Slash holdings to improve performance

"I'd like to achieve a total return of at least 5 per cent a year above inflation," says Alan. "I'm saving to provide security in retirement for me and my partner, who is eight years younger than me, and also to give my grown-up children lump sums from time to time.

"I'm happy to take risks, given that I don't rely on an income from the investments, and I'm young enough to be able to ride out short or medium term downturns. But I'd feel uneasy if I incurred heavy losses over a prolonged period.

"I recently sold all my corporate bonds as I felt it was unlikely they would gain much in value. Instead I'm inclined to increase my holdings of property funds, but I'm not entirely sure if that's sensible.

"I also recently sold all my holdings in individual company shares that had risen in value between 20 and 70 per cent. I had held these for between a few months and three years.

"Overall I banked a 50 per cent gain, and invested the proceeds in Biotech Growth Trust (BIOG). But I know I still have more individual shares than I ought to have, and plan to consolidate these over time, although I find it difficult to sell for fear of missing out on future gains.

"I want a diverse portfolio that will make above-average capital growth. I'm unsure whether I should reinvest in bonds, add to my property funds or just stick with a diverse range of equities."

Alan's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

The problem with this portfolio is that it is overdiversified. In holding so many different stocks and funds you have pretty much diluted away the impact of any particular stock. You have, in effect, something like a tracker fund.

Except that your portfolio isn't this good. In holding a lot of actively managed funds, you're incurring unnecessary fees. So you're getting less than tracker fund performance.

You say that what's stopping you consolidating your portfolio is the fear of missing out on profits if you sell a stock and it rises. One way to overcome this fear is to sell a lot of stocks - and, in particular, funds - at the same time and switch into a tracker fund.

If you do this you'll miss some potential profits. But with around average luck you'll also dump some underperformers. Remember, what matters is the performance of your whole portfolio.

One thing you are doing right is holding cash. However bullish you are, you must acknowledge that there is a significant risk of shares falling. Not only does cash protect you from this, it has another virtue that other assets don't: it protects you from correlation risk. There's a danger that all assets will fall together: for example, fears of tighter global monetary policy could hit bonds as well as equities. Cash is the only asset that protects against this.

Colin Low, managing director at Kingsfleet Wealth, says:

Certainly maximise your individual savings account (Isa) contributions in each tax year, but also consider using the tax efficiency available through venture capital trust (VCTs) - as long as you are aware of and are happy with their higher risk.

It might also be sensible to hold non-income-producing funds outside your Isa, and populate this tax wrapper with income-producing funds as this is a much more tax-efficient way of managing your investments. Due to your other income and the likelihood you are paying income tax at the higher rate, it would be most advantageous to ensure that any income from dividends or interest is held within an Isa so you do not have tax deducted from this.

Additionally, if your growth assets are held outside the Isa and there is no income declared, then it assists you in managing your annual capital gains tax (CGT) allowance, which is £11,100. So, for example, you hold some property funds outside an Isa and these generate an income, whereas some of your index funds may have a much lower yield.

VCTs pay their income tax-free and some will enable you to reinvest these into additional shares, which is another way of building assets over the longer term. It would be sensible to investigate the different types of VCTs available as some are structured for capital preservation or planned exit, whereas others are more generalist and seek high-growth opportunities in small businesses.

Other matters you may wish to consider include estate planning and the amount of inheritance tax (IHT) that may be due on your estate. One option for investors with a higher risk appetite is to use Alternative Investment Market (Aim) investments or even Aim Isas as a means of both long-term growth and IHT mitigation. They can be used to supplement your income or capital requirements, and present an opportunity to invest in an efficient manner.

James Norrington, specialist writer at Investors Chronicle, says:

There is much to like about your overall approach. You seem to take a holistic view of wealth and there are plenty of reasons to be relaxed about your situation: no mortgage, the kids off your hands, a reliable final-salary pension income, and the capacity to work if you want or need to.

If you have not already done so, there are some issues it might be worth discussing with a qualified tax professional.

If you have already crystallised a defined-benefit pension and it is paying you £32,000 a year, I assume that you have used up a sizeable chunk of the lifetime tax-free pension allowance, which is currently £1m, although some people have a higher legacy allowance from when it was last cut. This needs to be watched because if the money in your Sipp breaches the overall limit the excess will be subject to a punitive 55 per cent tax rate.

VCTs make sense as a tax-efficient way to invest in potential growth, although the underlying businesses may be very sensitive to broader economic strength and interest rates if they have significant debt funding. All of these investments carry the risk of substantial peak-to-trough falls in a crisis like that of 2008-09. But you have the capacity in terms of reserve capital and liquidity, and the time on your side, to ride out tough times.

Psychologically, this is easier said than done, but you have to accept the risk or revise your target returns down.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

In one respect your diversification looks sensible to me. Your holding of several VCTs seems reasonable. The case for these is not merely - or even perhaps mainly - that they offer tax advantages. It's that private equity carries two other advantages.

One is that it helps spread creative destruction risk. There's a possibility that existing quoted firms will be competed out of business by new firms and new technologies: this would be a sign of a healthy, competitive economy. Holding unquoted stocks might give you a stake in successful future businesses and thus spreads risk away from incumbent large companies.

The second is that private equity can be hard to sell quickly. It should therefore carry a liquidity risk premium, which longer-term investors like you should be able to reap.

But there's a problem with VCTs: their performance varies massively across funds. This is because it is almost impossible to spot successful businesses in advance. Some venture capitalists will therefore be luckier than others. The huge disparity in corporate performance - ranging from complete collapse to great success - will therefore translate into great disparity of VCT returns. In holding several you are diversifying away manager risk, leaving you with exposure to what might be a good asset class.

In doing this you are incurring fees. But these should be offset by those tax breaks. Again, remember to judge your portfolio as a whole. You will almost certainly see one or two funds do badly. But view these in the context of others that might do well.

But I would do something about your overdiversification.

James Norrington says:

There are plenty of good points about this portfolio. There is broad international exposure, including a global approach to defensive and growth sector-specific themes, via healthcare and technology respectively.

You mentioned your property holdings, which in total make up about 6 per cent of the portfolio. Recently IC columnist Mr Bearbull explained his general aversion to UK property investments, arguing that most Brits have high enough exposure to the domestic property market, and for those with a mortgage this is also leveraged. However, as you own your home it should be seen as risk-free, so it is reasonable to separately seek investment exposure to UK property. Your allocation is not outsized and many of your property funds are internationally diverse, spreading the risk of any potential downturn in UK property. If you do increase the size of these holdings, though, be aware of how much of your total portfolio is invested this way, and maybe have a maximum exposure of 10 per cent.

The difficulties that you have in deciding when to sell and avoiding the temptation to buy too many investments are common among investors. The cut-off rule you adopted, selling companies that have risen by at least a certain value, is not an approach I'd recommend, for two reasons. Firstly, you may be missing out on further upside and, secondly, crystallising all of these gains at the same time will increase your liability for CGT with investments held outside tax wrappers.

Discipline is key. For individual shares you should set yourself a limit of 15 to 20 holdings and manage these on the basis of whether or not you still believe in the fundamental investment case. I'd also get out of the habit of having a punt on stocks with a few hundred quid - this just leads to an unwieldy portfolio. Either you believe in a stock or you don't, so why not put a minimum of, say, £2,000 behind the companies you like most? Choose no more than one or two stocks from each of the sectors you like and, rather than focus on the price gains, set targets for review.

For example, a share price may have gone up but positive and improving earnings figures will mean that the price/ earnings (PE) ratio will still indicate value. It may therefore be better to reassess your position once a certain PE multiple is reached. Also, there are different ways to analyse companies in different industries - check out Phil Oakley's recent articles in Investors Chronicle on how to assess the best performers and prospects in various sectors.

For your fund investments decide on the goal and your asset allocation strategy, then choose the best performing/best value products that give you the requisite exposure. Five per cent above inflation is ambitious in the current climate and requires you to take risks. The asset allocation here does give you a chance of achieving this target, with exposure to smaller companies and emerging markets, although emerging markets may suffer in the short term from policies proposed by incoming US president Donald Trump.