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Pruning a portfolio for a modest retirement

This investor can easily achieve his £4,000 income goal. But he needs to focus on his portfolio as a whole and take into account potential longevity and inflation risks.

Mark from Birmingham is 52 and has been investing since 1999. He has an investment portfolio worth around £150,000, plus £200,000 in cash and a mortgage-free home. He says: "I read some research which suggested that the average Briton needs £15,000 a year in today's values to be happy in retirement. I expect to get a full basic state pension (currently £6,029.40 a year) plus £5,200 from employer pensions. So if I can get around £4,000 a year additional income from my self-invested personal pension and other investments, I'll think that enough. You don't need a huge income to be happy."

He has started to build up investments in a self-invested personal pension (Sipp). "I like the Sipp for the tax advantages. I am a standard rate taxpayer. I will aim to maximise the tax benefit of annual Sipp investment, with some individual savings account (Isa) investments on any 'dips'. I wish I'd started my Sipp years and years earlier."

Reader Portfolio
Mark 52

Sipp and Isa


£4,000 annual retirement income


"I accept that investments can fall 20 per cent in a day and stay low. I mostly take a 10-year timescale. I did invest a small sum in Anglo-American in 2013 as a "punt" because the price seemed low but I didn't like the sensation of seeing the price fall further, although I sold four months later at a gain.

"I am conscious that I have a very higgledy-piggledy portfolio. As the reputed advice to a lost traveller has it, 'if you want to get where you're going, I wouldn't start from here'. It could well do with a good prune. I accept that I have been lax and remiss at watching performance, and then taking action to ditch under-performers or switch into lower fee alternatives.

"I am moving towards a core of solid holdings in index trackers and Fundsmith Equity (GB00B41YBW71), and a satellite of spicier things around - such as smaller companies, some investment trusts and exchange traded funds (ETFs)."



Name of share or fundValue%
Jupiter Asian Unit Trust£9171
Jupiter Small Companies Unit Trust£3,3002
Jupiter European Special Situations£5,0003
Jupiter Income£7,7005
Jupiter Japan£5600
Jupiter Global Managed Fund£3800
Artemis European Growth Fund£3,0002
Invesco UK Equities£19,00013
Jupiter European Fund£3190
Jupiter Green Investment Trust£1,8111
Artemis Strategic Assets£5,3154
Jupiter Absolute Return £2,1531
Fidelity China Special Situations IT£1,9571
Ruffer European£9341
Ruffer Total Return£8441
First State Emerging Markets Leaders £5380
Lazard Emerging Markets£8111
AXA Framlington  UK £3,6462
BlackRock World Mining Trust £2,9002
EuroStoxx 30 IDVY (ETF)£1,7801
Woodford Patient Capital Investment Trust £3,7863
No tax wrapper  
M&G All Share index tracker£28,80019
M&G Dividend Fund£13,2509
HSBC index trackers: - US index£3,8003
- HSBC European index£2,8002
- HSBC FTSE 100£1,1601
- HSBC FTSE 250£2,3002
- HSBC Japan index£1,0891
- HSBC Pacific Index£3,1512
Fundsmith Emerging Equity Trust£2,0881
Fundsmith Equity Fund£7,7005
UK Equity Growth Fund£4,8003
National Express£2380
Morgan Crucible£7300.5
Royal Mail£1,1371
Total investments£149,561100
Cash in Isas and NSI£97,000 
Cash outside ISAs, in current accounts£103,600 
Total cash£200,600

Source: Investors Chronicle



Chris Dillow, the Investors Chronicle's economist says:

Your biggest asset is your low expectations. You need income of £4,000 per year and you should be able to get more than this from your portfolio even now. If we assume that equities give a total return of 5 per cent a year after inflation and cash a zero real return, your portfolio will return just over 2 per cent a year - which is £7,000.

Note here that I'm defining income as the amount you could take out of the portfolio while leaving its real value intact, on average. Income is not merely the dividends you receive. You can, in effect, create your own dividends by selling shares. If you move into funds or shares that pay big dividends, you are often taking on the risk of greater cyclical exposure (many dividend-payers do badly in downturns) or buying shares which the market believes have poor growth prospects. There might be a case for doing this - but it should not be assessed merely by whether you need an income.

Given that your portfolio already exceeds your expectations, one otherwise odd feature becomes explicable - your high cash weighting. Many readers would think that cash holdings of more than 50 per cent of your total assets are very high - unless they are big advocates of 'sell in May'. However, it makes sense for an investor who wants to conserve his wealth more than grow it.

Many would also think that such a big cash weighting exposes you to inflation risk - the chance (likelihood?) that inflation will exceed interest rates meaning you'll suffer a fall in real wealth. I'm not sure how big a problem this is. For one thing, if inflation does rise more than expected (which is a big if) the Bank of England should raise interest rates, so nominal returns on cash should rise. And for another thing, big rises in inflation are often bad for equities too - there's a huge correlation between inflation and the FTSE All-Share dividend yield - so shifting from cash to equities for fear of inflation gets you out of the frying pan but into the fire.

The only reason for shifting from cash to equities is if you are happy to take on more risk in the hope of higher returns. Does the prospect of an average real return of 5 per cent a year justify taking on the roughly one-in-six chance of a loss of around 15 per cent or more? This is, ultimately, a matter of taste.


Adrian Lowcock, head of investing at AXA Wealth says:

You have modest retirement expectations and are a self-confessed saver, not a spender. Your objectives with your existing pension portfolio are also modest. The good news is you could already achieve your retirement income goals with your existing pension pot of £150,000. An income yield of 2.7 per cent would achieve your target income of £4,000 and even in this low interest-rate environment that can be easily achieved.

However, planning for retirement is not that easy, particularly with the new pension freedoms, it means we have to take a number of factors into consideration. Before celebrating the good news that you could achieve your financial goals with plenty of time to retirement, you should review your spending habits and expectations for spending in retirement. I would always suggest it is better to be over-prepared for retirement than under prepared as there is little you can do to change the amount you save when you have retired.

There are two key risks that you need to consider when investing for your retirement; the first is longevity, ie how long you will live in retirement. Most people significantly underestimate this and live much longer than planned. With people living longer than expected, they do not forecast correctly how much money they will need in retirement and believe they have more money each year, and risk over-spending and running out of money. As you haven't planned to draw down on your capital the risks of running out of money are relatively low but you should think about healthcare costs and any other big bills that may arise and cost money such as a new boiler, car or repairs to the home.

The second major risk for you is inflation, while non-existent now; it is not likely to stay this low. You plan to retire in around 15 years' time. Based on historical inflation figures of the past 15 years, £4,000 would be worth 50 per cent less, so you would need £6,000 today to have the same income. When you retire you will also need that income to grow and support you in retirement. It is this future income requirement which I suggest you target with your pension.



Chris Dillow says:

There is one key principle I fear you are forgetting - that what matters is your portfolio as a whole, and not individual parts of it.

I say this because you say you didn't like the sensation of seeing Anglo American's price fall. However, it is inevitable that one or two holdings will fall: no investor - not even Warren Buffett - has a 100 per cent success rate. What matters is whether losses are offset by gains elsewhere - which they are if real interest rates are positive and you have lots of cash - or if they are offset by future gains. If lower prices are a sign of higher risk aversion, they imply higher expected future returns.

It's when you think about your portfolio as a whole that you should be careful about investing in actively managed funds. Sure, you might be happy to pay higher fees for better performance. But if you hold many funds, good performance by one might be diluted away by poor performance elsewhere - in which case you have a tracker fund, but with higher fees.

You should also be wary of bond funds. These do protect you from short-term fluctuations in share prices. But your cash is already doing this. So what do bond funds add? (The answer could be that they would do well if fears of secular stagnation intensify so that real interest rates fall even lower - but how great this risk is is not at all quantifiable.)

Instead, what do perhaps become more attractive in the context of your whole portfolio are frontier markets funds. These are less well correlated with western equity markets than conventional emerging markets, and so might offer some diversification - especially perhaps against secular stagnation risk - as well as decent returns.


Adrian Lowcock says:

You have a good grasp of the risks of investing, understanding that investing can be volatile. You have been able to see through this volatility which will have helped protect you against taking unnecessary losses. You have a cautious attitude to investing but have taken some risky investment decisions in the past, possibly without fully appreciating the risks involved. You have expressed a desire to run a core/satellite portfolio but prefer to be hands off.

I would suggest using funds for your core retirement portfolio as this would address this hands-off approach. You could consider a small satellite portfolio to address your interest in taking some risks. Given your portfolio size, I would suggest no more than 15 funds to provide a concentrated portfolio from which to build out. You actually have quite a risky portfolio with a number of higher risk funds in emerging markets, specialist sectors and individual companies which need addressing.

I suggest you take the four following actions :

1) Transfer any investments and cash not in a Sipp or Isa into a Sipp, up to your annual allowance maximum of £40,000 per year. The tax relief on any contributions is 20 per cent up to your net relevant earnings for a basic rate taxpayer.

2) Reduce your cash to around three years of expected income, and invest any cash held inside Isas into funds as returns on cash are low and likely to remain that way for some time.

3) Reduce the number of investments to around 15. There are too many small holdings which won't contribute significantly to the performance of the portfolio.

4) Rebalance your existing portfolio to reduce risk, creating a core around which you can save for retirement addressing the key risks of inflation, longevity and volatility.



Fund£Yield Income 
Threadneedle UK Equity Income £15,0003.84%£576.00
Franklin UK Smaller Companies£10,0001.06%£106.00
Old Mutual UK Select Opportunities£15,0002.46%£369.00
Schroder European Alpha Income £15,0003.21%£481.50
GLGL Japan CoreAlpha £10,0000.84%£84.00
Schroder Asian Income£7,5003.82%£286.50
JP Morgan Emerging Markets Income £7,5003.81%£285.75
M&G UK Inflation Linked Bond£30,0001.25%£375.00
JP Morgan US Select £15,0000.51%£76.50
Standard Life Global Absolute Return Strategies £15,0001.24%£186.00
M&G Global Dividend £9,5613.02%£288.74
Portfolio Total£149,5612.08%£3,114.99

Source: Adrian Lowcock, as at 3 June 2015.