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Building up a sum to pay off the mortgage

Our reader needs to diversify his portfolio if he wants to generate enough money to pay off his mortgage

Tom is 57 years old and married with three children who have left home. He retired from the police force six years ago so has an occupational pension, although still works part time. He has an interest-only mortgage of £86,000 with 10 years left to pay off.

Reader Portfolio
Tom Ross 57
Description

Shares and funds

Objectives

Pay mortgage off early

"I have always been interested in shares, funds and other investments, but have never put serious amounts of money into them," says Tom. "However, three years ago the interest rate on my mortgage dropped to 1.99 per cent and I was reading about shares paying 4 to 5 per cent dividends, so I wondered if I could raise the £86,000 to pay off the mortgage early and now this is my aim.

 

 

"Including dividend reinvesting I have £300 a month to invest. I buy mainly using a regular monthly investment scheme that costs £1.50 per trade. My strategy is to invest 80 per cent in blue-chip high-dividend-paying shares, and 20 per cent in small-caps. I've had some success and profit in the past couple of years buying Anite (AIE) and Hyder Consulting (HYC), and BG (BG.) when it was down. But I seem to be sitting on quite a loss at the moment with Centrica (CNA), GlaxoSmithKline (GSK), HSBC (HSBA) and Royal Dutch Shell (RDSB).

"I have the time to monitor prices daily and am an avid reader of investment information. I do read tips but don't rely on just one, and if I read something interesting I will research further information about the company. I am also happy to buy funds and investment trusts for wider global or sector exposure.

"I am having fun investing and enjoying the experience, as well as hopefully learning along the way. But I would like to know how you think I am doing, and if I should just abandon my plan and pay off the mortgage monthly.

 

Tom's portfolio

 

HoldingValue (£)% of portfolio
BAE Systems (BA.)962.43.2
Bovis Homes (BVS)1572.55.2
BP (BP.)2123.87.1
Centrica (CAN)1893.06.3
GlaxoSmithKline (GSK)3198.410.6
HSBC (HSBA)2103.27
Imperial Tobacco (IMT)888.33
ITV (ITV)580.81.9
Lancashire Holdings (LRE)1833.76.1
MFM Slater Growth (GB00B0706C66)1717.75.7
MFM Slater Growth (GB00B7T0G907)1652.25.5
Phoenix Group (PHNX)1610.15.4
Rio Tinto (RIO)1331.74.4
Royal Dutch Shell (RDSB)1829.86.1
Telford Homes (TEF)2730.59.1
Tullow Oil (TLW)546.51.8
Vodafone (VOD)1296.34.3
Cash2180.87.3
Total30051.7 

 

Source: Investors Chronicle

 

THE BIG PICTURE

Chris Dillow, the Investors Chronicle's economist, says:

I reckon there's around a 50-50 chance that you'll be able to pay off your mortgage with this portfolio in 10 years' time. If share prices rise by 4 per cent a year and you continue to invest £300 a month, the portfolio should grow to around £86,000 by that point.

However, this is by no means guaranteed. One danger is simply that normal stock market volatility will cause you to fall short: even over a period as long as 10 years there's no reason to suppose there'll be as many good times as bad for the market. Another danger is that we might remain stuck in a world of secular stagnation in which markets are disappointed by the sluggish pace of economic growth: Japan's experience since 1990 is a good reminder that there's no guarantee shares will rise over the long run.

The reasonable chance of falling short is an argument for diversification - perhaps you could combine paying off a little of the mortgage each year with continued investing. That said, there might be a few tricks you could use to tweak the chances of success in your favour.

 

Danny Cox, chartered financial planner at Hargreaves Lansdown, says:

You are enjoying your investments, which is really important as we are more likely to spend time and effort on the things we take pleasure in. There is nothing more likely to dent a portfolio than neglect.

Based on the current values, and assuming you continue to save £300 a month, you need to achieve a 5 per cent return over the next nine or so years to achieve your goal of paying off your mortgage. The average yield on the FTSE All-Share is around 3.5 per cent, so a 5 per cent overall return after charges should be achievable - especially as we are at a relatively low base today. But importantly, this is not guaranteed. So the question is what happens if the portfolio falls short? You need a plan B and, based on the current mortgage market, you may not get the option to extend if you fall short.

Tax could also be an issue. Unless you hold your investments in an individual savings account (Isa), your profits will take you over the capital gains tax (CGT) allowance and incur tax at either 18 per cent or 28 per cent, reducing your net returns.

 

Peter Day, partner at Killik & Co, says:

While equities will undoubtedly experience a great deal more volatility than other asset classes, over long periods they have consistently delivered higher real returns than all other asset classes. Should you remain invested for the long term, you can expect to achieve returns of around 5 per cent a year above inflation.

Therefore investing into a well-diversified portfolio of equities would be a good strategy for achieving your long-term financial goal of paying off your mortgage early. The interest rate on your mortgage is currently at a very attractive level and you could certainly hope to achieve average returns greater than 1.99 per cent a year. But with a floating rate mortgage, should we enter a period of high and increasing interest rates, albeit some years down the line, the risk-return argument for investing in equities over paying off your mortgage may need to be reassessed. However, we expect the base rate to remain low for some time to come, with inflation at 0 per cent and a very slow recovery under way.

 

HOW TO IMPROVE YOUR PORTFOLIO

Chris Dillow says:

You could use momentum. Your biggest loss is on Centrica, which is a classic negative momentum stock. Because people are slow to revise down their opinion of shares or realise losses, they often hang on to stocks that have suffered bad news. This causes the share to be overpriced, with the result that it subsequently falls further. You can mitigate this problem by cutting losing stocks, and having some kind of stop-loss limits.

You can also use positive momentum. When you are considering stocks to buy, look at their longer-term (say 200-day or 10-month) moving averages. There's evidence that buying when prices are above this average and selling when they are below it can improve risk-adjusted returns.

A second thing you can do is have a bias towards low-volatility shares: you can use Investors Chronicle's stock screen to look for lower-beta stocks. There's good evidence from around the world that defensive stocks do better than they should on average over the long run.

Thirdly, you might try to invest seasonally - to some extent. If you're going to hold more speculative stocks, try to do this more in the winter than the summer, as that is when they tend to do better. You could also exploit the seasonal pattern in returns by holding a FTSE All-Share tracker exchange-traded fund (ETF) during the winter, but selling every May Day.

There are, of course, big caveats to this. No strategy is 100 per cent certain: defensives and momentum stocks fail sometimes, as your losses on GlaxoSmithKline show. It's just that if you look for these you are at least fishing in richer waters. Also, try not to trade too much: your trading costs seem rather low, but even so they can add up over time.

I'd also caution you against monitoring your portfolio every day. Most day-to-day price moves are mere noise that tells us nothing about the future. There's a danger that in looking at them you'll trade on irrelevant news or - perhaps worse still - infer that the market is too risky and throw in the towel at the wrong time.

 

Danny Cox says:

Your portfolio is pretty concentrated with a heavy weighting to oil, mining and energy stocks, which have all suffered as a result of the collapse in commodity prices. The prospects for the sector look pretty dire in the short term given the slowdown in global growth and it seems unlikely that dividend policies will be sustainable.

On a longer-term view, miners and energy companies could look cheap, and your regular savings strategy means you are buying low and should make better profits. But you'll need to hold your nerve and be patient.

The MFM Slater Growth Fund (GB00B7T0G907) is more diverse and has been volatile, but has done a decent job so your entry point was good. The yield is low at around 0.69 per cent, so for your objectives I favour income stocks, as the dividend yield reduces the risk and takes you part way to your goal, even if the market remains flat. You can get exposure to these via Marlborough Multi Cap Income Fund (GB00B908BY75), which has a more consistent track record, is cheaper than MFM Slater Growth and has a yield of over 4 per cent which can be reinvested to augment growth.

Further investment into equity income would seem a good way forward to provide diversification and that all-important yield.

 

Peter Day says:

It is very important to maintain a diversified portfolio, and you are doing this reasonably well. You have exposure to a number of different market sectors and your weightings are sensible. I would, however, consider slightly reducing your exposure to oil and gas. You are currently overweight, with around 16.5 per cent of your portfolio invested in the sector. I suggest a 10 per cent weighting would be more appropriate.

I would also add some technology stocks as you currently do not have any. A stock such as Alphabet, more commonly known as Google (GOOGL:NSQ), the world's leading search engine, would fit nicely in your portfolio. The company's recent results have been very strong, with revenues and profits increasing at a rate of around 17 per cent. The US dollar exposure would also add an element of diversification.

You could use funds more, which would help 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 would encourage you to invest in Scottish Mortgage Investment Trust (SMT), which has been one of the standout performers in the Association of Investment Companies Global sector over the past decade. The trust offers access at a comparatively low cost (it has an ongoing charge of 0.48 per cent) to an attractive basket of companies spanning a wide array of business areas, with significant structural growth potential following disruptive technological developments.