Risk tolerant investor needs new strategy

Chris Dillow, Investors Chronicle's economist, says:

The first question to ask of any portfolio is: is this on track to meet your objectives?

If we assume a real return of 5 per cent a year and that you add £200 per month to it, this portfolio will get you an income of just over £13,000 in today's prices in 10 years' time (I’m assuming you'll be able to take 5 per cent out of it per year in income). But of course, there's risk around this. Assuming 20 per cent annual volatility, there's a roughly one-in-six chance you'll get an income of less than £7,000 a year, and a one-in-six chance of an income greater than £16,000 a year.

These are rough projections suffice to focus attention on two questions.

One is: will this income, when added to your other pension income, be sufficient? If not, you need to save more, perhaps by using the money you are saving by paying off the mortgage.

The other is: are you comfortable with such wide variation in prospective income? If you are, then fine. If not, you have two possibilities. One is to shift into safer assets, such as bonds - those that mature in your early 60s, not just bond funds. This is more easily done if your retirement income looks like exceeding your requirements, as it is then easier to sacrifice returns. If not, then you might have to save more as well.

But you might have another margin of adjustment - changing your retirement plans. If you and/or your wife are able or willing to postpone retirement, then you are better able to cope with equity volatility and the income uncertainty it causes, because you can work longer if your retirement income falls short. How far this is possible varies from person to person depending on job security, how much you like your work and your health.

Yet another adjustment is the support you give your youngest son. You might be able to share risk with him - being able to help him out a lot if shares do well, but not so much if they don't. (Whether you should tell him this or not is a separate matter!)

My point here is a general one. Investors should always ask: how many margins of adjustment do I have? If you can comfortably adjust how much you work, or save, or help your family, or how big a house you have, then you are better able to bear equity risk than someone without such margins of adjustment.

Regular readers will have anticipated my main gripe with this portfolio - that it's overdiversified.

Put it this way. If you own a lot of premium bonds, your return is likely to be close to that on premium bonds generally. If you have a lot of lottery tickets, your return will be closer to that on the lottery as a whole than it would be if you had just one ticket. The same is true of shares. The more of them you own, the more likely your returns are to track the general market. This is especially true for investors like you who hold lots of funds, as many of these, by virtue of their wide holdings, have returns similar to the market anyway.

So, what are you achieving with this portfolio that you couldn't achieve with an index tracker fund? It's not giving you exposure to individual stocks, as many of your holdings are less than 2 per cent of your total portfolio. This implies that, even if one of them beats the market by 30 percentage points, it would add less than 0.7 per cent to your portfolio - which is really only the difference between one decent day for the market and one average day over a whole year.

Granted, your emerging market funds mean you are leveraging up a little, as these tend to outperform rising global markets and underperform falling ones. But if you want exposure to these, you can have them alongside a tracker fund.

As it is, I fear you're getting tracker fund returns, but at a higher cost. I'm glad to see that you've recognised this problem - a 'one in, one out' rule is often a good idea. But I fear you haven't gone far enough in simplifying. What's wrong with a core-satellite strategy in which you have a big holding in a low-cost tracker fund, supplemented by a few interesting stocks or funds?

Patrick Connolly, a certified financial planner with AWD Chase de Vere, says:

I am fully supportive of your decision to use a recent inheritance to pay off your mortgage. While interest rates may currently be low that situation won't continue indefinitely and paying off your mortgage effectively equates to getting a guaranteed tax-free return on the interest repayment money you save.

However, I don't believe that your investment portfolio is constructed in the most suitable and straightforward way to help achieve your financial goals.

You have a portfolio of about £119,000 made up of 64 different holdings. This must be incredibly unwieldy to manage and means that your inbox, or your letterbox, is constantly full. I would expect a portfolio of this size to have perhaps 15 or 20 holdings at most.

I am also not convinced about how you are making new investments. While regular monthly contributions is a sensible way for many to invest, as it helps to negate the risks of market timing, when buying individual stocks at £100 to £200 a time this can be proportionally really expensive when paying stockbroking charges.

I suggest you review your financial objectives. You will want to generate income from your investments when you retire in about 10 years' time. The first question is how much of your required income will be met by your pensions and so how much needs to come from your investments? If you will be relying on investment income then you need to address the risk you are taking in his portfolio as a matter of priority, despite being able to accept significant losses.

A portfolio that is so heavily weighted toward equities isn’t the most suitable for somebody who will be relying on income from it to support their standard of living in retirement. For that matter, if other priorities such as supporting your son are important then this should be reflected in your portfolio. You may be considering downsizing, but this is often more difficult than people think and the overall benefits are often much less.

Before considering investments I suggest that you put some money aside in cash, ideally using a cash individual savings account (Isa), where you are able to cater for any short-term emergencies or requirements. This will help to avoid the need to go into debt or cashing in investments at the wrong time if money is required.

I then suggest that you think about an asset allocation strategy. This will depend on your pension assets but could be, for example, 70 per cent equities, 20 per cent fixed interest and 10 per cent property for now with a lower amount in equities by the time you retire if you will be relying on this money. If you haven't already you should aim to hold as much as possible in tax-efficient Isa wrappers.

I would sell every single individual shareholding. While you have a wide spread of shares, I much prefer a portfolio that is much easier to manage. Each individual share adds very little to your overall portfolio and a good quality UK equity fund, such as AXA Framlington UK Select Opportunities, can provide broadly similar exposure but far more efficiently.

I would also sell many of the more specialist collective funds, including those investing in India and Russia and get general emerging markets exposure through general emerging markets funds such as the First State Global Emerging Markets fund and Templeton Emerging Markets that you hold.

I would keep repeating this process until the portfolio is in much tidier shape with far fewer holdings and fewer specialist ones. You need to ask yourself whether you want the portfolio to be based around your high tolerance to risk and see where that takes you, or around your financial objectives and let this dictate the amount of risk you take.

RYSZARD FILIPIAK'S PORTFOLIO

Source: Ryszard Filipiak as at 7 December 2012

*Includes small cash holding