How to invest a £190,000 Sipp

ANDY RUMFITT'S SIPP PORTFOLIO

Chris Dillow, Investors Chronicle's economist says:

The simplest way to invest £190,000 is merely to divide it between cash and equity tracker funds. A 130-60 split in favour of equities would, on reasonably cautious assumptions, give you a retirement income of just under £14,000 a year in today's money in 15 years' time*.

Is it possible to do better than this?

Possibly, through luck alone. Such is the volatility of equities that this allocation gives you a one-in-six chance of getting an income of £18,000 - although an equal chance of one as low as £10,000. Another hope - which I think is a strong one - is that the ending of the global savings glut might raise gilt yields and hence annuity rates.

If we ignore the possibility that you can consistently outperform the market by stock-picking - as I think we should - there are only two ways of doing better than this.

One is to hold more shares and less cash. This doesn't get us far, though. Assuming an equity premium of three percentage points, a £10,000 shift from cash to shares generates additional annual income in 15 years' time of only around £300. A low equity premium, multiplied by low annuity rates, gives us a depressingly low number.

The second possibility is to hold higher-beta shares such as resource stocks or emerging market equities. Here, though, we run into a problem. There's evidence that, over longish periods, high-beta assets do less well than they should. Their prices contain a 'hope premium', which is often unwarranted. And right now - with the Federal Reserve's easy money policy boosting commodity prices and emerging market shares - this premium might be unusually high.

Perhaps, then, a cash-equity split is the best we can do.

Except for one thing. Such an allocation leaves you vulnerable to unexpected inflation; I stress "unexpected" because expected inflation should be discounted in current share prices. This would hit you from two directions. It would raise your future cost of living. And - because inflation is often bad for shares - it could reduce your equity holdings even in nominal terms.

There are two obvious protections here: gold (though this is volatile); or index-linked gilts. Both, though, suffer from the same problem - they offer low expected returns. Real yields on index-linked gilts are below 1 per cent, and Hotelling's rule tells us that the prospective gains in the gold price shouldn't be much more than this. This, though, is quite natural. These assets offer you insurance, but insurance is expensive - especially when everyone wants to buy it.

On balance, my best suggestion is a mix of equity tracker funds (UK plus overseas ones), plus cash and a few index-linked gilts to protect against that risk of inflation. I say "few" because your job should protect you against inflation, insofar as your pay rises in line with prices (and if it doesn't, your problem isn't inflation but rather with your human capital).

This doesn't sound very inspiring. But nor can it. In an age of low expected returns, there can only be meagre prospects for investors.

* The assumptions are: 2 per cent return on cash, 5 per cent on equities, 2.5 per cent annual inflation and no change in annuity rates.

Richard Hunter, head of equities at Hargreaves Lansdown, says:

The portfolio has yet to form a definite shape, but you have time on your side. We shall assume that your requirements for the portfolio are aimed towards capital growth rather than income, given your age.

There are some decent funds in the portfolio, mixed in with some quite standard ones. We have a slight question mark over the asset allocation for a 42-year-old, bearing in mind that you have about £60,000 in bond funds, unless you bought them as a strategic decision as bonds were so cheap at one point.

You have some good high-risk funds in the portfolio (Aberdeen, First State, JPM, both M&G funds and Schroder all have decent managers) but I am unsure about your strategy.

You probably have at least 20 years to retirement. In the normal course of events, therefore, we would expect virtually all equities to be the position. Obviously, you have missed the recent market rise with a lot of your cash, so dripping it in seems the most sensible course of action.

The tracker fund and balanced managed fund are obviously core investments - there is nothing wrong with the core/satellite approach as long as there is a sufficient geographical spread, for example not just the emerging markets and Asia.

However, if you view the JPM Natural Resources fund as a back door emerging markets fund, your portfolio holds five emerging market funds or approximately 44 per cent of the value of the existing invested Sipp.

My suggestions for additional holdings are that the FTSE 250 or FTSE 100 index iShares exchange-traded funds potentially form building blocks in any portfolio.

The British Empire Investment trust, which is on your watchlist, has a history dating back to 1889. Shares in the fund (epic: BTEM) currently form a constituent of the UK's FTSE 250 index. The manager attempts to invest in value shares; companies where certain attributes may have been overlooked by investors more generally.

Funds where the manager has the scope and expertise to invest across the spectrum are often used as building blocks for a portfolio. Such funds outsource decision making to the investment manager, with the manager using their expertise to allocate funds between various global stock markets.

With timing everything in the world of investment, you might wish to drip-feed the existing £190,000 of Sipp cash into a series of funds but more importantly equities given the size of investable money, with existing investments providing a starting base.