Join our community of smart investors

Covering a £10k care cost shortfall

Our reader needs to cover a £10,000 shortfall in the cost of care for his mother, but as her cash savings will more than cover this he could reduce the allocation to it
March 23, 2017, Martin Bamford and Rachel Winter

John is running a portfolio on behalf of his 95-year-old mother Diane for whom he has an enduring power of attorney. She is in a care home and about two years ago sold her home and gave her two children £100,000 each. Before the sale she had assets worth about £390,000 - £300,000 in investments and £90,000 in cash. She now has about £686,000.

Reader Portfolio
Diane/John 95
Description

Isa and trading account

Objectives

Cover £10,000 a year shortfall in care home costs

Portfolio type
Investing for goals

"However, there is a shortfall of about £10,000 a year between her care home costs and current income, which comprises her state pension, attendance allowance, dividends and interest," says John. "The portfolio is her only source of income and capital other than state pension and attendance allowance - my mother has no other assets.

"We would like to maintain my mother's capital as far as possible while ensuring that she is well cared for in her old age. My mother's estate will be split equally between my sister and me - but we are reasonably well off and the priority is my mother's comfort in old age.

"I have been investing modestly on my own account for about 25 years, but it is only more recently that I have become involved with my mother's affairs. I am fairly risk averse with her investments, although believe that something pretty catastrophic would have to happen for her to run out of money.

"The current cash buffer should prevent the need to crystallise losses, but I am conscious that during the financial crisis in 2008 it was not unusual for investment trust prices to halve. Shares are a different matter as Tesco (TSCO) has taught me, with the added downside of dividend suspension, and I worry that the exposure to Experian (EXPN) may be too high.

 

 

"My investment approach is influenced by the three elements of my mother's portfolio. My mother inherited the direct shares from her father when he died in 1977 and I have been reluctant to make changes to these apart from trimming the tobacco exposure.

"But there was a need to increase the investment income and with the advice of a financial adviser she acquired some convertible preference shares in Reckitt Benckiser (RB.) and Tesco, and shares in Scottish Investment Trust (SCIN) and Dartmoor Investment Trust, which has since collapsed.

"Other investment trust holdings were acquired between 2000 and 2014, most recently with a property bias, which I think are an attractive investment.

"I have sold a holding in Keystone Investment Trust (KIT) as it hasn't been performing well recently and has the same manager as Edinburgh Investment Trust (EDIN) - Mark Barnett. I used the proceeds to top up the holdings in Standard Life Investments Property Income Trust (SLI) and Ranger Direct Lending Fund (RDL).

"I have also invested in RIT Capital Partners (RCP) to give the portfolio a bit more international exposure following the Brexit vote in 2016, and have since made some further small additions to this via the reinvestment of dividends. I expect to add again to RIT Capital Partners in the coming months and possibly further increase the portfolio's overseas exposure via an investment trust such as Monks (MNKS).

"I struggle with trying to determine what is the appropriate balance between assets such as bonds, infrastructure and property, and UK and overseas equities.

"I feel the portfolio's cash allocation, £34,719 of which is held in a fixed-term individual savings account (Isa), is probably too high. So I would welcome some suggestions on suitable exchange traded funds (ETFs) into which I could deploy some of it."

 

Diane's portfolio

 

HoldingValue (£)% of portfolio
British American Tobacco (BATS)27,0633.95
Experian (EXPN)43,9926.42
Imperial Brands (IMB)33,4484.88
Land Securities (LAND)14,9992.19
Reckitt Benckiser (RB.)35,0375.11
Royal Dutch Shell (RDSB)35,7765.22
City of London Investment Trust (CTY)21,0473.07
Edinburgh Investment Trust (EDIN)21,0853.07
Henderson Diversified Income (HDIV)11,4601.67
Invesco Perpetual Enhanced Income (IPE)16,3272.38
John Laing Infrastructure Fund (JLIF)22,4903.28
Scottish Investment Trust (SCIN)20,8583.04
TR Property Investment Trust (TRY)23,4323.42
RIT Capital Partners (RCP)7,4241.08
Empiric Student Property (ESP)15,1902.22
Primary Health Properties (PHP)15,7872.3
Ranger Direct Lending Fund (RDL)17,9582.62
Standard Life Investments Property Income Trust (SLI)16,3872.39
NS&I Monthly Income Bond110,00016.04
Cash176,00025.66
Total685,760 

 

 

 

None of the commentary here 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:

You say you have a shortfall of £10,000 per year between care home costs and your mother’s care costs. There are two things you could do about this.

One would be to shift from cash into equities. With equity yields above cash returns, this would increase income. I stress here that you needn't buy high-yield stocks. Remember that what matters is total returns. You can create your own dividends by selling some shares.

Your other possibility is simply to run down capital by £10,000 per year. You're right to say that it would require something catastrophic for your mother to run out of money. As a rough guide, I reckon there's only around a one in 50 chance that you'd lose thirty per cent over a five year period. Even this would leave you well able to afford care home fees.

It's in this context that the question arises of whether you are indeed holding too much cash. Given that your mother's comfort should be easily taken care of, you can afford to take more risk. How much is, ultimately, a matter of taste for you and your sister.

 

Martin Bamford, managing director of Informed Choice, says:

You have a really important role to play in managing your mother's affairs as an attorney: she has given you responsibility to make decisions about her property and money. Any decision you make must be in her best interests, and you should start by reading the Mental Capacity Act Code of Practice, which offers comprehensive guidance on what you must do when you act on behalf of someone.

You also need to check the Enduring Power of Attorney document to see if your mother has given any specific instructions or guidance that will affect your responsibilities. But it's also important that you don't simply step into your mother's shoes and make investment decisions in the same way as she would.

It's right to consider the amount of capital needed to pay for your mother's care. With a £10,000 a year shortfall to meet, the cash balance of £286,000 should be more than sufficient. I agree that the cash balance is too high, especially with rising price inflation likely to erode its buying power over time. So you need to strike the right balance between holding enough cash to avoid selling investments during market dips, and holding too much cash, which will not benefit from the potential for future investment growth.

Assuming the cost of providing for your mother's care needs is unlikely to increase in future, I would suggest a cash buffer of up to £100,000 would be more appropriate.

Due to the complexities of funding care and managing investments as an attorney, I would consider overhauling this portfolio, taking into account tax and other considerations, with the goals of reducing risk and simplifying the approach to making investment decisions.

 

Rachel Winter, senior investment manager at Killik & Co, says:

A cash buffer is certainly a good idea, and we generally recommend holding at least six months' worth of expenditure in cash. However, I agree that the cash component of the portfolio is too high. The low interest rates currently on offer mean that cash cannot produce a return above the rate of inflation, so its value is being eroded in real terms. I would consider some short-dated corporate bonds, which will offer a regular income stream without the volatility of the equity market.

I think it would be entirely feasible to cover the entire £10,000 income shortfall by investing some of the cash and switching out of some of the existing investments into higher-yielding alternatives. Your mother's care home fees could then be paid entirely from natural income, and there should be no need to dip into capital.

It's great that your mother has built up an Isa, and I'd definitely recommend using the full Isa allowance every year. However, I would suggest using the Isa for investments rather than cash, as this will lead to a greater tax saving. An Isa protects against income and capital gains tax, so you're better off using it for high-yielding investments rather than cash paying negligible interest. I'd therefore keep the cash buffer outside the Isa.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

If you want to take on more risk, the obvious kind of ETF to buy is one that tracks MSCI World index. You should regard a global tracker as the default option when investing in equities. Only if you get a better idea should you invest elsewhere.

Because Monks Investment Trust has done so well recently it is now a bet on momentum. And we know that momentum pays off, on average, over the long run. But Monks' discount to net asset value (NAV) is now unusually narrow by historic standards. This might be a sign that investor sentiment towards the trust is abnormally high. History warns us that this can be a warning that sentiment - and hence the trust's price - will fall back.

I'd also caution against a large increase in exposure to property trusts. Property becomes illiquid in bad times, which means that property trusts might see their discounts to NAV increase a lot in bad times. This isn't a problem for long-term investors who can ride out such swings. But it is a consideration should you need to sell in the event of your mother's death - you don't want to find yourself selling when prices are unusually depressed.

You say you recently reweighted the portfolio to increase income. Most investors, however, don't need income stocks to get an income. What matters is total return: if a share goes up you can create your own dividend simply by selling part of it. Many stocks that pay an attractive dividend do so because they are risky.

Luckily, though, you are chasing income the right way. Your main direct equity holdings are defensive stocks, and City of London Investment Trust (CTY) also has a heavy weighting in these. The case for holding these is not so much that they'll protect you from a market downturn - in such an event they'll probably only fall less than the market. It's that such stocks tend to outperform on average over the longer term - defensives tend to be underpriced.

You might want to trim Experian a little - otherwise, your portfolio is more or less OK.

 

Martin Bamford says:

Something else you need to consider as an attorney is whether the level of risk is acceptable for any proposed investments. The invested part of the portfolio is mainly allocated to equities and contains little diversification, which is important for risk management.

There is an emphasis on individual stock holdings, which are riskier than collective investments, and nearly a third of the portfolio is held in just six direct holdings. This approach does not sit at all comfortably with the risk-averse approach you want to take with your mother's investments.

Within the other holdings, there is a good deal of risk: while investments such as Empiric Student Property (ESP) appear to offer diversification, this is a non-mainstream investment, which is highly questionable for a 95-year-old investor living in a care home.

 

Rachel Winter says:

If I'm investing in individual equities I aim to hold at least 10 to 15 different ones so that I am not overly exposed to any one individual company or sector, and I think this portfolio has a lack of diversification. Your mother only has six different stocks with significant concentration on the tobacco sector, so I would either add a greater selection of stocks, or reduce the direct stock holdings and focus on a fund-based strategy.

Holding high-quality shares for long time periods is a proven investment strategy, but I would be wary of retaining inherited shares for sentimental reasons. That said, if your mother has held these shares since the 1970s I assume it would be difficult for you to reduce these holdings without crystallising significant amounts of capital gain and creating a tax liability. Make sure you are taking full advantage of the annual capital gains tax allowance of £11,100.

There are several large holdings that do not offer particularly high dividend yields, such as Experian and Reckitt Benkiser, which both have yields in the region of 2 per cent. Many other blue-chip stocks in the FTSE 100 yield over 4 per cent, and diversifying into some of these would help to cover some of the £10,000 income shortfall.

I strongly agree with your plan to add more international investments, which will benefit the portfolio in the event of further sterling weakness, and also offer exposure to sectors such as technology, which are not very prevalent on the London Stock Exchange. There are some fantastic businesses listed in the US, such as Microsoft (MSFT:NSQ) and IBM (IBM:NYQ), which offer good growth prospects as well as decent dividend yields.

Or you could look at a fund such as Fidelity Global Dividend (GB00B7778087), which is heavily weighted towards the US and focuses on income.