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An early start to fund significant life costs

Our reader hopes for a return of at least 8 per cent a year but may have to adjust his expectations
June 9, 2016, Gregg Crawford and Alan Steel

Chris Hanson is 29 and has been investing for six years. He is in full-time employment and single, and owns a mortgaged property in Manchester that he lives in. He also gets income from renting out the second bedroom, which he uses to cover mortgage and service charge payments.

Reader Portfolio
Chris Hanson 29
Description

Isa

Objectives

Long-term wealth accumulation to fund significant life costs

The investments he holds in his individual savings account (Isa) are intended for long-term wealth accumulation. He also has £6,000 cash in his Isa that he is looking to invest in stocks and shares - existing or new holdings.

"The investments in my Isa are intended as long-term holdings to fund significant life costs, primarily post-retirement, and maybe also costs such as children's education in due course. I have a few current accounts with in-credit balances which have relatively attractive levels of interest, so I don't intend to use these for short-term withdrawals, but have them there if necessary.

"I'm a long way from retirement, so I'm at present trying to contribute as much as possible into my Isa each year, and reinvest all dividends. I would like to aim for a return of at least 8 per cent a year, otherwise I may as well have just put the entire portfolio in a FTSE All-Share tracker fund.

"Since establishing this portfolio with Hargreaves Lansdown in 2011, the value has grown by around 15 per cent in terms of the return on investment.

"I have a moderate attitude to risk as reflected by certain portfolio holdings. However, I am very aware of the need for a balance between investing in higher-risk areas, given my age and time horizon, versus the need for stability as this portfolio is intended to fund substantial costs in the future.

"I also have a small portfolio of shares in individual companies worth around £5,000 that I treat separately from my Isa investments. This is more for interest, typically focused on small- and mid-cap companies. But over the last few years I have transferred a few of these to my Isa - for example, Ted Baker (TED) and Porvair (PRV).

"When investing in collective investments I tend to have a bias towards investment trusts and like to keep annual management charges down if possible, given my long-term horizon. My intention is to hold investments for a minimum of five years, although that hasn't always worked out, and I try to avoid investing in trusts that trade at a significant premium to net asset value (NAV). I wondered if it is possible somewhere to keep track of investment trusts' premiums or discounts to NAV, and how this compares to the average levels over one, three and five years?

"I’m conscious of not spreading investments across too many different funds and trusts, so I am open to reducing my number of holdings if appropriate.

"My last three trades were: putting £2,700 into Jupiter Asian Income (GB00BZ2YND85) in March and £1,945 M&G Property Portfolio (GB00B8FYD926)* in October last year; and selling shares in Schroder Oriental Income Fund (SOI)* worth £2,450 in March this year.

"I have on my watchlist, in order of preference: Rathbone Global Opportunities (GB00B7FQLN12)*, Scottish Mortgage Investment Trust (SMT)*, Lindsell Train Global Equity (IE00BJSPMJ28)*, First State Global Listed Infrastructure (GB00B24HJL45)*, Standard Life Investments Property Income Trust (SLI)*, Ecofin Water and Power Opportunities (ECWO) and MI Twenty Four Dynamic Bond (GB00B5VRV677)*

Chris's portfolio

HoldingValue (£)% of portfolio
Acorn Income Fund (AIF)3,1923.03
Biotech Growth Trust (BIOG)2,3562.24
BlackRock Frontiers Investment Trust (BRFI)1,9471.85
Finsbury Growth & Income Trust (FGT)3,0792.92
MFM Slater Growth (GB00B7T0G907)4,7154.47
ETFS Physical Gold (PHGP)2,7712.63
European Assets Trust (EAT)2,9642.81
F&C Global Smaller Companies (FCS)3,4223.25
Fidelity China Special Situations (FCSS)4,2043.99
Porvair (PRV)7370.7
Jupiter Asian Income (GB00BZ2YND85) 2,6872.55
Jupiter European Opportunities Trust (JEO)4,8444.6
Jupiter Merlin Growth Portfolio (GB00B6QGLF53)8,0797.67
Jupiter Strategic Bond (GB00B4T6SD53)2,5432.41
M&G Optimal Income (GB00B1H05718)3,2963.13
M&G Property Portfolio (GB00B8FYD926) 2,0181.92
Man GLG Japan CoreAlpha (GB00B0119B50)3,8283.63
Schroder UK Dynamic Smaller Companies (GB0007220360) 1,7451.66
Newton Global Income (GB00B7S9KM94)3,8693.67
Standard Life UK Smaller Companies Trust (SLS)3,1062.95
Schroder Managed Balanced (GB0002899846)6,9836.63
Ted Baker (TED)7620.72
City Merchants High Yield Trust (CMHY)4,1223.91
Stewart Investors Asia Pacific Leaders (GB0033874768)3,9713.77
Edinburgh Investment Trust (EDIN)3,5683.39
TR Property Investment Trust (TRY)3,6623.48
Troy Trojan Income (GB00B01BP176)2,7802.64
Vanguard LifeStrategy 60% Equity (GB00B3TYHH97)8,1167.7
Cash6,0005.69
Total105,366

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

Well done - you've got the big decisions right. When starting investing early in life, you can exploit the most powerful force in investing - the power of compounding. In contributing as much as possible to an Isa, you're also avoiding tax - legally. It's also a good idea to reinvest dividends - in an era of probably low returns these are likely to account for most of the total returns on equities.

You are also right to keep an eye on investment trust discounts. A low discount, relative to the trust's own history, can be a sign that sentiment towards a fund - and perhaps its asset class generally - is too depressed, and this can be a buying opportunity. You can check charts of trusts' discounts on Hargreaves Lansdown's website or Morningstar.

You are also right to want to minimise fund charges, given your long-term horizon, as these compound horribly over time. For example, if you invest £10,000 in an equity fund that charges 1 percentage point a year more than necessary, if the market returns 5 per cent a year you will lose almost £11,000 over 30 years - more than your initial investment! Before buying any high-charging fund, consider: what is this offering me that an exchange traded fund (ETF) or cheaper active fund is not? In many cases the answer is nothing.

 

Gregg Crawford, senior financial planner at Informed Financial Planning, says:

An Isa and its tax benefits may not be the best wrapper for your retirement provision. So consider a pension or the new Lifetime Isa which is available from April 2017. You could receive tax relief on your pension contributions, which would give you a larger fund than an Isa at retirement.

To be as tax-efficient as possible, you could use an Isa and a pension to get both flexibility and greater tax benefits for longer-term planning. If you need more flexibility within a pension a self invested personal pension (Sipp) is the answer.

It's good to see a portfolio diversified across direct shares, investment trusts, and open-ended funds, in varying asset classes and geographic locations. However, I suggest following a specific asset allocation model that could involve funds focused on fixed interest, property, the UK and overseas equities, as well as cash, to ensure you are investing in line with your attitude to risk and that you are not taking significant risks in one area. Asset allocation models can change based on guidance, but diversification is key to achieve growth in the long term.

For any investment or pension portfolio it is important to set objectives early. For post-retirement objectives, look forward and establish what income and capital you require, taking into account inflation. This will identify any future income shortfalls sooner rather than later, and allow you to address these early.

You may need to adjust your growth expectations. You achieved good returns over the past eight years or so, in a period of significant recovery. The next eight years may not be as kind, so a return of at least 8 per cent a year, after costs and fees, may be ambitious. But a well-managed portfolio could perform better than a FTSE All-Share tracker.

You currently hold some investment trusts that can borrow to invest, known as gearing. While this can enhance returns, gearing can increase investment risk and any losses can be magnified. So you might be taking more risk than you are comfortable with.

For research on funds including investment trusts, www.trustnet.com compares factors such as premiums and discounts to NAV.

 

Alan Steel, chairman of Alan Steel Asset Management, says:

You say if you don't obtain a net 8 per cent a year you might as well stick to a FTSE All-Share tracker. They're actually down 8 per cent over the past 12 months, and over 20 years have compounded at below 6 per cent a year. Also, going forward a FTSE All-Share tracker is unlikely to work in the same way.

If your returns are net what the FTSE All-Share total return has done over the last 20 years, your portfolio on average would double every 13 years, ignoring further contributions. But I'd be extremely disappointed if high quality equity income funds could not beat these returns. And remember that even a 10 per cent total return makes a huge difference over time, doubling a portfolio on average every seven years.

For example, Invesco Perpetual High Income Fund (GB00BJ04HP86), net of charges, compounded at almost 11 per cent a year and achieved a 685 per cent gain. Reinvested dividends are as important over the long term as the quality of the best active managers.

Your portfolio is all over the place mixing all sorts of asset classes, including cautious investments, even though you are only 29. And stop just focusing on charges.

I'd also advise you to find out what you're good at and stick to it - have a look at the last three years to check how well you've done.

Drip feed contributions into Isas and a personal pension, which is free of capital gains and inheritance tax.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

My biggest problem here is that your aim of an 8 per cent return might be unrealistic. This is because your portfolio is too diversified. For one thing, around 10 per cent of it is in assets such as gold and bonds which offer protection against some falls in equities, but have low expected returns. Also, by holding 28 different assets, you are diluting the effect that any good fund might have. With the average holding comprising less than four per cent of your portfolio, even if a fund outperforms by ten per cent over a year, it would add only 0.4 per cent to your total returns. That's just an averagely good day of returns.

I suspect this might have happened because you've taken an ad-hoc approach to picking funds. Doing so can easily lead to over-diversification simply because so many can seem attractive. To counterbalance this, keep an eye on the big picture asset allocation.

Firstly, pay more attention to which equity factors are likely to out-perform over the long run. Emerging markets and small cap stocks are likely to, not because they offer long-term growth but rather because they are riskier than average and so should offer better returns in normal times to compensate.

Better still, defensive stocks do this because they are, on average, genuinely under-priced. At least two of your holdings - Finsbury Growth & Income (FGT)* and Edinburgh Investment Trust (EDIN)* - give you exposure to these. Apart from momentum, to which successful exposure is surprisingly hard to find in funds, there are few other factors which pay off well.

Secondly, consider how you want to split your holdings between equities, and safer assets such as bonds and cash. Vanguard's LifeStrategy funds, one of which you hold, give you a simple and cheap off-the-peg starting point here.

In considering this, forget old wives' tales about young investors being able to take more risk. This isn't necessarily true. Younger investors are more at risk of long-term negative returns and shares doing badly at the same time as they lose their jobs.

Protecting yourself from these risks, however, would mean sacrificing some expected returns in normal times.  

Alan Steel says:

I've no idea how long Rathbone Global Opportunities and Lindsell Train Global Equity have been on your watch list, but both are up around 33 per cent net over three years, while Jupiter Merlin Growth (GB00B6QGLF53) is up less than 12 per cent and FTSE All-Share trackers are up 6 per cent at most.

If I were you I'd cull my portfolio right down. Keep the small-cap holdings, remove deeply cautious and bond funds, and pick 10 fund managers to stick with over the next decade, who I believe should be in areas such as quality global equities, UK mid/small cap, and speciality funds such as Baillie Gifford Global Discovery (GB0006059330) which seeks to invest in disruptors.

For the US I'd follow Cormac Weldon, who runs Artemis US Equity (GB00BMMV4S07) and Artemis US Select (GB00BMMV5105), or an S&P 500 tracker fund [see our IC Top 50 ETFs for suggestions]. I'd have a slug of Terry Smith via Fundsmith Equity (GB00B41YBW71)* which is up 49 per cent over three years and 113 per cent over five net of charges, and Gervais Williams [who runs a number of funds including Diverse Income Trust (DIVI)*].

I would also favour the experienced equity income skills of Neil Woodford, manager of CF Woodford Equity Income (GB00BLRZQC88)*, Carl Stick, manager of Rathbone Income (GB00BHCQVM34)* and Francis Brooke, manager of Trojan Income (GB00B01BP176).

And when James Harries, who used to run Newton Global Income Fund (GB00B7S9KM94)*, starts to run a fund at Troy Asset Management I'd put a decent amount of money into that.

*IC Top 100 Fund