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29-year-old aims to improve structure of £60k Isa

This young investor worries that he is too exposed to equities. But our experts say his fears might be misplaced

David is 29 and wants to improve the structure of his stocks and shares individual savings account (Isa) portfolio.

He says: "Over three years I have accrued an Isa portfolio of more than £60,000. This is spread across 30 holdings from direct equities to index trackers and actively managed funds."

In addition to the Isa portfolio, which is earmarked for his retirement and to fund his children's education, David has £3,000 in euros and £4,000 in a cash Isa. He owes £99,000 on a property worth £310,000.

"Having read the 'cannon’ of investing books, I have learned to confidently read an annual report and analyse a business. Apart from a few instances of short selling, I am a buy-and-hold investor," he says.

"However, I have never considered the shares 'together'. I simply bought and sold businesses when I deemed it appropriate.

"I really worry about whether I have too much in equities. I also wonder whether perhaps I have too many shares and may risk underperforming in the future unless I keep up with the research.

"I am open to a medium level of risk. I purchased European equities during the latest Greek crisis. I treated this as an opportunity to increase exposure to mainland Europe.

"I do not panic when holdings decrease in value, generally, unless it is clear that the underlying business has changed or the investment case has altered. I have a very long time horizon (20-30 years) and therefore want to acquire a sensible balance of equities and cash in Isas for my age bracket."

Reader Portfolio
David 29
Description

Individual savings account

Objectives

Retirement income and children's education fund

DAVID'S ISA PORTFOLIO

HoldingNumber of shares/units heldPrice Value%
Vanguard FTSE 100 UCITS ETF (VUKE)35£29.84£1,0441.5
Ideagen (IDEA)441947.25p£2,0873
BT (BT.A)300464.86p£1,3942
Xchanging (XCH)1517103.25p£1,5663
Revolymer (REVO)177961.5p£1,0942
PPHE Hotel (PPH)400621.31p£2,4854
NCC (NCC)475234p£1,1112
Diageo (DGE)1671,809.5p£3,0215
Tate & Lyle (TATE)320543.5p£1,7393
Unilever (ULVR)1362,955p£4,0187
Alliance Pharma (APH)303061.5p£1,8633
Centrica (CNA)300270.4p£8111
e-Therapeutics (ETX)340737.65p£1,2822
Aberdeen Asset Management (ADN)723344.4p£2,4904
Utilitywise (UTW)1158223.58p£2,5894
Safestyle UK (SFE)1030235.6p£2,4264
McColl's Retail (MCLS)1177155p£1,8243
CF Woodford Equity Income C Acc (GB00BLRZQ737)2499122.53p£3,0625
Ithaca Energy (IAE)389234p£1,3232
GlaxoSmithKline (GSK)1511,439.5p£2,1734
Ergomed (ERGO)587185.6p£1,0891.5
Vanguard FTSE 250 UCITS ETF (VMID)108£28.87£3,1175
Carillion (CLLN)615344.14p£2,1164
easyJet (EZJ)1001,698p£1,6983
Smart Metering Systems (SMS)470340p£1,5983
Woodford Patient Capital Trust (WPCT)3430119.7p£4,1057
Siemens AG (0P6M)30100.15 euros£2,1333
db X-trackers DAX UCITS ETF (XDDX)257545.75p£1,8863
db X-trackers CAC 40 UCITS ETF (X40)5553.46 euros*£2,0873
Munich RE 17174.15 euros**£2,1013
Total£61,332100

Source: Investors Chronicle, *Morningstar & **Bloomberg, as at 10 August 2015

Note: 1 euro=0.71 GBP

HIGH EQUITY EXPOSURE

Chris Dillow, Investors Chronicle's economist, says:

You worry whether you have too much invested in equities and the mere fact that you're worried suggests that you do indeed have too many equities. The main point of having savings is to give us peace of mind. If your savings aren't doing this for you, then you are indeed taking on too much risk.

Let's, though, be clear what this risk is. There is a roughly one-in-seven chance of you losing 10 per cent or more in a 12-month period; this is based upon annual real returns (including dividends) being around 5 per cent a year, with a standard deviation of around 15 percentage points. Can you tolerate such a loss?

There's a big reason to think you can. You're a young man. This means your biggest asset is your human capital - your ability to earn a living. You should therefore be able to use your wages as a hedge against stock market losses. You can top up your wealth in the event of losses by working and saving. It's for this reason that young people are advised to invest heavily in shares.

In this sense, your fears might be misplaced: they arise from thinking of your equity holdings in isolation, rather than as part of your whole portfolio, the biggest part of which is your human capital.

In another sense, though, you might be right to worry. The really big danger for someone like you is that the UK economy gets trapped into secular stagnation - sustained low growth. If this happens, equities will do badly even over decades. We cannot quantify this risk. But it is this that would suggest you might be investing too much in UK equities.

In starting investing so young you have one massive asset on your side - the power of compounding. If we avoid the danger of secular stagnation, equity returns of 5 per cent per year compound fantastically over 30 years. The trick is to be in the market for that time. And this means having a portfolio robust enough to see you through those times when you might become disheartened.

 

Ian Forrest, investment research analyst at The Share Centre, says:

You have a very long-term investment horizon which enables you to take some risks to achieve growth. Focusing on companies and funds is one way of doing that but it's important to be diversified. Having all your eggs in one basket, or not regularly rebalancing your portfolio, can both cause some serious problems over time.

Some simple portfolio management techniques might also help you reduce the risks but still allow you to remain invested in shares and share-based funds. All investors are different and, as with everything, there are personal preferences that come into play when constructing a portfolio. What proportion should be invested in large companies, medium-sized companies, and smaller companies? Similarly, which sectors are the best for growth and should the companies be UK or overseas?

The widely followed private investor indices published by FTSE and the Wealth Management Association suggest a portfolio seeking mostly growth should have approximately 40 per cent in UK shares and 37.5 per cent in international shares, with the remainder spread across a mixture of cash, bonds, commercial property and hedge funds.

 

Peter Day, partner at Killik & Co, says:

The table below is taken from the renowned Barclays Equity Gilt study. It highlights the longest period of data that we have for the real returns achieved from equities, gilts and cash from end-1899 to end-2014. Index-linked gilt returns are only available from 1982, while corporate bonds begin in 1999. The nominal returns have been adjusted by inflation in order to show real returns achieved on each asset class (ie, the return achieved over and above inflation on average each year).

 

Real investment returns by asset class (% a year)

Last201410 years20 years50 years115 years*
Equities-0.44.14.65.75
Gilts16.43.75.12.91.3
Corporate Bonds10.72.5nanana
Index-linked143.54.4nana
Cash-1.2-0.71.11.50.8

Source: Barclays Research. Note: *Entire sample

 

While equities will undoubtedly experience a great deal more volatility than fixed income assets, over long periods equities have consistently delivered higher real returns than all other asset classes. As you have a very long investment time horizon and sufficient appetite for risk, equities should represent a core part of your investment portfolio, and I do not believe that you are particularly overweight.

We would suggest holding enough cash to cover six to 12 months' worth of living expenses plus any significant upcoming purchases. Inflation eats into the return from cash savings and therefore we would avoid holding more than required.

Traditionally, we would recommend a reasonable exposure to corporate bonds (ie, circa 25 per cent) in order to provide diversification and also to dampen down the volatility within the portfolio. However, with bond yields at historically low levels, (driven by central bank asset purchase schemes), we recommend a reduced exposure. The language from the US and UK central banks appears to be changing in preparation for a potential tightening of policy. Accordingly, the trajectory of base yields over the medium term seems more likely upward. Given these factors there is an argument for holding a lower allocation to the asset class than historical average weightings.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

I fear that, like many investors, you are quicker to add holdings than cut them. Your biggest holding is only 6.6 per cent of your portfolio, which means that even if it does very well and rises by, say, 20 per cent it would add only 1.3 percentage points to your performance. This is only the difference between an average and good day for the market.

In having so many holdings, you are diversifying away individual stock risk and so, in effect, have something like a tracker fund.

Of course, there's nothing wrong with tracker funds. But yours is inferior on two counts.

One is that you have a bias towards speculative stocks. This is dangerous because people tend to pay too much for stocks with the small chance of huge returns, with the result that such shares tend on average to underperform. Luckily, you've mitigated this bias by having a few defensive shares which tend - on average over the long run - to outperform.

Secondly, such an unwieldy portfolio incurs dealing charges as you keep tweaking it. And the problem is that you'll have to keep tweaking it. Young people cannot be buy-and-hold investors because there is a big chance that even their apparently best stock picks will eventually do badly simply because they will be on the wrong side of creative destruction; technical change or bad strategy can destroy even sound companies. With average luck, you will outlive most of your shareholdings - which means that you will have to rebalance them simply to avoid ending up with worthless stocks.

The cheapest way to achieve this rebalancing is simply to hold tracker funds. I'd suggest that you increase the weighting of these in your portfolio, at the expense of some of your more speculative holdings.

 

Mr Forrest says:

You have gone some way to achieving a good level of diversification although you have a relatively high proportion in the pharmaceuticals and energy sectors.

Over time you may want to consider including other asset types in your portfolio, such as commercial property or bonds, to aid further diversification. By adjusting the percentage of asset types in your portfolio you can vary the amount of risk you are exposed to and the potential return on your portfolio.

There is a strong argument for holding onto winners, but be careful not to let them distort your portfolio. It's important to regularly review and rebalance the asset allocation in a portfolio, as not doing so can allow big changes in the level of risk taken to occur, which will impact returns over time.

For example, if one of your shares rose by 30 per cent in a year but the value of your bonds fell at the same time, your shares would then account for a much greater proportion of your overall portfolio. If the portfolio was not rebalanced the asset allocation, and therefore the risk you are taking, will distort and the investment goal you are pursuing will be harder to achieve.

Funds, whether tracker or actively managed, are a better way for most private investors to get exposure to overseas shares than directly investing in individual companies. Large investment management groups have the time, language skills and expertise to gain a proper understanding of foreign companies, so for most private investors it's worth taking advantage of that.

 

FIVE NEW HOLDINGS

Mr Day says:

While investors with the risk tolerance and time horizon to withstand higher volatility may consider increasing their allocation to equities, allocating an element to shorter-dated fixed income investments could prove valuable. Consider iShares GBP Corporate Bond 1-5yr UCITS ETF (IS15), which offers passive exposure to a Markit iBoxx index of sterling denominated corporate bonds with an expected remaining time to maturity between one and five years.

Further diversification could also be achieved by allocating a portion of a diversified fixed income portfolio to investments offering alternative sources of income. PFS Twentyfour Monument Bond I Acc (GB00B3V5V897), for example, offers protection against a rising interest rate environment and lower correlation to broader fixed income markets from a diversified portfolio of high-quality UK and European residential mortgage-backed securities.

In an equity portfolio, reducing risk through diversification across sectors, industries and geographies is a prudent strategy to adopt. Conversely, over-diversification can hinder returns. Modern Portfolio Theory would suggest that full diversification can be achieved through investment into approximately 20 stocks and we would therefore suggest that you have about the right number of individual equities (24 in total).

Equity growth funds should represent a larger part of your portfolio. They will help you achieve your long-term growth goals through a diversified basket of stocks while protecting you from the specific risks involved in single stock investing. I am pleased to see that you already hold both Woodford funds and we believe that Neil Woodford will continue to outperform the market. I would consider investing into Fundsmith Equity I Acc (GB00B41YBW71)* which invests into a global portfolio of equities with the objective of long-term capital growth. Manager Terry Smith's record has been very strong since inception in 2010.

Overall, you have a well-diversified portfolio, although perhaps too UK/Europe-centric. While adding the Fundsmith Fund would add to the global exposure, I would invest a small portion of your portfolio into Japan through CF Morant Wright Japan Fund B Acc (GB0033010124) and emerging markets through Utilico Emerging Markets (UEM)*. These investments would further diversify your portfolio and offer you exposure to some exciting growth markets.

*A member of IC Top 100 Funds.