obvious objective to the themes or markets in the portfolio. There are some allocations that we like, such as 9 per cent in smaller companies, a modest private equity holding and smart ETFs, such as the Aristocrats funds - but make sure you understand the smart strategy thoroughly. We do not currently invest in peer-to-peer lending, but have considered some of the investment trusts that offer a different way of accessing the peer-to-peer market.

It is difficult to understand the strategy of the portfolio: for example, why do 25 collectives have less than a 1 per cent weighting? It is not efficient, as any fund that has a period of strong performance is not going to make an impact. Furthermore, 6.7 per cent in GlaxoSmithKline is aggressive.

We would rationalise the portfolio and concentrate on the best ideas. It will cost to do this, but the medium-term benefits will probably outweigh the initial costs of getting the structure right.

Leonora Walters, personal finance editor at Investors Chronicle, says:

You ask what is "a reasonable proportion of cash, which by definition is risk-free, to allocate to peer-to-peer lending?" Quite simply 0 per cent.

If you need a portion of your portfolio in something risk-free there's only one suitable asset - cash. You are likely to lose less from inflation erosion than a substantial default. If you shop around you can find some better interest rates, as explained in my article on how to max your cash in the 26 February issue.

But that is not to say that you shouldn't invest in peer-to-peer lending - there are many reasons to allocate to this attractive area of fixed income. It could account for a small part of your investments to add diversification and potential extra return.

But that is the point: peer-to-peer lending is high-risk fixed income - not risk-free cash - so should be counted in the part of your portfolio allocated to higher-risk alternative areas.

Borrowers of peer-to-peer loans may not pay back all of the interest they owe you or the capital you have lent them. A deterioration in the economic climate and rising unemployment could lead to an increase in defaults.

And peer-to-peer lending is not covered by the Financial Services Compensation Scheme (FSCS) in the event one of the companies involved collapses. If your cash is in a regulated bank that becomes insolvent the FSCS will repay up to £75,000 of your savings per company.

For these reasons, advisers suggest you only invest in peer-to-peer lending if your risk profile is medium or higher, and that you do not commit more than around 5 per cent of your portfolio to it - money you can afford to lose.

HOW TO IMPROVE THE PORTFOLIO

Dan Burnham says:

Stock selection is only one facet of portfolio composition, however the right asset allocation is an important consideration. Your current portfolio looks high-risk and may no longer be appropriate for you. Once you have quantified your risk tolerance and the required yield, you can produce a model allocation against which the portfolio can be reviewed and rebalanced. Your existing holdings could, where appropriate, then be used to populate the allocation given your preference to buy and hold.

Consider implementing a core and satellite investment strategy. The core could be used to produce the retirement income you require, while the satellites would allow you to take advantage of investment opportunities.

Ben Wattam says:

The portfolio is heavily weighted towards equity, which was appropriate when you were adding to your assets. However, you now need to preserve and use the wealth you have accumulated. Therefore, the level of equity exposure should be reduced to limit the beta of the portfolio. Historically, you could have increased your equity exposure and ridden out volatility. However, if you are relying on capital to provide income, it is important to try to protect against severe market falls.

There are asset classes you could consider to reduce equity market risk: index-linked bonds, investment-grade bonds, commercial property, infrastructure, and absolute-return or hedge funds.

While bonds are not as attractive as they once were, they can still hold some important insurance characteristics: adding some index-linked gilts could be sensible, despite their expensive valuation. Investment-grade bonds look attractive on a relative basis and would require a strong rise in yields or credit spreads to lose money over a two- to three-year holding period.

The ratings of many commercial property trusts have fallen and these offer relatively attractive yields. We would increase your exposure to this asset class through vehicles such as Custodian REIT (CREI) and Standard Life Investments Property Income Trust (SLI).

We like infrastructure trusts, such as International Public Partnerships (INPP) and John Laing Infrastructure (JLIF), but the sector has been priced at a premium for some time. But their premiums have generally fallen when they have raised new capital, so there are opportunities to get in at a lower level if you are patient and wait until one of these trusts does this.

The absolute-return/hedge sector might be difficult, bearing in mind your cost focus. Your allocation to Standard Life GARS Fund is high. We would diversify this allocation by adding some other funds and strategies, such as Old Mutual Global Equity Absolute Return (IE00BLP5S809) and JPMorgan Global Macro Opportunities (GB00B4WKYF80). The protection holdings provide some diversification, but it is a good time to re-evaluate this part of the portfolio and consider alternative holdings.