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Consider trackers to simplify retirement fund

OUr reader needs to align her portfolio with her own needs
November 10, 2016, Neil Jones and Mary Waring

Deborah is 52 and has inherited a large portfolio of shares from her uncle, who died in November 2015. She has never run an equity portfolio before, but has invested via Virgin Money Individual Savings Accounts (Isas), which are worth £15,000. She does not have any dependants and is in a job earning £60,000 a year.

Reader Portfolio
Deborah 52
Description

UK shares

Objectives

Pay off mortgage and generate £30,000 a year in retirement

"I have decided to manage my uncle's portfolio as he did, taking dividends. I am trying to suss out the strategy he was using: his first investments in 1994 were Rolls-Royce (RR.) shares, so I have a soft spot for them and, although they seem to fluctuate considerably, I think they will increase again in the future.

"He seemed to like defensive shares that brought him an income, and in the last year of his life he also started to buy gold coins, so his estate includes a collection of these worth £50,000.

"My uncle didn't want to pay high charges, so shopped around and bought shares with various brokers including Capita, TD Direct, Computershare and EQ Shareview.

"I want to be able to pay off a mortgage of £300,000 within 10 years - it increased just as I had to pay an inheritance tax (IHT) bill. But it is interest-only, so the repayments are very low, and I don't want to dilute too much of the portfolio's capital.

"I want to grow the portfolio so that I have an income of £30,000 a year when I retire, as my workplace pensions are not worth much, although I have accumulated various of these over the past 20 years. This is my retirement fund, so I do not want to mess it up. I don't want to have to worry about the future - I plan to live at least until 85, play golf, travel and enjoy life!

"I would say that my attitude to risk is medium.

"So I need to figure out what to keep and what to sell. I was advised to sell portions of shares across the board rather than one specific share to pay off my uncle's debts, and have a few in mind. I also want to know if any of the shares can automatically be put into a self-invested personal pension (Sipp), or need to be sold and repurchased?

"I have had meetings with a number of independent financial advisers, who advise different things. Their suggestions included:

■ Selling all my Rolls-Royce shares and using the proceeds to pay off part of the mortgage.

■ Handing over the management of the portfolio to a financial planner who will sort everything out, but charges 1 per cent a year of the total capital.

■ Selling a portion of each holding, topping up my pensions and putting it all in a wrap account, which would be managed on my behalf.

"I read a lot about what is going on in the market and want to be sure I am doing the right thing. Otherwise I will hand over the portfolio to a specialist company, pray they do a good job - and don't charge the earth for every single transaction.

"I recently sold 6,000 Lloyds Banking (LLOY) shares, 3,500 Man Group (EMG) shares and 2,000 Pets at Home (PETS) shares to raise cash for legal bills.

 

Deborah's portfolio

HoldingValue (£)% of portfolio
BAE Systems (BA.)4610.08
BP (BP.)61,86011.03
BT (BT.A)27,7024.94
Carillion (CLLN)24,2844.33
Centrica (CNA)4,7420.85
Compass Group (CPG)7,4251.32
De La Rue (DLAR)2,3380.42
Devro (DVO)2,8960.52
Entertainment One (ETO)3,1910.57
Fenner (FENR)1,5280.27
FirstGroup (FGP)15,9262.84
GKN (GKN)4,8510.87
International Consolidated Airlines (IAG)12,5612.24
Jardine Lloyd Thompson (JLT)8,6461.54
Ladbrokes (LCL)4,0330.72
Lloyds Banking (LLOY) 17,4063.1
Man Group (EMG)17,2433.08
Marston's (MARS)13,4102.39
WM Morrison Supermarkets (MRW)9,0411.61
National Grid (NG.)11,3172.02
Old Mutual (OML)3,9340.7
Oxford Instruments (OXIG)1,6040.29
Pennon Group (PNN)4,5270.81
Rolls-Royce (RR.)140,66025.09
DS Smith (SMDS)3,9120.7
Standard Life (SL.)10,3151.84
Standard Life UK Smaller Companies Trust (SLS)8,1871.46
United Utilities (UU.)48,0418.57
Vodafone (VOD)6,0631.08
Hansteen Holdings (HSTN)18,9333.38
JPMorgan Emerging Markets Investment Trust (JMG)28,1855.03
Advanced Medical Solutions (AMS)25,8124.6
Colfax Corp (CFX:NYQ)1,9260.34
ITV (ITV)7,6651.37
Total560,625

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

There's one great oddity about this portfolio: a quarter of it is in one risky stock, Rolls-Royce. You might want to consider reducing this weighting.

And I don't say this just because of its big weighting in the portfolio. Consider under what circumstances Rolls-Royce would do well. Some of these would be company-specific. But others are more general. For example, a pick-up in the global economy would tend to increase demand for its engines, while Rolls-Royce would also benefit from a general pick-up in stock markets. But these are circumstances in which some of your other holdings would also do well, including International Consolidated Airlines (IAG), JPMorgan Emerging Markets Investment Trust (JMG) and Standard Life UK Smaller Companies Trust (SLS). Conversely, if the world economy and markets tumble, all these holdings might fall together.

In this sense you are not just taking a big bet, but also one that's correlated with your other bets, and that's risky.

In another respect, however, your uncle did well. He's left you decent exposure to defensive stocks such as utilities and telecoms. This is good because history tells us that defensive stocks tend on average to do well over time.

There are several reasons for this. Investors often under-rate the importance of what US investor Warren Buffett has called "moats" - sources of monopoly power that help a company fend off competition. The converse of this is that investors often overpay for growth stories: if defensives are underpriced, something else must be overpriced.

I mention this to warn you against taking an interest in more unusual smaller companies. Yes, these can occasionally deliver massive returns if market sentiment shifts in their favour. But on average over the long run they disappoint, not least because investors underestimate just how difficult it is for smaller companies to expand. Be very, very cautious about growth stocks.

I'd therefore suggest cutting your holding in Rolls-Royce and trimming a few other non-defensive holdings.

 

Neil Jones, investment manager at Hargreave Hale, says:

This portfolio is a significant amount of money and very important to your financial wellbeing in retirement, but you are new to investing and still working. So you should assess whether you have the time and/or expertise for something that is so vital to your future; having your portfolio professionally managed on your behalf is an option to consider. A properly managed portfolio could yield better returns - even after costs - and would hopefully offer you peace of mind while you enjoy a busy lifestyle.

But if you opt to have your portfolio professionally managed, don't outsource it to anyone. Undertake a lot of research on different firms, meet a number of them, and talk to people you know who use investment managers and ask them for their recommendations.

Don't dismiss your current pension arrangements, as it is likely you will be able to consolidate these into a Sipp. This could be managed alongside your portfolio, is likely to be cheaper and would provide a more bespoke approach.

 

Mary Waring, chartered financial planner and founder of Wealth for Women, says:

Your main priorities are to repay your £300,000 mortgage and have an income of £30,000 a year when you retire.

A net income of £30,000 a year requires gross income of around £35,000. Assuming you are eligible for a full state pension, at age 67 this will be £8,500. Therefore, you will need to achieve £24,500 from this portfolio and your company pensions.

Achieving this level of income looks tight based on the value of the portfolio after repaying the mortgage, and your assertion that your company pensions are not worth much. But have you obtained up-to-date valuations from your pension providers? I'm surprised that this is the case after 20 years of contributions, with a further 15 to go.

And do you have sufficient income from your salary to start making some form of monthly repayment on your mortgage? This would leave more money invested in the portfolio to achieve long-term growth. I would avoid drawing a large sum now to repay the mortgage as this would limit your future growth and may result in a capital gains tax (CGT) liability.

To improve tax efficiency, each year you should transfer a portion of the portfolio into an Isa. As a higher-rate taxpayer you should also consider setting up a personal pension. For each £60 contributed your tax allowance would raise the contribution to £100.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

If you trim your exposure to Rolls-Royce and a few other non-defensive holdings, what you do with the cash raised depends on how much stock market exposure you want. One hundred per cent exposure would probably, with average luck, be just about sufficient to get you an income of £30,000 a year in ten years' time while preserving capital. This is assuming you reinvest all dividends, and create a little of your retirement income by taking profits on capital gains as well as dividends.

But of course, we might not get average luck. You might want to hold more cash to protect yourself from the risk of markets falling. Yes, this comes at the price of guaranteed low returns. But if you're prepared to run down capital after retirement, such low returns might be a price worth paying for the greater security.

If you wish to stay fully or nearly fully invested I'd recommend a tracker fund - preferably that tracks the global market. A virtue of these is that they save you time and effort: you can more or less safely buy and forget them - or certainly more than with individual stocks. Also, tracker funds are in effect funds of funds. They embody the best (or least bad) thinking of all investors.

So I'd suggest shifting to a portfolio comprised of a few defensives, a tracker fund plus - depending on your risk appetite - some cash. This should be easy to manage; certainly sufficiently easy for you to manage rather than spending money on entrusting the portfolio to a financial adviser.

 

Neil Jones says:

Your portfolio is quite diverse and includes a number of small holdings, so a bit more structure would be useful. It looks as though many holdings have been bought and left, rather than held with conviction. You also have very limited overseas exposure, so I would encourage further investment in this area via investment trusts or open-ended funds to improve diversification, along with some index-linked gilts to help counteract inflation. The weak value of sterling is making both areas attractive for investors and we are seeing some good opportunities.

I also think you have too much exposure to UK consumers, an area I feel will struggle over the next couple of years.

You need to make rational investment decisions not emotional ones, especially when a holding is worth £140,660 - as is the case with Rolls-Royce. You don't have to sell all of your Rolls-Royce shares, but it would be sensible to consider reducing this holding at an appropriate time. History is littered with blue-chip companies that go wrong, including BP (BP.) after the spill at one of its oil wells in 2010 and Royal Bank of Scotland (RBS) during the banking crisis in 2008. Retaining such a large holding carries risk.

This is not a portfolio, but rather a collection of investments. It doesn't work for you and your requirements, so you should consider how it can be better tailored to meet your financial goals.

 

Mary Waring says:

You wish to keep the same investments your uncle had, but he had different priorities to you.

Your investment strategy should be based on long-term growth, so I would suggest you stop drawing the dividend income and reinvest it to improve your long-term position.

Retaining the Rolls-Royce shares in the belief that they will increase is trying to time the market, and you could get it wrong. These shares represent 25 per cent of your overall portfolio, which is a very large exposure and does not provide good diversification.

Although the portfolio has a large number of holdings, the top five account for about half the value, so you need much greater diversification. And maintaining your current allocation would also require a lot of effort and research. Since you do not have previous investment experience, does this suit you?

If not, there are a number of low-cost tracker funds available that provide diversified access to both UK and overseas markets, and would reduce the amount of time you need to spend on the portfolio.