How to start investing with £700,000

They explain: "We are a 50-year-old couple and have £500,000 in two self-invested personal pensions (Sipps) and £200,000 in two individual savings accounts (Isas). We want to create invested portfolios, but are confused as to how we can do this when markets and funds are at all-time highs."

The first thing any investor needs to consider when putting together a portfolio is their aims and objectives. This couple wants to retire in 10 years' time on a combined income of £25,000 a year, and plans to contribute the maximum to their Sipps and Isas over that time. They own an engineering company that they are both directors of, with no mortgages or debt. They also have savings of £275,000 in easy-access cash accounts and money in their company account for luxuries such as new cars and travel.

"£25,000 a year from a portfolio of £700,000 today is an absolutely reasonable aim," says Ben Yearsley, a director at Shore Financial Planning. "That level of income represents a yield on £700,000 of less than 4 per cent, and factoring in 10 years of potential portfolio growth, this couple could have a portfolio of over £1m in 10 years easily, meaning they could take an even larger income."

Jason Hollands, managing director at Tilney Group, adds: "With £500,000 in Sipps and £200,000 in Isas, if they just invested that money alone, without contributing any more, and achieved an average compound annual growth rate of 5 per cent a year over the next 10 years, the total portfolio would be worth £1.153m (£823,000 in the Sipps and £329,000 in the Isas). If they took a 3.5 per cent yield off this, it would deliver an income of £40,351."

Even though our readers do not need to grow their portfolio by a large amount over the next 10 years to generate the income they want, they will need to grow it to keep pace with inflation to retain the purchasing power of their £25,000 annual income.

"That will probably require a fairly high exposure to equities as a very low-risk, steady income portfolio is the kind of utopia we can no longer deliver on," says Petronella West, director, private clients at Investment Quorum. "With bond yields at record lows, you will need to invest in equities to generate the right level of returns."

And even when investors start drawing on a portfolio, to keep generating an inflation-pacing income they will need it to keep growing. So although they might want to de-risk it slightly when they retire they will need to remain invested in growth assets.

"People tend to think in today's money but in 10 years' time you might actually need £30,000 to buy the equivalent of £25,000 today," explains Mr Yearsley.

What to put in your portfolio

Regardless of whether you are happy taking a high or low level of risk, a good place to start with a new portfolio is a core of UK and global equities. Even if you are worried about market highs, you will still need to allocate to a broad mix of equity markets and assets to achieve a diversified portfolio. If you invest your money with a good active fund manager, you should be able to ride out market corrections by being invested in less vulnerable stocks.

"People assume that because they are cautious they should not have any exposure to areas such as emerging markets or smaller companies," says Adrian Lowcock, investment director at Architas. "But the investment itself is not the risk - it is the level of exposure you take and how that investment interacts with everything else in your portfolio."

A reasonable number of funds for a portfolio of this size is 15 to 20. You should hold a mixture of equity funds, which tend to be higher risk, alongside other assets. However, the extent to which you allocate to equities, which are likely to generate higher returns but with higher volatility, depends on your risk tolerance.

Adrian Lowcock's suggested allocation

In a case like that of our readers Mr Yearsley would allocate the whole portfolio to equity funds because of their long time horizon. "These investors are 50, so likely to be relying on this portfolio for at least 30 years," he says. "In this situation I would put together a moderately adventurous portfolio allocated to the major equity markets, with 50 per cent in UK and 50 per cent in global funds."

But Mr Hollands suggests a lower-risk asset allocation: "Ten years is a long time horizon so this couple does not need to structure this as a high-yielding portfolio at this stage, but rather as a core, balanced portfolio focused on total return that doesn't take excessive risks," he explains.

Jason Hollands' suggested allocation

The equity portion would be 53 per cent UK, 15 per cent Europe, 15 per cent US, 7 per cent Japan, 7 per cent Asia ex Japan and 3 per cent emerging markets.

However, Darius McDermott, managing director at Chelsea Financial Services, thinks that in this situation you should mainly invest in funds that aim to preserve the value of your investments rather than grow them aggressively. He thinks the readers featured in this article should opt for an asset allocation model with the lowest risk attached.

So he suggests they invest half of their money into UK and global equity income funds, and the other half into ultra low-risk funds such as Premier Defensive Growth (GB00BTHH0518).

Funds to fill your portfolio

A good place to start is UK equity income funds, and if you reinvest their dividends by holding the accumulation share class you can generate higher returns. Mr Yearsley likes Artemis Income fund (GB00B2PLJH12), run by well-regarded manager Adrian Frost, which invests in companies with strong cash flows and good potential for dividend growth.

He also likes JOHCM UK Equity Income (GB00B8FCHK57), where managers Clive Beagles and James Lowen take a contrarian approach, looking for undervalued companies with an above-average yield and the potential for a turnaround.

He also suggests holding large-cap equity funds alongside smaller companies funds such as Marlborough UK Micro-Cap Growth (GB00B8F8YX59) and River and Mercantile UK Equity Smaller Companies (GB00B1DSZS09).

You should also allocate to managers with different investment styles as they could perform well at different times. Mr Hollands likes Evenlode Income (GB00B40SMR25), which also focuses on high-quality companies that have strong positions in markets, and has delivered strong total returns. He also suggests the more value-oriented Liontrust Special Situations (GB00B57H4F11). And he highlights Lindsell Train UK Equity Fund (GB00BJFLM156), managed by reputed manager Nick Train.

For global exposure options include M&G Global Dividend (GB00B39R2Q25), Artemis Global Income (GB00B5ZX1M70) and Fundsmith Equity (GB00B41YBW71).

Or you could invest in a combination of funds focused on specific regions. Mr Hollands suggests Threadneedle European Select (GB00B8BC5H23) and Standard Life Investments European Equity Income (GB00B7LG0W70).

These could be held alongside CF Morant Wright Nippon Yield (GB00B42MKS95) for Japan exposure, Stewart Investors Asia Pacific Leaders (GB0033874768) for non-Japan Asia and Somerset Emerging Markets Dividend Growth (GB00B4Q07115) for exposure to emerging markets.

For US exposure Mr Hollands recommends using passive funds such as Vanguard S&P 500 UCITS ETF (VUSA) and PowerShares FTSE RAFI US 1000 UCITS ETF (PRUS), which are low cost. Broad index trackers are likely to fall further in a market correction than an active fund which invests in less expensive stocks. However, PowerShares FTSE RAFI US 1000 is a value-style ETF that may be able to dodge some of the worst effects of a broad market sell-off.

How to invest

Fears of investing when markets seem high or just before a crash should not put you off investing, but rather affect the way you put your money into the market.

Dennis Hall, chief executive officer of Yellowtail Financial Planning, says that volatility does not necessarily mean capital loss. "If you have a long enough time horizon you can ride out market storms, and volatility can be good as well as bad," he explains.

A good strategy is to put a set portion of your cash into the market on a regular schedule, for example once a month, rather than investing the whole lump sum at once. By doing this you avoid the risk of putting all your money in when stocks are most expensive. This is known as pound cost averaging and means you also exploit market downturns, because your set amount buys more units or shares of your investments when they are cheaper, and fewer when they are expensive.

"The most straightforward way to get into the market from scratch is to choose an asset allocation and a basket of funds with which to express it, and then drip in your money over a set period of time," says Mr Yearsley. "You could, for example, invest £50,000 on the first of every month, split between 20 funds. But whatever you do, invest, because if you start trying to work out the best time to enter the market you just never will."

Your timeframe doesn't matter - the important thing is to stick to it. Mr Lowcock suggests investing a portfolio of £700,000, such as our readers have, in 10 segments of £70,000 once a month, according to the asset allocation they have chosen.

You could invest over a longer timeframe, for example, dividing your pot into 12 or 18 segments and investing one per month, so you have it invested within a year-and-a-half.

Sustainable income in retirement

A way to protect your investments is to not draw much income from them when markets have fallen, but instead take it from a cash reserve. So Mr Hall recommends holding between two and three years' income in cash or short-dated bonds to draw on at such moments.

You should draw income from your investments in the most tax-effective way by maximising Isas and Sipps. These have different tax benefits, which should affect where you take your income from when you retire.

A Sipp can be passed on to beneficiaries free of inheritance tax (IHT) if you die before 75, and is taxed at the beneficiary's income tax rate if you die after this age. But an Isa will incur IHT, so if you have beneficiaries to pass money to it makes sense to draw on your Isa and all your other funds, before taking income from your Sipp.

Income drawn from Isas is also free of income tax, whereas income taken from a pension, other than your 25 per cent tax-free lump sum, is taxed at your marginal income tax rate. This is another reason to take income from your Isa before your pension in retirement, and make use of any pots of spare cash (over and above your reserve) before running down your investments.