Look beyond equities

"I have fixed protection 2014 (FP2014) with a £1.5m limit," says John. "Should I take a 25 per cent lump sum from my self-invested personal pension (Sipp) or leave the money in the pension pot for an income? If so, what is the best way to achieve an income from the portfolio?

"I have an offset mortgage of £236,000 on a home valued at £800,000, so wonder if I should pay that off? There is no exit fee. Or should I leave this offsetting and use the money to seek other financial opportunities? I pay no actual money to the mortgage and the funds are in the bank.

"Other than my portfolio, I have around £150,000 in cash and £50,000 in premium bonds.

"I invest the maximum annual individual savings account (Isa) allowance each year. I also invest the maximum annual Junior Isa allowance for my three children and will continue contributing to these each year.

"I now invest almost wholly in funds and the shares I still own are the failures that I hope will eventually come out even.

"Do I have too much in markets that are correlated with each other, and should I be spreading the risks further and be more diversified? And have I invested too much in the UK?

"I am comfortable with multi-year losses as I investing over the longer term has proved the merits of this approach. I try not to trade regularly, and take a buy-and-hold approach."

John and his children's portfolios

THE BIG PICTURE

James Norrington, specialist writer at Investors Chronicle, says:

If you plan to work part-time from age 55 you should speak to a professional tax adviser as there are some issues you need to consider before taking pension benefits at the same time.

If you are going to continue to earn £100,000 a year you may not need to draw income from your pension until much later. You can leave your pension pot uncrystallised until you decide to give up work entirely. When you are fully retired, you can crystallise separate bits of your pension at different times, known as taking uncrystallised funds pension lump sums. You can take 25 per cent of the amount you draw as a tax-free lump sum each time, provided the cumulative total of tax-free payments doesn't exceed 25 per cent of your lifetime allowance.

This can work better than taking a starting lump sum as you can get more tax-free benefit from the growth of the pension capital after you have retired. And it allows you to keep a large portion of your pension savings sheltered from inheritance tax (IHT) provided they are written in trust.

With your NHS pension and Sipp already totalling about £1.3m seven years ahead of your planned retirement age, it will soon be time to consider reducing pension contributions so that you don't exceed your protected lifetime allowance. If you exceed it you will incur tax of 55 per cent on the excess. But as the annual Isa limit increases from £15,240 to £20,000 this April there are other tax-free investment wrappers available.

With interest rates so low there is only a small opportunity cost in terms of savings rates from holding money in cash to offset the mortgage. Given your stable income, there is no great imperative to pay the mortgage off right away if it isn't costing you anything. Whether you do this depends on if you like having the liquidity of cash in the bank. That said, if you also have £150,000 in other cash savings and £50,000 in premium bonds, I'd be tempted to just clear the mortgage and have done with it.

I would exercise caution is in using the money earmarked for your house to look for "other financial opportunities". Given that this money was intended to clear the debt on your home, disappointing investment performance would be especially galling. You are not in a position where you need to take risks, so why give yourself the stress?

Tim Stubbs, independent investment consultant, says:

You have a high-risk portfolio, suitable only for adventurous investors who are able to tolerate elevated levels of risk. Half of your funds by value are invested in emerging markets and smaller companies, while you also have exposure to the biotech sector. Other than your cash and Premium Bonds, your portfolio is only invested in equities.

Your assertion that you are prepared to sustain losses for multi-year periods suggests you understand the key principals and hazards of long-term investing. But be sure that you are comfortable with this level of risk.

Petronella West, director of private clients at Investment Quorum, says:

I am presuming you left the NHS Pension Scheme on 5 April 2014 and haven't continued to accrue benefits, as otherwise you may lose your FP2014, which doesn't permit further accrual in the NHS Pension Scheme. You may also have lost any entitlement to death-in-service benefits, so check this and make sure there is sufficient protection in place for your family in event of your death.

With regard to taking tax-free cash from the Sipp, my advice would be to leave that for as long as possible as the 25 per cent applies to the value of the funds at the time of withdrawal, and hopefully this will grow over time.

Pensions have become much more inheritance tax efficient so we generally advise clients, where cash flow permits, to access available them as a last resort. But check with your Sipp provider who your nominated beneficiaries are, as it would be worth considering adding the children to give maximum flexibility in the event of your premature death.

If you need income, consider first depleting the money in your trading account, then the Isa, and then withdrawing from the pension. But make sure the overall withdrawal amount is no more than 4 to 5 per cent a year to prevent the risk of long-term capital erosion. And when the time comes always have sufficient reserves in cash - enough to meet income needs for 12 to 18 months and for short-term capital expenditure. This should be reviewed at least annually so you are never left short and forced to sell in a bear market, as doing this would erode capital faster.

We also recommend harvesting income in good times and building up a reserve, so when markets are volatile you could reduce the amount of income you need to take from your portfolio.

Your children will gain full access to their Junior Isas at age 18. So I suggest some family financial planning, agreeing values for what the money is used for and getting the children involved in the investment process as early as possible.

HOW TO IMPROVE THE PORTFOLIO

James Norrington says:

You are to be commended for keeping your total holdings to a manageable number.

Lindsell Train Global Equity Fund (IE00B644PG05) has about 27 per cent of its assets in the UK and CF Woodford Equity Income (GB00BLRZQC88) is also UK focused. Added to the UK small and micro-cap funds in your dealing account, roughly a third of your portfolio is invested in UK equities. This is not an uncommon bias towards a home equity market, but there are other developed markets, such as Europe and Japan, which could offer more upside in 2017. But note that you already have some Japanese exposure via Lindsell Global Equity.

One of the drivers of UK and US stocks over the past six months has been the re-emergence of value investing - share prices re-rating as the market realises their intrinsic worth has been overlooked - and this theme could have further to run in Europe and Japan.

It is possible to over-emphasise the benefits of diversification reducing downside risk - many developed stock markets are highly correlated. However, having a more international spread of holdings gives you a broader mix across sectors and styles of investing.

You seem to prefer managed funds, which is not a bad thing as many of the themes you invest in benefit from specialist knowledge. If you are concerned about costs it would be cheaper to make further tactical investments using exchange traded funds (ETFs). For example, it is possible to play the value theme on eurozone stocks with ETFs that cost less than half the management fee of an active fund.

Overall, however, it is sensible to have a combination of active and passive products.

Tim Stubbs says:

You need to introduce other asset classes to the mix. Property, infrastructure and commodity funds are interesting due to the shift in global economic stimulation away from monetary policy and towards fiscal policy. These are real assets that may benefit from the longer-term inflationary consequences of letting governments play a greater role in running the economy.

Hedge funds may also protect or benefit from turbulence, and would reduce excessive equity market risk.

You have generally done a decent job of diversifying your equity exposure, with a relatively similar split between emerging, global and UK equities, and the number, variety and reputation of the funds via which you do it.

But you could reassess the bias towards quality/growth stocks. Value stocks appear attractive on valuation grounds following years of underperformance. Vanguard Global Value Factor UCITS ETF (VVAL), for example, could provide global equity exposure with a value style tilt at low cost. You could fund this position by trimming Lindsell Train Global Equity, which accounts for an excessively large portion of your assets.

I would suggest selling your individual shares: with a value of just £5,600 within a £1.2m portfolio they will not have any meaningful impact on your wealth. Exposure to natural resources could be instead obtained from a diversified commodities fund. Cut your losses on the shares and try to recoup them via fund investments. Losses do not have to be regained in the same way they were lost.

And whereas individual shares can present spectacular and permanent losses in a worst case, the same is extremely rare at an aggregate market or asset class level - especially when diversified again across asset classes and geographies.

Your children's Junior Isas look to be in safe hands in terms of the fund managers you have selected, although the same argument for diversifying into other asset classes applies here too.

Petronella West says:

Your current portfolios have an excellent selection of funds, but we have some concerns about diversification and exposure to the UK. You need to have a wider asset allocation, which will de-risk your position given that a sharp fall in any one of the existing holdings could have a detrimental effect on your overall wealth.

Your UK investments include large, mid and small-caps, so here you have diversification between the various sized companies that will benefit from both overseas and domestic earnings. Although there will be difficulties with the UK's exit from the European Union and invoking Article 50, the collapse in sterling has had a positive effect on many UK companies' overseas corporate earnings expectations, and foreign tourism into the UK. So we remain cautiously optimistic on this area.

We would suggest selling your three individual share holdings and then re-balancing the remainder with the following funds which would give you a total return strategy, diversification into other asset classes and themes, and some protection against probable higher inflation and interest rates over the coming years.

Vanguard UK Inflation-Linked Gilt Index (GB00B45Q9038), First State Global Listed Infrastructure (GB00B8PLJ176) and Barings Global Resources (IE00B4V6GM81) should help counteract some of the early inflationary pressures that appear to be building. And the UK and US governments' proposed increase in infrastructure spending should benefit construction companies, defence, and commodities which have already seen a pick-up in their share prices.

You could consider recently launched Trojan Global Income (GB00BD82KP33) and Evenlode Income (GB00B40SMR25) as total return strategies. Both these have excellent managers with good investment processes and impressive track records.

Also consider increasing Japan exposure via Lindsell Train Japanese Equity (IE00B7FGDC41) as the potential for further economic recovery unfolds.

And Aviva Multi-Strategy Target Income (GB00BQSBPF62) would provide both growth and income via a much wider exposure to various asset classes, so also further diversify the portfolio.