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Prepare for redundancy by de-risking

Our reader may soon be made redundant and retire early so he should diversify and de-risk his portfolio
May 18, 2017, Adrian Lowcock and Lauren Peters

Matt is 52 and works in the NHS. He earns a salary of £41,000 a year, but thinks he might be made redundant in the next two years due to reorganisation.

Reader Portfolio
Matt Hayes 52
Description

Sipp, Isa and cash

Objectives

Income of £30,000-£42,000 in retirement

Portfolio type
Investing for income

"In all likelihood I will start to receive an NHS pension between the age of 55 and 58," says Matt. "If I retire early I would like to work part-time at least until I'm 60. My NHS pension is likely to be between £14,900 and £18,200 a year, depending on criteria such as redundancy and age at retirement.

"My state pension, which I am due to start receiving at age 67, is contracted out. My self-invested personal pension (Sipp) is valued at about £150,000 and I intend to increase this by reinvesting £10,000 held in an individual savings account (Isa). I also expect to receive a bequest of £18,700 fairly soon.

"My partner, who is 60 and not working, receives a guaranteed annuity payment of £264 a month. He also has about £100,000 in a Sipp, which he is not drawing at the moment and will probably contribute to it for two more years. He is due to start receiving state pension at age 66.

"Our assets are almost equally divided between us, although he lets me make the investment decisions. My partner owns the leasehold to our property, which is valued at about £170,000. This has high maintenance charges and a garage rent of £105 a month.

"We would like a joint gross income of between £30,000 and £42,000, taking advantage of our two full personal allowances. We are thinking of retiring to Devon to be near family and buying a property with a value of up to about £350,000. We might also take in a rescue dog and travel more.

"I have been investing for 25 years and don't mind the risk associated with being largely invested in equities. A market fall of about 20 per cent wouldn't worry me too much, although it would worry my partner who doesn't like risk. His notional annuity capital, and investment in funds rather than investment trusts, lowers his risk profile. My investments lean more towards investment trusts, which I think are higher risk.

"Overall I am fairly happy with a split of 65-70 per cent in open-ended funds, and 30 per cent to 35 per cent in investment trusts. I recently sold a small investment in GlaxoSmithKline (GSK), which was our only money directly invested in shares. I look to have between 20 and 25 holdings at most.

"I try to avoid high charges, which is why I like Royal London Asset Management's funds and certain investment trusts. However, I think passive funds and bonds are a bit boring, and sold a Vanguard tracker fund I held.

"I prefer to invest mainly in the UK, with a slight bias to smaller companies. Although I'm aware that past performance isn't always a good predictor I'm too scared to invest in poorly performing funds.

"I look at FE Trustnet and Morningstar ratings as a guide, and like funds run by asset managers who achieve good performance across all their funds. When reviewing investments I look at the following on Trustnet.

■ 10-year performance to judge how a fund performed over a volatile period.

Sharpe ratio, volatility and alpha. The Sharpe values listed are for a three-year period, so I also look at short-term performance against the FTSE All-Share index.

"I prefer to try not to trade too much, and only switch up to about 10 per cent of my portfolio a year. If a fund underperforms I may reduce my allocation to it as I did with Temple Bar Investment Trust (TMPL). But I still have some shares in this investment trust due to its low charges.

"I also recently reduced my investments in Unicorn UK Income (GB00B9XQFY62). And I reduced Perpetual Income & Growth Investment Trust (PLI) because it has a performance fee, and switched the money from this into Edinburgh Investment Trust (EDIN), which [is run by the same manager Mark Barnett] has lower charges. I like these two funds because of their long-term performance record.

"I recently bought Monks (MNKS) and Law Debenture Corporation (LWDB), and increased my investment in Royal London UK Equity Income (GB00B8Y4ZB91).

"I am thinking of investing in Royal London Sustainable Leaders (GB00B7V23Z99), Foreign & Colonial Investment Trust (FRCL), Threadneedle UK Equity Income (GB00B888FR33) and Trojan Income (GB00B01BP176).

"I'm also interested in Murray International Trust (MYI).

 

Matt and his partner's portfolio

 

HoldingValue (£)% of portfolio
CF Lindsell Train UK Equity (GB00B18B9X76)16,496.354.79
CF Miton UK Multi Cap Income (GB00B41NHD71)12,636.183.67
CF Woodford Equity Income (GB00BLRZQ737)32,803.599.53
Invesco Perpetual Distribution (GB00BJ04FH62)10,837.853.15
Invesco Perpetual High Income (GB00BJ04HP86)19,684.495.72
Invesco Perpetual UK Strategic Income (GB00BJ04KY80)24,227.717.04
Jupiter European (GB00B5STJW84)12,646.353.67
Marlborough Multi Cap Income (GB00B907VX32)11,938.513.47
Marlborough Special Situations (GB00B659XQ05)10,293.952.99
Royal London UK Equity Income (GB00B8Y4ZB91)12,874.743.74
Unicorn UK Income (GB00B9XQFY62)3,272.660.95
Edinburgh Investment Trust (EDIN)26,434.727.68
Finsbury Growth & Income Trust (FGT)23,541.216.84
Jupiter European Opportunities Trust (JEO)5,155.651.5
Keystone Investment Trust (KIT)8,763.322.55
Law Debenture Corporation (LWDB)6,271.961.82
Monks Investment Trust (MNKS)5,587.501.62
Perpetual Income & Growth Investment Trust (PLI)16,054.464.66
Scottish Mortgage Investment Trust (SMT)10,7823.13
Temple Bar Investment Trust (TMPL)8,485.822.46
Mercantile Investment Trust (MRC)5,472.241.59
Cash60,00517.43
Total344,266.26 

 

 

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS READER'S CIRCUMSTANCES.

 

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

Despite the fact that real interest rates are negative, I don't think your cash holdings are high. This asset has limited downside risk whereas equities have much more. And your job insecurity justifies a big allocation to safe assets. Your human capital - your power to earn a living - is part of your portfolio. And common sense says that if one part of your portfolio is risky then other parts should be safe.

 

Adrian Lowcock, investment director at Architas, says:

I don't agree with your view that open-ended funds are lower risk than investment trusts. Investment trusts can be more volatile in the short term, and trade at discounts and premiums to net asset value, but over the longer term a fund's risk is related to what it invests in rather than its structure.

You say you are comfortable with a higher level of risk, however your combined portfolio is mostly invested in equities, putting it at the higher end of the risk spectrum, so it does not reflect your partner's attitude to risk.

I would also be concerned about being largely invested in equities if you expect to be made redundant in the short term and retire in the medium term. The ability to tolerate a big drop in the value of your investments is likely to change once you have no income and are dependent on your assets for retirement.

Equities can be volatile and could fall much more than 20 per cent. If they do this just as you retire you could find that your income also falls significantly and this would have a permanent impact. So I would also suggest considering your future income. Equities offer an attractive yield with the potential to grow that income, but there is always a risk that they may have to cut it during a recession. Could you tolerate a huge fall in yield if companies cut back on their dividend?

 

Lauren Peters, chartered financial planner at Helm Godfrey, says:

Working out a retirement budget, and thinking about how much income you need and want in retirement is a great place to start.

By the time both you and your partner get to state pension age, it's likely you will be close to hitting your target retirement income of £30,000-£42,000 per year with guaranteed income streams alone: you will have two state pensions at approximately £8,000 per year each, your NHS pension at around £15,000- £18,000 per year and your partner's annuity.

The difficult part is determining how you will fund the years between early retirement and hitting state pension age.

Here, cash flow planning will be critical. This involves mapping all the different dates for obtaining various income streams, and then using invested pensions and/or any other savings to plug the gaps. You will need to consider different rates of return to determine whether or not the additional savings and investments will provide enough money to hit your target income. This will also tell you if achieving your target income is possible given your current investment mix and risk profile. It's usually worth consulting a financial adviser to help you with cash flow planning. It is critical to consider the impact of taxation, inflation and fees in a situation like this.

Regarding your NHS pension, you should be aware that taking the pension early - especially if not made redundant - typically leads to an 'early retirement reduction factor' being applied to your income. This could reduce the amount of annual income you receive by 3 to 6 per cent a year, for every year you draw the pension early.

Redundancy money can be contributed to your pension, as long as you don't contribute more than your total income for the tax year and, of course, assuming you don't need the money for anything else.

It's hard to say whether you should transfer Isa money into your pension without going into more detail with you. But it's generally a good idea to have both an Isa and a pension to draw upon in retirement. Pension income is taxable, apart from the tax-free cash component, whereas income from an Isa is tax-free. Having both accounts in retirement allows you to manage your income tax liability more efficiently as you can top up taxable pension income with tax-free Isa income - particularly useful for random lump sums.

And it's always worth having some accessible money. You can't access your pensions until 55 at the earliest, so you may prefer to keep the Isa for now just in case you are made redundant.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

This portfolio is less diversified than you might think, albeit in what is probably a good way.

Some of your biggest fund holdings have something in common. CF Lindsell Train UK Equity (GB00B18B9X76), CF Woodford Equity Income (GB00BLRZQ737), Invesco Perpetual UK Strategic Income (GB00BJ04KY80), Edinburgh Investment Trust and Finsbury Growth & Income Trust (FGT) all invest in quite similar stocks: large higher-yielding defensives.

This bias is the natural result of you selecting funds according to their Sharpe ratios. Because defensive stocks have for years offered outperformance with relatively low volatility, they've had good Sharpe ratios. Many good fund managers have held defensives not necessarily because they are good stockpickers, but because they know that defensives have for years done better than they should.

Herein, though, lies a question: can this continue? There's good reason to think so. Many bullish investors take a pseudo-geared position by buying high-beta stocks. That leaves low-beta ones relatively under-priced. And many fund managers don't want to exploit this because they fear underperforming the market if shares generally do well. The upshot is that defensives are systematically underpriced.

But while this has been the case historically, it might not continue to be. The great run-up in defensives means that many are now on quite high ratings. And it's possible that many investors such as you have finally wised up to the defensive anomaly and so eliminated it. You are therefore exposed to the risk that defensives might no longer be underpriced.

I'm not sure how big a danger this is. Even if it materialises, it might be that defensives rise less than the general market rather than fall a lot. If so, your loss would be an opportunity cost rather than an out-of-pocket one. As investors' mistakes go, being highly exposed to defensives is one of the smaller ones.

Nevertheless, you might want to consider diversifying this risk a little. I'm not sure your antipathy to overseas stocks is fully warranted. Nor should you avoid trackers because they are 'boring.' Pete Sampras's tennis, Tony Adams' defending and Geoff Boycott's batting were boring, but they were also very effective! A tracker fund might help spread your high exposure to defensives.

 

Adrian Lowcock says:

Holding a mix of assets including bonds, property and alternatives - as well as equities - would help diversify your income stream.

You also have a diversification problem in terms of the composition of your equity exposure. You have substantial exposure to UK equities and a lot of UK funds, which means the 10 shares you have most exposure to via your funds also account for a substantial proportion. And your portfolio is highly exposed to region-specific issues such as Brexit.

Diversification into other countries such as the US or Europe is essential, as it reduces the impact of specific risks, and provides exposure to other markets that offer potential for growth and income not available in the UK.

I would suggest you consolidate some of the UK holdings, reducing the exposure to fund managers Mark Barnett and Nick Train. Both are great managers, but funds run by them account for over a third of your portfolio.

Reallocate some of this money to US, Japan, Asia and emerging market funds. Also look to add property funds for income and absolute-return funds, in particular to reduce volatility.