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Aiming to become an Isa millionaire

Our reader hopes to become an Isa millionaire by 2030, but he may need to adjust his expectations
November 17, 2016, Rosie Bullard & Ian Marsden

David is 30 and has been investing for five years. He and his wife have stable jobs: she is a paediatrician and he works in a managerial position. They have one child and plan to have another.

Reader Portfolio
David 30
Description

Sipp, Isa and international trading account

Objectives

David and his wife invest £2,000 every month, plus his bonus of £5,500 at the end of the year. They own their own home on which there is not much debt to pay, and have £16,000 in cash. David's portfolio was previously reviewed by Investors Chronicle.

"I want to make a total return of 6 to 7 per cent a year," says David. "I believe I am on track to become an individual savings account (Isa) millionaire by April 2030 at the current rate of saving, factoring in rising contributions in eight years' time as our salaries increase. We're fairly frugal and have so far managed to keep up a very high savings rate by not splashing out on anything fancy apart from the odd holiday. That's unlikely to change even with a second child. But we did recently take £12,500 out from the portfolio to fund an extension to our home.

"Within 14 years my wife and I would like to move into semi-retirement, and use the interest on the million to allow us to move out of permanent work and into contracting. I would like to know if my strategy is right and if I really am on track to make £1m by April 2030.

"I would be prepared to lose 20 to 30 per cent of the portfolio, but would be disappointed if I lacked the cash to top up. As Chris Dillow said in my review last August, I have my human capital to support me when times are rough because I can continue buying when markets drop. What's important to me is that I don't significantly underperform the market so I compare my portfolio's net asset value (NAV) with the FTSE All-Share.

"I have Canadian dollar exposure - I lived in Toronto and invested in some well-regarded Canadian funds to diversify.

"I understand the need to take a long view, and be data-driven when it comes to analysing a business and deciding whether to invest. But perhaps an area of weakness for me is buying overseas exchange traded funds (ETFs) or diversifying away from the UK/Canadian markets that I'm familiar with. I find it difficult to hold somewhat 'faceless' ETFs - especially when they underperform.

"I don't know much about emerging markets, however since my previous Investors Chronicle portfolio review, I have diversified into these and reduced my exposure to European and UK equities to below 60 per cent.

"I follow CF Woodford Equity Income Fund (GB00BLRZQC88) closely and learn from its trades. Manager Neil Woodford seems to look out for what to buy with future market turbulence in mind."

David's portfolio

HoldingValue (£)% of portfolio
Utilitywise (UTW)651.590.58
Ergomed (ERGO)713.210.63
Jupiter Asian Income (GB00BZ2YND85)976.850.87
Vanguard FTSE 100 UCITS ETF (VUKE)1,066.630.94
Alliance Pharma (APH)1,499.851.33
Global X MSCI Nigeria ETF (NGE:PCQ:USD)1,627.8211.44
Castlefield CFP SDL UK Buffettology Fund (GB00B3QQFJ66)1,649.231.46
Accrol (ACRL)1,679.181.49
Stewart Investors Asia Pacific Leaders (GB0033874768)1,846.371.64
Provident Financial (PFG)1,884.181.67
Vanguard FTSE Developed World ex-UK Equity Index (GB00B59G4Q73)1,956.971.73
Baillie Gifford Japan Trust (BGFD)2,009.131.78
Vanguard FTSE 250 UCITS ETF (VMID)2,090.161.85
iShares Japan Fundamental Index ETF (CJP:TOR:CAD)2,125.1651.88
CF Lindsell Train UK Equity (GB00BJFLM156)2,374.82.1
MI TwentyFour AM Monument Bond (GB00B3V5V897)2,467.082.18
Ideagen (IDEA)2,474.642.19
db X-trackers FTSE Vietnam UCITS ETF (XFVT)2,622.962.32
Foresight Solar Fund (FSFL)2,7052.4
Safestyle UK (SFE)2,775.852.46
PPHE Hotel (PPH)2,7802.46
Tourmaline Oil (TOU:TOR)2,851.72.53
Lloyds Banking (LLOY)3,093.022.74
Aviva (AV.)3,162.142.8
Lindsell Train Global Equity (IE00BJSPMJ28)3,2242.86
Legal & General (LGEN)3,537.483.13
Walt Disney (DIS:NYQ)4,308.8333.82
GlaxoSmithKline (GSK)4,4143.91
NewRiver REIT (NRR)4,702.074.16
Unilever (ULVR)4,800.224.25
MI TwentyFour AM Dynamic Bond (GB00B5VRV677)5,108.224.52
ITV (ITV)5,257.144.66
Fairfax Financial (FFH:TOR)6,553.4135.8
Woodford Patient Capital Trust (WPCT)9,035.368
CF Woodford Equity Income (GB00BLRZQC88)12,894.4311.42
Total11,2918.7

None of the following commentary should be regarded as advice. It is general information based on a snapshot of the reader's circumstances

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

Your expectations for returns might be too high; 6 to 7 per cent is a reasonable expectation for nominal returns, assuming you reinvest dividends. But it might be too much to expect for returns after inflation - which are what matter.

I would use 5 per cent a year as an expectation for real equity returns over the longer run. And given that about a fifth of your portfolio is in cash and bonds, which are likely to return less, it's more likely that your portfolio will return only around 4 per cent a year with average luck. This would give you only around £700,000, in today's money, by 2030 if you maintain current contributions.

You say it's important that you don't significantly underperform the market. This raises a puzzle. If this is your objective, why not simply hold tracker funds? As it is, you have a big weighting in actively managed funds whose charges threaten to subtract from your performance: remember that fees compound horribly over time. I wonder whether these can be justified.

They might be justified in the case of CF Woodford Equity Income Fund, not so much because he has special skill, but because he's investing in the right segments of the market. He holds lots of defensive stocks, and history and theory tell us that these outperform on average and over time. Exposure to defensives is a good idea.

Where I applaud you is in having decent overseas exposure. This is important for a younger investor because there is a risk that the UK economy will perform badly over coming years: Brexit has perhaps increased these risks, but they were present anyway. This poses the danger that your shareholdings would do badly at the same time as your job prospects worsen: your management job might be secure in the near term, but who knows what the next 15 years hold? International diversification helps to spread this risk.

In this context, you raise an under-appreciated paradox when you say that you don't like 'faceless' ETFs. Efficient diversification requires that you invest in things you don't know. If you invest only in businesses you understand, you'll have few holdings and they'll be concentrated in one or two industries. You might feel comfortable with these, but they expose you to price risk. I think this is important because however much you know about the businesses now doesn't give you much knowledge about the future - especially over longer horizons. Greater diversification reduces this price risk, but at the expense of holding assets you don't feel so comfortable with. There's a trade-off.

My personal solution to this is to become accustomed to the fact that I know pretty much nothing about the future, so spread risk by holding trackers - even though this means investing in countries and businesses of which I know nothing.

I'd recommend a similar approach. Given that you are willing to take on market risk but reluctant to underperform, global tracker funds - perhaps accompanied by exposure to defensives or, if you must, one or two favoured plays, seem appropriate.

If all this sounds critical, it shouldn't be. In saving so much you are getting the big thing right. What matters over the longer term is how much you save rather than, within reason, what you save in. But you might be able to improve upon the latter.

 

Rosie Bullard, portfolio manager at James Hambro & Partners, says:

Your spreadsheet shows you have about £130,000 in shares and cash. You want to have £1m by 2030, and at your current saving rate of £30,000 each year, with a commitment to save more as your salaries increase and assuming a 7 per cent total return a year, you appear to be on track to meet your goal. However, you are making a lot of assumptions in your calculation that you can continue to achieve such a strong rate of return, including that you will both carry on earning and that life won't throw up any distractions or unpleasant spanners. You also assume that you will be able to continue saving in a similar tax-efficient manner, but we all know the rules can change.

Your emphasis on equities appears sensible as historically these have proved to be a source of real returns after inflation. You also understand the volatility you may face.

However, you have only been investing your own money for five years, a positive period for equity market returns. Markets move in cycles so you will need to make sure you have the resources, flexibility and courage in your convictions at times when markets are at extreme levels of pessimism.

 

HOW TO IMPROVE THE PORTFOLIO

Ian Marsden, investment manager at Redmayne Bentley, says:

Your portfolio has a very high allocation to cash of over 12 per cent and, although I would not argue against holding some in the current climate, I think this level is rather high - especially when you are looking to grow your portfolio. A single fund, CF Woodford Equity Income, also accounts for around 11 per cent of your portfolio's value, and I consider this to be too high - even for a fund with good performance.

You only have a relatively modest allocation to the US stock market, which given its long-term outperformance relative to other developed markets, dynamic technology sector and scale could go higher. You could invest in North American Income Trust (NAIT), which invests in blue-chip US companies paying high dividends such as Pfizer (PFE:NYQ), Wells Fargo (WFC:NYQ) and Microsoft (MSFT:NSQ). Despite performing strongly over the past year this trust trades on a discount to NAV of around 8 per cent and yields about 3 per cent.

Given your focus on capital growth, you may want to consider a US smaller companies fund, such as JPMorgan US Smaller Companies Investment Trust (JUSC), which has comfortably outperformed the Russell 2000 Index over the past five years and trades on a discount to NAV of more than 12 per cent.

Given the historical link between rises in US interest rates and volatility in emerging markets, I would be reluctant to recommend adding significantly to your emerging market exposure when it appears likely that the Federal Reserve may raise rates soon. However, as much of your emerging markets exposure is focused on Asia, it would be sensible to diversify geographically with another global emerging markets fund. Henderson Emerging Markets Opportunities (GB00B87M3G18) has been a consistently strong performer over the past few years and has quite a different geographic spread to your existing emerging markets funds, with greater exposure to Latin America.

Given that so much of your portfolio is invested in equities and you already have some fixed-income exposure, you have room to add infrastructure assets, which typically pay high, inflation-linked dividends coupled with relatively low volatility. The recently launched VT UK Infrastructure Income Fund (GB00BYVB3J98) invests primarily across a range of listed investment companies as well as direct equity investments, and aims to deliver an income of 5 per cent a year. However, I should point out that the popularity of infrastructure as an asset class has meant that many listed infrastructure investment companies are trading at large premiums to NAV, which is why I think the diversification this fund offers is so valuable.

 

Rosie Bullard says:

You have recognised your home country bias, and there is sound logic in continuing to reduce your UK and Canadian holdings. This is not only to increase diversification and your opportunity set, but also because currencies can have a large impact on returns. Between the start of this year and the end of October, FTSE World Equity Index has returned just under 5 per cent in local currency terms but over 27 per cent in sterling terms, meaning portfolios with overseas investments have benefited hugely.

You could start with looking at internationally diversified stocks listed in the US and Europe. Investing in these regions means you have the comfort of similar accounting standards to the UK and Canada, as well as transparency, good information and reasonable trading liquidity.

Getting exposure overseas through ETFs makes sense where active managers struggle to consistently outperform their benchmark, as is often the case with US equity managers - this can be seen by comparing some of the better known US active managers with Vanguard S&P 500 UCITS ETF (VUSA).

In other equity regions, however, we prefer actively managed funds where managers can exploit pricing anomalies. In Japan, for example, the managers of CC Japan Income & Growth Trust (CCJI) avoid the larger Japanese companies with the least attractive return profiles, which are the ones to which you have most exposure through your Japan ETF.

Finally, your portfolio may also benefit from more exposure to Asia and emerging markets, which offer excellent long-term growth opportunities in line with your long time horizon. Be aware of volatility and timing - you only have to look at a fund such as Hermes Asia ex Japan (IE00BRHY9X99) to see that if you had bought it in early April 2015, your return to date would have been around 10 per cent, but if you had purchased it a few months later in mid August 2015, your return to date would be closer to 50 per cent. Your entry point is the key determinant of future returns.