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Care fees Isa needs to lock in recent gains

Our reader is investing his individual savings account in quality companies to pay for care fees later in life. But he needs to rebalance his sector exposure.

Bruce, aged 69, is using his individual savings account (Isa) as a fund to provide care for himself and his wife if their health deteriorates. He has been investing for 16 years and has recently changed his strategy from 'above average income' to 'income growth'.

He says: "I am no longer contributing to my Isa but do not need to draw income at the moment - it is all reinvested.

"The possibility of large falls in equity markets does not concern me, providing I am investing in quality companies. I do not want to invest in fixed interest securities at the moment and will wait until the future is clearer. I do not invest in unit trusts or oeics. I have used investment trusts for areas where I can make big mistakes trying to do it myself."

Reader Portfolio
Bruce 69

Individual savings account


Provide care if health deteriorates


Name of holdingNumber of shares/units heldPriceValue%
Babcock (BAB)2051459p£2,9903
Beazley (BEZ)2100258.7p£5,4325
Cineworld (CINE)1000316.25p£3,1623
Costain (COST)1300269.5p£3,5034
Cranswick (CWK)2501255p£3,1373
EnQuest (ENQ)1650145.3p£2,3972
GKN (GKN)1250409.4p£5,1175
Halma (HLMA)900603.04p£5,4275
Hansteen (HSTN)2863109.2p£3,1263
Hill & Smith (HILS)700560p£3,9204
HSBC (HSBA)390632.6p£2,4673
J Sainsbury (SBRY)800347.34p£2,7783
Kentz (KENZ)550748.5p£4,1164
Melrose (MRO)1500327.1p£4,9065
Rio Tinto (RIO)803415p£2,7323
Rolls-Royce (RR.)299996.5p£2,9793
Royal Dutch Shell (RDSA)1102178.5p£2,3962
Standard Life (SL.)670380.2p£2,5473
XP Power (XPP)2001720p£3,4403
Herald IT (HRI)1400740p£10,36010
Scottish Mortgage IT (SMT)7811091p£8,5209
Standard Life UK Smaller Cos Trust (SLS)2711344.28£9,3339

Source: Investors Chronicle. Price and value as at 28 February 2014.


Vodafone (sell), Babcock (buy), Tui Travel (sell)


Electra Investment Trust

Chris Dillow, the Investors Chronicle's economist says:

There’s a paradox about this portfolio. On the one hand, you’ve diversified individual equity risk well; apart from your investment trusts, no individual stock accounts for much above five per cent of your portfolio. What you haven’t done, though, is diversify asset risk.

There’s a nasty mathematical fact about spreading equity risk. It’s that as you buy more individual shares, you naturally dilute the risk that an individual stock will do badly but you do so by increasing the importance to your portfolio of correlations between shares. And this means that you end up taking on market risk; if the market falls, it’s almost certain that your portfolio will.

You have little protection against this. You have little cash, and no bonds.

Now, I sympathize with the latter. If, as is likely, the global economy continues to recover, bond prices are likely to fall. But you should never base your investments upon a forecast. There is a risk that we’ll get a nasty surprise about the world economy which would see shares fall and bonds do well. You’re exposed to this risk.

You say that you’re not concerned by this danger, as long as you’re holding quality stocks. Please check this statement, in two ways.

First, remember that people are poor predictors of their future tastes. It’s easy to say in good times that you’re not worried by a fall in share prices, only to become worried when it happens. Ask yourself: what would I do if my portfolio fell 10 per cent – which is roughly a one-in-six chance over the next 12 months? If the answer is “nothing”, then fine. If, however, you would need to adjust your lifestyle or cut your spending, then you might be taking on too much risk.

Secondly, remember that quality is not merely subjective, but can be quantified: quality stocks are profitable, growing ones with decent payouts. Check that your stocks meet these criteria. And check too that you’re in a position to stick with them even if they fall. Remember – the secret of Warren Buffett’s success isn’t that he’s a mega-smart stock-picker, but that he’s had the discipline to stick with quality stocks even when they fall out of favour.

Even after you’ve made these checks, there’s a problem that remains. I fear that an equity portfolio is an imperfect way of meeting future care costs, if these are needed. This is simply because shares are volatile so there’s a danger you will have to sell them when their prices are temporarily low in order to meet your care needs.

I’m not sure the answer to this is to hold bonds. The problem is that you don’t know when you might need care – in five years’ time, 10, 20? – and so you can’t buy a bond that give you a guaranteed payout when you need it.

In a rational world – one in which politicians and bosses of financial companies served the interests of voters and customers – there’d be a simple solution to this: one could simply buy insurance against such a contingency. But we don’t live in such a world - prefunded care plans are no longer sold by insurers.

I fear that there’s no alternative here but to do what you’re doing – just hope that you’ll not need expensive care, or that if you do share prices will be OK.

There’s one other point here. Some readers might think it odd that you don’t invest in unit trusts. I agree that there’s always a case for tracker funds. But otherwise, I see a case for such a rule: not holding funds can be a good way of avoiding the temptation to buy into high-charging fees. It’s not a perfect rule, but it’s not a bad one either.

Helal Miah, investment research analyst at The Share Centre, says:

Looking at your portfolio and investing objective, to provide for yourself and your wife should your health deteriorate, I think that capital preservation is probably more important than taking risks to increase the size of the portfolio. It is unknown when you may need to access the capital and, at 69 years old after 16 years of investing, I would recommend reducing risk and protecting gains.

I would say that for this reason it is worth reassessing and clarifying your attitude to risk. Although you are not concerned by a large fall in the equity market provided that you are invested in “quality” companies, this is actually a relatively risk averse strategy being invested in stocks that have a lower beta to try and avoid big losses.

I agree with your strategy of using investment trusts in areas where you may not feel entirely confident in investing directly. While the Herald and Standard Life trusts will give you good exposure to UK and international smaller cap stocks, the Scottish Mortgage IT looks to invest overseas and does not place any restrictions on the size of the company. With these investment trusts 19 per cent of your portfolio is exposed to global small to mid-caps and 8 per cent to large caps. Whilst I think this is suitable for your strategy I wouldn’t be against perhaps increasing the investment into large caps.

You do not invest in unit trust or oeics, which is something I wouldn’t dismiss. Most unit trusts and oeics are just as liquid if not more than investment trusts, the management fees have become more competitive and you don’t have to pay stamp duty. There is certainly a bigger selection to choose from than what you get with investment trusts.

You invest in a large number of engineers, industrial and infrastructure related companies. Together these represent about 36 per cent of your portfolio, and even one of your insurance companies is heavily focussed on serving these sectors. Whilst a good number of these companies have performed extremely well in recent years after becoming more cost efficient during the recession and are reaping the rewards now that a recovery is underway, I would question whether you need to be so highly exposed to the sector.

I agree that a number of these are quality companies, including Rolls Royce, Babcock, GKN and Melrose, however, no matter how good the individual company and management are, if an industry comes under pressure your portfolio will inevitably take a hit directly or indirectly. We have seen an example of this through cuts in defence spending in the UK and US impacting Rolls Royce and GKN to a lesser extent. Many of these companies do not look cheap on a price to earnings basis anymore and locking in some gains would not be a bad idea here.

As you’re looking to achieve a mixture of growth and income from your investments, I think you can almost certainly improve upon the 2.5 per cent dividend yield that is currently generated from the portfolio. Moving away from the engineers and diversifying into other sectors would help this.

Other sectors I would recommend to consider could be utilities and pharmaceuticals, both offering investments in high yielding large blue chips companies, and there is still plenty of scope to add some weight to the big oil and large cap diversified miners. Reinvesting the income as you are doing will help generate capital growth in the medium to long term, so I think there is not so much of a need to focus on slightly higher risk growth orientated companies and add lower risk companies that can offer a balanced investment.