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Is a 50:50 cash and equity split right for £2m portfolio?

Mr and Mrs A are about to retire, but their portfolio is heavily weighted to cash

Mr A is 59 and Mrs A is 53. They have joint assets of £2.2m and are in the process of selling their business before retiring next year.

Mr A says: "We have been investing over 20 years but the weight of my attention was on our business and I feel this is reflected in our equity/bond portfolio. I expect a professional review will reveal holdings tilted toward income to the exclusion of growth with not much thought to overlap, correct allocation or rebalancing."

The couple have investments worth over £1m held across self-invested personal pensions (Sipps), individual savings accounts (Isas) and a taxable trading account. They also have more than £1m held in low-risk assets such as NS&I income bonds, premium bonds and index-linked bonds, and - with other providers - cash Isas and some easy access accounts.

"We have an active lifestyle and enjoy travel," says Mr A. "We would like to take annual income of £50,000 to £60,000, with occasional capital spends to replace cars and for special holidays. Our basic living expenses are £45,000 a year and we are happy to flex additional spending according to investment performance.

"We have no dependents or children and intend to spend the principal but wish to avoid significant capital erosion for around 10 years.

"We currently have a very large amount of cash relative to equities but we wonder if we need to exposue much more capital to higher-risk assets.

"I had high tolerance of risk in business and investing but as we move to retirement capital protection is of growing importance."

Reader Portfolio
Mr and Mrs A 59 and 54
Description

Sipps, Isas and taxable accounts

Objectives

£50k income and capital preservation

MR AND MRS A PORTFOLIO

Mrs A SIPP: £406,989%Mr A Sipp: £475,002%
British Land (BLND)1British Land Co (BLND)1
Burford Capital plc 6.5% 2022 (BP4WBB4)1Burford Capital plc 6.5% 2022 (BP4WBB4)1
CF Woodford Equity Income Class Z - Inc (BLRZQB7)3Enterprise Inns 6.5% 2018 (3258583)1
F&C Commercial Property Trust (FCPT)1Fidelity Moneybuilder Income Y Inc (B3Z9PT6)2
Intermediate Capital Group plc 5% Notes Redeem 24/03/2023 (BVW1P24)0.5Henderson European Focus Trust (HEFT)2
Invesco Perpetual Monthly Income Plus Class Y - Inc (BJ04K04)3Intermediate Capital Group plc 5% Notes Redeem 24/03/2023 (BVW1P24)0.5
iShares FTSE UK All Stocks Gilt ETF (IGLT)1Invesco Perpetual Distribution Y Inc (BJ04FJ8)3
iShares plc DJ Asia/Pacific Select Dividend 30 (IAPD)1Invesco Perpetual Enhanced Income (IPE)1
Jupiter Euro Opportunities Trust (JEO)3iSharesJPMorgan USD Emerging Markets Bond (IEMB)2
Kames High Yield Bond Class B - Inc (B1N9DY5)2iShares DJ Asia/Pacific Select Dividend 30 (IAPD)1
Ladbrokes Group Finance 5.125% Bonds 2022 (BMQX4Y8)1iShares FTSE UK Dividend Plus (IUKD)2
London Stock Exchange Group 4.75% Notes 2021 (B5W4F10)1iShares Markit iBoxx Euro High Yield Bond (IHYG)1
M&G Strategic Corporate Bond I Inc (B6VTPZ7)1iShares Dow Jones Emerging Markets Select Div (SEDY)1
Middlefield Canadian Income (MCT)1Jupiter Strategic Bond I Inc (B544HM3)2
Newton Emerging Income W Inc (B8HMC86)1Ladbrokes Group Finance 5.125% Bonds 2022 (BMQX4Y8)1
Newton Global Income W Inc (B8BQG48)2London Stock Exchange Group 4.75% Notes 2021 (B5W4F10)1
Paragon Group 6% NT Redeem 28/08/2024 (BYTLBZ3)0.5Marlborough Multi Cap Income P Inc (B908BY7)1
Provident Financial 5.125% Notes 09/10/23 (BWNH4K9)0.5Middlefield Canadian Income (MCT)1
SPDR S&P US Dividend Aristocrats USD (UDVD)1Murray International Trust (MYI)2
Utilico Emerging Markets (UEM)1Nestle Sa Ordinary CHF0.01 (NESN)2
Woodford Patient Capital Trust (WPCT)1Provident Financial 5.125% Notes 09/10/23 (BWNH4K9)0.5
Cash11Standard Life Investment Property Income Trust (SLI)1
Mrs A ISA: £6,274TR Property Investment Trust (TRY)1
iShares Markit iBoxx GBP Corporate Bond ex-Financials ETF (ISXF)1Utilico Emerging Markets (UEM)1
Cash0Cash14
Mr A ISA: £67,505Mr A Taxable: £89,488
Beazley plc 5.375% MTN 2019 (B73MKM3)1City Of London Investment Trust (CTY)3
Burford Capital plc 6.5% 2022 (BP4WBB4)0.5Finsbury Growth & Income Trust (FGT)2
CQS New City High Yield Fund (NCYF)1HICL Infrastructure Company (HICL)2
Greencoat UK Wind (UKW)0SPDR S&P US Dividend Aristocrats USD (UDVD)1
iShares EURO STOXX Select Dividend 30 (IDVY)1Tullow Oil (TLW)0.5
Paragon Group 6% NT Redeem 28/08/2024 (BYTLBZ3)0.5Cash0
Unilever (ULVR)1
Cash1TOTAL PORTFOLIO VALUE: £1,045,258100
Source: Investors Chronicle as at 9 October 2015

 

THE BIG PICTURE

Chris Dillow, the Investors Chronicle's economist says:

You're right. This portfolio does have a high weighting in safe(ish) assets; this isn't just because of your high cash holdings, but also because you have significant investments in bonds and bond funds. This allocation has served you well in the past six months, but you are right to question whether it is appropriate for the longer term.

Let's consider the general picture. As a rough rule of thumb, I'd assume that cash and bonds offer a return of around zero after inflation while equities offer a real return of 5 per cent per year on average but with a standard deviation of around 20 percentage points: big UK stocks are less risky than this, but emerging market ones are more so.

Now, imagine as a starting point a portfolio split 50-50 between equities on the one hand and cash or bonds on the other. My assumptions imply that it should offer an average annual return after inflation of 2.5 per cent. This means you should be able to take £55,000 per year out of it while leaving your capital intact in real terms: whether these withdrawals consist of actual dividends or dividends that you create yourself by selling some stock is unimportant except for tax considerations.

This, however, is only an average return. There's around a one-in-six chance that, in any 12-month period, such a 50-50 split will suffer a 15 per cent loss on its shares and therefore a 7.5 per cent loss of total wealth. On the other hand, though, there's also a roughly one-in-six chance of equities returning 25 per cent in a year, giving such a portfolio an overall return of 12.5 per cent.

How do these odds seem to you? If that chance of a loss feels too nasty, you should hold more than half your portfolio in cash and bonds. If, however, you find the odds attractive, you could hold more in equities. In considering this question, don't pay much attention to the economic outlook because nobody really knows for sure what this is. Instead, it is ultimately a matter of taste.

There is, though, a complication here. My assumption about equity returns is based upon their historic averages. But there's a danger that the future won't resemble the past even on average. Instead, we might fall into secular stagnation, in which we see poor long-run equity returns, much as Japan has suffered since 1989. This is a genuine uncertainty in the sense that it is an unquantifiable danger. It might argue for lower exposure to shares.

In this context, your bond holdings might be wise. You say you're thinking about buying annuities later. This isn't a bad idea. Annuities protect us from two big risks: falling share prices; and the danger that we'll live so long that we outlive our wealth. However, if we fall into secular stagnation bond yields and hence annuity rates will stay low. Bond holdings protect us from this risk: in this event, profits on bonds will compensate us for low future annuity rates. Conversely, if bonds do badly, losses on bond funds would be offset by higher future annuity incomes.

As for what form your equity holdings should take, your default investments should be a tracker fund - ideally one that tracks the world index. If you must, supplement this with specific investments in other market segments, but remember that most global shares are correlated with each other: if the general market does badly, so will most shares and funds.

 

HOW TO IMPROVE THE PORTFOLIO

Jason Whitcombe, a chartered financial planner and director at Evolve Financial Planning says:

There is often a tendency for investors to focus on "income" or "growth". However, why not aim for a bit of both? Looking at a portfolio on a total return basis seems more logical as it gives you the opportunity for much greater diversification.

For example, if we take two low-cost UK tracker funds from Vanguard, as at 31/08/2015, its FTSE UK All-Share Index fund held 555 individual stocks. Its FTSE UK Equity Income Index Fund held 132 stocks. It feels wrong to exclude so many good companies from a portfolio just because they don't pay a high dividend.

The same goes for the fixed income side of your portfolio. My view is that this should also be looked at on a total return basis. Risk and reward go hand in hand so the higher the yield, the greater the risk of capital loss.

In respect of costs, I can see that there has been a bit of focus on this in the past with a number of ETF holdings via iShares. While some actively managed funds will outperform the market, the majority won't. Using trackers allows you to keep a greater percentage of the market return for yourself. A number of index funds charge as little as 0.1 per cent a year.

Also, I don't feel there is any need for individual shares within a portfolio when you can buy the whole index so cheaply. A question for you, therefore, is what's stopping you from buying a global tracker fund for a large part of your equity portfolio?

You have so many different holdings in your portfolio that it must make it difficult for you to understand what the investment strategy is and also to work out what rebalancing is needed on an ongoing basis to maintain the right mix of risk and reward.

I like to take a really simple approach to investing. Think of it as whisky and water - the more water (cash or high quality, short-dated bonds for example) that you add, the more you can dilute the whisky (equities or other more volatile assets) to get the right balance for you. This balance depends on a four key factors:

■ Risk capacity - your financial capacity to suffer losses,

■ Risk need - the return required to meet your goals,

■ Risk appetite - current preference for risk,

■ Risk tolerance - willingness to take risk.

My impression is that you probably don't need or want to take much investment risk particularly given that you are happy to eventually eat into capital. In fact, I would argue that a different 'risk' you might face is actually finding that on the day you die, you still have a very large estate! There are, of course, inheritance tax implications to this but what I'm really getting at is that you could probably spend more than you are planning to if you think it would give you a better retirement.

 

Adrian Lowcock, head of investing at AXA Wealth, says:

I agree your cash exposure is quite high. What needs action is the cash Isas. Given the cash Isa interest rates are low and will likely remain so for some time. I would recommend transferring this amount into a stocks and shares Isa where you can earn a higher, but riskier, tax free income. Likewise I would look to invest the £250,000 held in cash in your Sipp to get that working for you.

Given your active lifestyle and enjoyment of travel I would suggest having a reasonable amount in easy access cash, perhaps three years' income (so circa £180,000) but I would include a buffer for the one off expenditure and travel, so put this at circa £250,000. Initially this money can be accessed via holdings in the NS&I pool, which can be converted to cash at convenient times, you are in a position where you don't need to rush. This pool of money can be topped up from the income you receive from the portfolio which gives you a lot of flexibility.

With regards to the portfolio, the number of holdings is too many and with so many individual bond holdings, along with exchange traded funds (ETFs), shares, funds and investment trusts this portfolio will require a lot of time to properly manage.

Individual bonds can actually be risky as holding individual shares as it depends entirely on the financial strength of the company. I would consolidate all of these and look to use bond funds in their place, held within an Isa to get the most out of the income efficiency of the Isa.

The portfolio also lacks some diversification with little exposure to property and alternative assets such as infrastructure.This can increase volatility and risk. I have constructed a core portfolio from the existing money in your Isas, Sipp and general investments. It will currently produce an income of around £47,000 but with top-ups to your Sipp and Isa from the NS&I savings pot you should be able to boost the income to the required level, not to mention that the NS&I pot is also generating some income itself.

 

Adrian Lowcock’s suggested portfolio for Mr and Mrs A

Fund% of portfolioYieldIncome
Fidelity MoneyBuilder Income103.62%£5,068
M&G Strategic Corporate Bond103.24%£4,536
Schroder European Alpha Income103.19%£4,466
Artemis Income103.81%£5,344
Schroder UK Alpha Income104.04%£5,656
Schroder Asian Income54.27%£2,989
Architas Diversified Real Assets103.50%£4,900
Fidelity Global Dividend102.94%£4,116
Threadneedle UK Property Trust104.45%£6,230
JP Emerging Markets Income53.81%£2,705
Standard life Global Absolute Return101.24%£1,736
TOTAL INCOME  £47,736

Source: AXA Wealth as at 7 October 2015

 

BE MORE TAX EFFICIENT

Mr Whitcombe says:

There's the question of which wrappers you draw money from first and the simple answer would be to spend taxable money before your draw on Isas and Sipps. A bit of finessing would be needed as it’s not always quite that straightforward but keeping your wealth as tax-efficient as possible means that it will last longer.

Mr Lowcock says:

I suggest you seriously look at whether you can top up your pensions for this year. You could carry forward previous years' allowances which means you could contribute your annual income up to a maximum of £180,000. Likewise it would be a good idea to make sure you are using your full Isa allowances each year. While the Isa allowance is not tax free, any income generated from them is. This can add up as currently together you could place £30,480 into an Isa this year and then similar amounts in subsequent years. Initially this money could be transferred from the investments held outside of the Isa followed by maturing NS&I money.

• None of the above should be regarded as advice. It is general information based on a snapshot of the reader's circumstances.