Capital for care and income for holidays

"At first I kept the equities and bought funds in my individual savings account (Isa)," she says. "I read Investors Chronicle, among other sources of advice, and tried to make sense of it all. Over the past few years I have sold most of the equities and reinvested in funds within an Isa because I thought that would be safer. I have added to the Isa portfolio, buying funds, but in some cases I would have been better putting the money under the mattress. Latterly I have decided to buy income funds because I could either take the income, if needed, or re-invest it.

Now that I am retired I sit for hours considering what to do with it all - ie, what should I sell and when, and if I sell what should I buy? I am now in a position that even just looking at anything to do with my portfolio gives me palpitations!

I now have a portfolio worth £100,761.57. Two holdings, Royal Dutch Shell and First State Asia Pacific Fund, are worth £26,820.79 and are responsible for the largest gains as they cost me £10,850. I also have a large chunk in Jupiter Financial Opportunities which has gone down the pan - I know now that I should have sold, but I want assets which I can hold.

Should I quit while I am ahead and send it back to an investment manager?

My investment objectives are to try and keep the capital appreciating but with some income so that in the short term, for example, I could go on a nice holiday. In the future I would like this fund to provide for my husband and myself should we need care.

I classify myself as medium risk but in reality I am probably a low-risk investor who takes the occasional high-risk punt: for example, I bought some Noreseman Gold shares in 2011 worth £1,000.

Many investors enjoy investing and see it as a challenge. I don't think I have the right sort of mentality to figure all of this finance stuff out and I don't enjoy gambling with my money which is what this is.

Chris Dillow, Investors Chronicle economist, says:

For me, the purpose of wealth is to give you an easy life and peace of mind. So the fact that you say that even looking at your portfolio gives you palpitations suggests that something has gone wrong. To fix it, let's remember first principles.One of these is that what matters is your portfolio as a whole. It's a cast-iron certainty that even the best investors will often lose money on any single asset. But such losses are tolerable if they represent only a small part of your wealth, and if you have diversified well so that you have winners as well as losers. And the thing is that you have diversified pretty well here, albeit with some caveats, using bond funds that cushion you against many types of equity loss.

So, stop fretting about individual losses. Think of them as being as inevitable as one or two plants dying in your garden: what matters is the whole garden.

This, though, raises the question: are you taking on too much equity risk? You say you don't enjoy gambling, so perhaps the answer is yes.

We can roughly quantify this. About four-fifths of your portfolio is in shares, with the rest in bonds. On reasonable assumptions about equity returns and volatility (5 per cent returns and 20 per cent annual volatility) this implies that there's a roughly one-in-six chance of you losing 12 per cent of your portfolio in a year.

Does this seem too much to you? Ultimately, this is a matter of preference with no right or wrong answer. If it is too much then you should cut your equity holdings and hold more bonds or cash. Cash may pay almost no real return but it carries no risk of loss either, except to the extent that inflation rises unexpectedly.

I have three other quibbles with this portfolio.

First, I'm not sure about its high exposure to emerging markets. About a third of your portfolio comprises emerging markets funds and things correlated with emerging markets such as resources funds. You are, therefore, taking quite a big bet on US monetary policy staying loose and growth expectations improving. This is reasonable for now, but there will come a point when it will become dangerous.

Secondly, you say you're attracted to income funds. Income, however, comes at a price. A share can only yield more than average if investors believe it is riskier than average, or has worse longer-term prospects than average. Investors sometimes overestimate these downsides causing income stocks to be under priced. But it is only when this is the case that income investing makes sense. Otherwise, you might as well hold general equities and take income by selling some. In this way you can create your own dividends.

Thirdly, there's a problem with holding so many actively managed funds - fees. It would be cheaper to simply hold a FTSE All-Share tracker fund. And given that your equity holdings are pretty well diversified (with the exception of the emerging markets exposure), I don't think you'd lose anything by switching.

For you, there's another argument for simply holding a tracker. You say that you "don't have the mentality to figure all of this finance stuff out". This is admirably self aware. But there's a solution here. You can back the field rather than any particular horse. And this is just what a tracker fund allows you to do. You don't need to figure out anything about finance to hold a tracker fund: the future is unknowable so no amount of effort or ability will allow you to know future returns. All you need to know is your tolerance for risk.

I'd therefore recommend that you sell most of your equity funds and buy a tracker fund instead, perhaps increasing either your cash or bond exposure depending on your appetite for risk.

Anna Sofat, founder of wealth manager Addidi, says:

Your asset allocation of around 82 per cent in equities, with about 8 per cent in bonds and 6 per cent in cash is not very diversified. You have around 50 per cent in UK stock with about 30 per cent in Asia, but little exposure to the US, Europe and other emerging markets. And most of the holdings are large companies, although there is a decent split between value and growth.

While many of the funds have good ratings a number have seen declines, including: Allianz BRIC Stars, Schroder UK Alpha Plus and Artemis Strategic Assets.

Historically, the portfolio would have outperformed the markets; however, that's if it had been invested for five to 10 years. But there have been changes and those changes were made with hindsight - for example, investment in funds which have performed well.

To build a portfolio, it is necessary to go through a number of key steps, such as:

Determining your needed/acceptable level of risk

■ Understand the level of risk you are comfortable with (you do not seem comfortable with the level of risk in your portfolio);

■ establish what downside risk you can afford to take (ie, how much loss can you suffer without impacting your lifestyle). The higher the loss you can afford, the higher the risk you can afford to take; and

■ work out the level of return you need.

You say you are medium risk yet 82 per cent of the portfolio is in equities. The portfolio's three-year standard deviation figure is 10.79, which is below the FTSE All-Share but a similar level to FTSE APCIMS Growth Index, which has around 78 per cent in equities. An appropriate level for you, based on your risk tolerance, might be 50 per cent in equities.

Appropriate split between asset classes

Usual practice is to determine the split between the main asset classes: cash, fixed interest (gilts and bonds), equities and property.

However, it might be better to define assets as defensive where the main purpose is risk management, and risk assets where the clear focus is on returns.

Know what role each fund is performing. All your funds, except for Invesco Perpetual Corporate Bond and Monthly Income, can be classed as risk, and even these two are not purely defensive.

Passive versus active

Most investors favour active strategies in the hope of outperforming the markets but statistics are stacked against them. Over 70 per cent of active managers do not deliver market-plus return: fund managers can do well for a period of time and then underperform.

So it's important that you have a good way of evaluating fund managers. You have bought a range of funds which are high profile, well publicised and mostly well rated, so they should be doing well.

Rebalance strategy

Studies of investor behaviour show that typically they buy when prices are high and sell when values are low. To counteract this, you should rebalance your portfolio to your strategic asset allocation. This allows emotions to be taken out of the equation and forces you to come out of funds and assets that are doing well, and buy ones that are not.

However, bear in mind that transaction costs can erode performance so rebalancing should not be done for minor shifts in value.

You mentioned moving into income units. This has been a popular area over the past 12 months but I am not convinced dividend levels will remain so attractive over the next two to three years. Unless a client needs the income, it's more economical and efficient to buy accumulation units as you automatically reinvest. If you accumulate the dividends, then every six to 12 months you have to buy additional units.

Bearing in mind your anxiety, I would strongly urge you to find an independent financial adviser or wealth manager who can construct a diversified portfolio and manage the funds to a mandate you agree.

Ruth Dixon's portfolio

Source: Morningstar & Investors Chronicle as at 3 April 2013

Latest trades:

Invesco Perpetual Corp Bond Inc, GB0033050690, Buy

Troy Trojan Income Inst Inc, GB00B05K0Q07, Buy

Watchlist:

Finsbury Growth & Income Trust, FGT

Scottish Mortgage Investment Trust, SMT