Saving for a home

"We live in London and have a family but missed out on the latest property price boom as we have been renting and have not been able to find a property in our area, while watching prices grow by 30 per cent in the last 18 months. We have a small flat in London worth around £350,000, however, which I am letting at the moment and which I would expect to grow further in value. We also own a small property in Europe which is slightly below the price level it was bought at: its current value is around €200,000 (£166,022). The money we intend to use as a deposit has been partly invested in individual savings accounts (Isas) worth around £57,000. And we have £40,000 in a current account paying about 3 per cent gross, and £150,000 generating 0.7 per cent gross.

My investment objectives are for the portfolio to generate a net gain of 7 to 9 per cent a year for the next three to five years. I want to use some of it for the home purchase and keep the rest until retirement. We are looking to use our Isa allowances by investing an additional £26,000 in the second quarter of 2014, as well as considering opening stock broking accounts outside of the Isas to use the rest of cash.

I would like your opinions on reducing my portfolio as I believe I have too many positions, and some ideas for additional investments into which I could put the £150,000 currently generating close to zero. I would like some advice on investing in funds of funds as opposed to shares, because I would like to be less hands on in the coming years.

I have a defined-benefit pension scheme with my employer so am less concerned with building a big pension pot, although this might be different if I change jobs. I am not willing to take on high risk and am probably positioned somewhere above a low-risk attitude.

I won't trade often but am prepared to hold my portfolio for the medium term.

Last three trades

My last three trades were LMS Capital (LMS), Conygar (CIC) and Global Energy Development (GED).

Watchlist

Syngenta and Russia funds are on my watchlist.

Chis Dillow, Investors Chronicle's economist, says:

There's a big fact about investing that nobody wants to tell you. It's that it's possible to make it very easy. All you have to do is buy an index tracker fund. Doing so gives you exposure to shares without having to incur big fund management charges, or worry about trading regularly. By all means then add some overseas exposure and your own stock picks.

The trickier issue is how much of that low-returning cash should you switch into a tracker fund? On the one hand, you want the portfolio to have a net gain of 7 to 9 per cent per year. But on the other hand, you're not willing to take high risk.

I'm sorry, but this is a contradiction. To see why, think about the likely returns on equities. Let's assume shares are fairly priced, so the dividend yield will stay at 3.4 per cent, implying that share prices rise at the same rate as dividends. Let's say too that dividends rise at the same rate as profits, which rise in line with nominal gross domestic product (GDP). And let's say the latter grows at the rate the Office of Budget Responsibility expects - 4.3 per cent a year in the next five years. This gives us a total return on shares of 7.7 per cent a year, comprising 4.3 percentage points of capital growth and 3.4 percentage points of dividend income.

This means that a 100 per cent equity portfolio would probably only just meet your objectives. But most of us would think it high risk to be totally invested in equities.

Your attitude to risk, therefore, is not consistent with your return objectives. So how can we reconcile this?

One possibility is that I've been too pessimistic about returns. Maybe profits and dividends will rise faster than I've assumed. Whilst there are reasons to believe this, it would be imprudent to fully invest on the basis of any forecast.

Another possibility is that you might beat the market by using a more active investment strategy. There are three strategies here which have a proven record of success: buying defensive stocks, momentum investing and quality stocks - those with rising profits and good payout ratios (the IC stock screens help you identify these).

However, while these might well outperform on average, the unavoidable volatility of returns means they might not do so over a period as short as three years. What's more, these strategies are perhaps inconsistent with hoping for big rises in shares generally, as they might well under perform if the market jumps a lot. This isn't a contradiction: these strategies' success comes from outperforming in bad or mediocre times rather than very good ones.

This leaves us with a third possibility: reduce your expectations.

I suspect you're looking for high returns because you fear that house prices will accelerate, so you'll need big rises in your share portfolio to buy a home. Relax. For one thing, there's no evidence that, over the long run, house prices outstrip shares. And if, as I suspect, profits rise faster than wages in the next few years, the opposite might be the case. And the fact that you already own one flat gives you some insurance against the risk of property price inflation: the same inflation that makes it harder for you to buy a place would also increase its price.

I say this because it highlights an important general feature of wealth planning. What matters is your portfolio as a whole. Some parts of your portfolio expose you to risks while others protect you. As long as your whole portfolio is balanced - housing, human capital plus financial wealth - you've little to worry about.

Paul Taylor, managing director, McCarthy Taylor, says:

You indicated that you are looking to reduce your involvement in your portfolio and the number of holdings. You also said you were above low risk and that your objective is to use part of the fund for a property purchase, but that you are a medium-term investor.

You must decide how much of your fund is for the property deposit and how soon. Most investments are unsuitable for holding short term money, and to do so is a high risk strategy. If the whole portfolio is for this purpose, then you should seriously consider taking recent gains and moving into cash, rather than adding to risk exposure.

If the plan is to only use part of the portfolio for a deposit, or if a longer-term horizon applies, then we would suggest the following.

Sell directly held shares in the Isa, and buy trackers and trusts. Capital gains tax does not arise on Isa disposals. This will provide greater diversification at a relatively low cost, with some potential outperformance and asset class diversification provided by the investment trusts.

We do not recommend directly held shares for clients holding less than £100,000 in the UK alone, as the ability to diversify is restricted by the size of holdings needed to justify dealing costs. Using trackers, exchange traded funds (ETFs), open-ended funds and investment trusts overcomes this problem but you have to be careful over costs, which will erode returns.

Sell the Japanese funds to reduce exchange-rate risks and concentrate on the UK. The UK is a global market place, and when you have a limited amount to invest and a low tolerance for risk, overseas diversification is not appropriate.

Use the new Isa allowances, £11,880 from 6 April and £15,000 from 1st July 2014. If cash is to be held the new Isa rules allow the full allowance to be cash and not half as at present.

Using Isa wrappers purchase institutional units and buy through a stock broking account with no initial charges. For example:

iShares FTSE 100 UCITS ETF (ISF). Its objective is to replicate, net of expenses, the FTSE 100 index. It has a total expense ratio (TER) of 0.4 per cent.

iShares FTSE 250 UCITS ETF (MIDD). Its objective is to provide a total return, taking into account both capital and income, which reflects the return on the FTSE 250 index net of expenses. It has a TER of 0.4 per cent.

City of London Investment Trust (CTY) has outperformed its benchmark over the last one and three-year periods. It has also grown its dividend for 45 consecutive years. The fund is currently defensively managed and it has a focus on large cap companies. It has an ongoing charge of 0.44 per cent.

Finsbury Growth & Income (FGT) is managed by Nick Train whose focus is companies with strong brands and franchises, and which offer entry into emerging markets. This investment trust has a clearly defined strategy which separates it from other income growth funds, and over a longer time frame it has a proven track record for strong performance. It has an ongoing charge of 0.85 per cent.

British Land (BLND) is a real estate investment trust. It provides access to a diverse range of property assets.

We would suggest your portfolio comprises 60 per cent equity funds, 10 per cent property and 30 per cent cash. When the bond markets correct you could then use the cash to buy bond trackers with yields around 3 per cent plus.

Our reader's portfolio