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Sipp versus Isa: asset allocation

How to run the two alongside one another
Sipp versus Isa: asset allocation
  • Running a Sipp alongside an Isa can complicate your asset allocation decisions
  • Some simple rules may point to the best approach

As we discuss in this year’s Isa supplement, selecting the right mixture of equities, bonds and other assets can be a complex affair driven by your circumstances, financial objectives and attitude to specific risks.

Running a self-invested personal pension (Sipp) alongside your Isa, as many do, only appears to complicate the issue. Yet many of the same rules of thumb, combined with an understanding of the relative advantages each tax wrapper can offer, should prove useful.

 

The growth phase - keeping it simple

Generally, having an investment horizon of 15 years or greater should allow you to focus purely on growth, allowing for an allocation of 100 per cent to equities and similar risk assets. As we note in the Isa supplement, more volatile holdings such as investment trusts and stock picks can work well - provided you have the time and enthusiasm to monitor the latter.

Sipps are well suited to such an approach, given investors cannot dip into the pot until the age of 55. While an all-out growth strategy is equally appropriate in an Isa, its easy accessibility can be a gift and a curse. Investors may be tempted to dip into an Isa at times of need, or deliberately use it as a growth pot they can withdraw funds from if absolutely necessary. If this is the case, a 60/40 portfolio of equities and diversifiers such as bonds may seem more practical - though this will likely drag on growth in the long run.

When it comes to flexibility, having a good amount of cash - within an Isa or elsewhere - can prevent the need to water down the level of investment risk in a portfolio. Being able to cover at least six months and potentially a few years of outgoings later on can allow you to tolerate more risk in a portfolio. This can be especially important in retirement, when being forced to realise a loss at times of market stress to meet a financial need can be disastrous.

 

Approaching retirement: Isa first?

While growth investing is relatively simple, asset allocation gets much trickier as you approach the point of relying on your investments - either by holding income-producing assets in the portfolio or actively withdrawing money from it. Here, the relative merits of Isas and Sipps can guide how each is managed.

Both wrappers allow you to receive income payments tax-free but Isas, unlike pensions, form part of your estate for inheritance tax purposes. Withdrawing money from an Isa will also not count as taxable income. It can therefore make sense to run down your Isa assets before touching a pension – or at least use your Isa as a flexible source of funds while avoiding taking money out of a Sipp. Very broadly your Isa may therefore carry less risk than your pension, with the latter growing more defensive as you get closer to relying on it.

Generating income from either will likely lead you to a good weighting to equities, with some allocation to the likes of bonds or other assets such as property that can both provide income and diversification.

In terms of asset allocation, anyone looking to rely on Isa withdrawals - either as a regular source of income or on an ad hoc basis – will be similar to an income investor in needing a “balanced” portfolio. The exact parameters of this will differ based on when you need the money. If you need to withdraw money in five years or less you may hold some 40 per cent of the portfolio in equities with the balance in bonds or other diversifiers.

 

Taking risk off the table

When it comes to Sipps, your method of generating an income in retirement can have a big effect on asset allocation.

As Willis Owen's head of personal investing Adrian Lowcock notes, savers who choose to use income drawdown as a source of funds still need to manage their money, requiring a balance between achieving some growth and taking more defensive allocations. “You may find that you remain invested in retirement rather than taking an annuity, and this where the risk needs to be carefully managed and controlled as losing money in retirement can have a permanent impact on your standard of living,” he explains.

Again, an allocation of around 40 per cent in equities and the balance in more defensive assets may appeal, with some of the better known "wealth preservation" funds following this rough approach. Personal Assets Trust (PNL) and Ruffer Investment Company (RICA) have limited equity allocations (42 per cent of assets in PAT and 39.6 per cent in Ruffer at the end of January) with other exposure to the likes of bonds and gold to protect against the risk of stockmarket volatility.

These funds will not achieve huge returns but they should deliver some growth while protecting your savings at times of stress. They have lagged global equity returns but stayed ahead of the consumer price index (CPI) measure of inflation in the past decade.

 

Strategic bond funds such as Allianz Strategic Bond (GB00B06T9362) and Jupiter Strategic Bond (GB00BKSFXX05) can also serve as diversifiers. The first fund specifically targets a correlation of zero to global equities and has fared extremely well in both the sell-off of late 2018 and last year’s ups and downs. The Jupiter fund has proved less defensive at moments of market stress but does still have some merit on this front, while also providing an attractive yield.

Investors who have specific views on the merits of different diversifiers may wish to take matters into their own hands with a low allocation to equity funds, and some defensive holdings such as gold and government bond exchange traded funds. 

Rob Morgan, pensions and investments analyst at Charles Stanley, warns that managing a pension in drawdown can be the “trickiest” approach. “The need to keep volatility quite low but still take enough risk to grow over time is a difficult balancing act,” he notes.

By contrast, preparing to buy an annuity can be relatively straightforward. Here, similar rules to those governing the balanced portfolio apply, with an investor gradually moving to a very defensive allocation largely composed of government bonds and other diversifiers.

“You would generally gradually de-risk in the years before retirement age to avoid the consequences of a market shock,” notes Morgan. “Generally you would migrate to lower risk bonds, which broadly correlate to the cost of buying an annuity. With drawdown you would likely maintain your asset allocation but ensure you are really diversified as your time horizon is basically the rest of your life – an unknown.”