Will my number of holdings detract from performance?

Craig is age 38, has worked part time for four years and earns £29,000 a year. Until recently, his wife had been earning about £75,000 a year but is now setting up her own business.

Their home is worth about £600,000 and has a mortgage of £460,000. They also have a buy-to-let property worth about £70,000 with a mortgage of £40,000 which provides income of £495 per month. They recently sold another buy-to-let property of similar value and are holding the proceeds in cash.

"Our retirement income should mostly be met by our workplace pensions,” says Craig. “I contribute to a defined benefit (DB) pension which should should pay £5,295 a year from age 65 and a further £4,060 from age 68. My wife has various former workplace pensions, including a DB pension which should pay her £4,500 a year from age 60. We should have paid off our mortgage by the time we retire, and have £80,000 in cash savings which we will use to fund home improvements, further study and holidays.

“We would like to use the assets in our individual savings accounts (Isas) and self-invested personal pension (Sipp) to fund luxuries such as travelling when we retire. And if my Isa investments outperform I may phase into semi-retirement at an earlier age, rather than wait until retirement age when I would receive a higher income.

“I would like our investments to make an average annual total return of 5 per cent. I am prepared to take a riskier approach with the investments in our Isas and Sipp. I could tolerate a fall in the value of my Isa and Sipp of up to 20 per cent in any given year as riskier assets tend to outperform safer ones over longer time horizons, and I don’t expect to retire for at least 20 years.

"I have aimed to diversify our portfolios geographically and by sector, and to have a balance between growth and value funds with exposure to areas that I think will outperform. I have been thinking of adding bond exposure to reduce the risk profile of the portfolios and a real estate investment trust (Reit).

"I also wondered if holding 5 to 10 per cent of my investments in gold would be a good hedge? And, if so, is my holding in BlackRock Gold and General (GB00B99BDY18) a good way to do this or would a physical gold exchange traded commodity (ETC) be better?

"I initially invested in active funds in the hope that they would outperform the broader market and some of them, such as Marlborough UK Micro-Cap Growth (GB00B8F8YX59), have performed very well. But I have recently added more passive tracker funds to cut expenditure on fees. 

"I have sold very few funds, as I prefer to buy and hold investments. But I am now concerned that I have too many holdings and this will this result in our portfolios delivering a similar performance to a tracker fund but with higher fees.

"We plan to add at least £1,200 a year to my five year old son's Junior Isa until he turns 18. We hope that this will enable him to get through university without having to work during term time."

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

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

You may be over diversified. As you add assets to your portfolio you dilute the contribution that any one of them makes to its overall return, which is why diversification reduces risk. But at the same time you increase the importance of correlations between assets. This means that an equity fund is unlikely to deviate very much from its benchmark, even if its manager isn't trying to track that benchmark. This is because correlations of relative returns are often very low: for each stock that beats the benchmark, another is likely to under perform it.

If you hold funds of funds, you add another layer of diversification meaning that your only chance of beating the market is if those funds are correlated with each other. With your Sipp, this is the case. Many of your holdings are cyclical: emerging markets and small caps tend to do well when the world economy does well, and badly when it doesn’t. So you are not quite holding a closet tracker fund.

But you are incurring unnecessary fees which compound horribly over time. Over 20 years, an extra percentage point in charges can easily cost you over £4,000 for every £10,000 you invest.

You can avoid this by replacing more expensive active funds with cheaper ones or passive tracker funds. Only hold active funds only if they do something unique (within your portfolio) such as providing exposure to particular segments of the market or offer a strong chance of out performance. 

There is a very strong relationship between the gold price and bond yields. When bond yields rise the gold price falls, and when yields fall gold rises. This indicates that gold is not a hedge against inflation. Inflation would cause bond yields to rise and gold to fall. Gold has risen enormously since the 1990s as inflation has been low and stable, suggesting that it isn’t really an inflation play.

But gold is a hedge against many of the things that are bad for shares. If investors become more nervous or fear an economic downturn, they may dump shares and buy bonds which would result in the yields of the latter falling. In such an environment, gold would do well so it mitigates the effect of falling share prices on portfolios.

But this insurance comes at a price: if bond yields rise, gold will do badly. So if you are a long-term investor and willing to sit through short-term dips in equities you probably don’t want to pay this price.

If you opt for gold exposure, BlackRock Gold and General Fund is not the answer. It invests in the shares of gold mining companies which are sensitive to investor sentiment so isn't protection against increased risk aversion. If you want such protection, you need a physical gold ETC.

Adrian Lowcock, independent investment analyst, says:

It makes sense to have substantial cash savings, given the recent changes in your household income, the need to fund home renovations and your wife's career change. Also ensure that you are living within your means and have enough income to support day-to-day expenses, as well as non essential costs like holidays. It would be prudent to draw up a budget to see what your cash flow is likely to be. This would give an early indication of any potential shortfalls and time necessary to adjust accordingly.

The ability to tolerate a fall in the value of your investments of up to 20 per cent in any given year doesn’t suggest an appetite for taking a lot of risk, but rather a more moderate risk tolerance. Equity markets can fall 20 per cent, and if you only invest in equities you should be prepared for falls of up to 30 or 40 per cent.

Your investments are almost entirely invested in equities so could fall more than 20 per cent from their peak. If you want to reduce this risk, introduce other assets such as bonds, absolute return funds, and property or real assets.

Many investors mistakenly over diversify, resulting in them paying relatively higher fees for active funds but getting tracker fund-like performance. Holding too many funds and shares means that good investment decisions don’t have much impact on your overall wealth. Conversely, bad decisions don’t cost as much.

Your portfolios have too many investments for their sizes. Your £6,084 Sipp, for example, holds seven UK equity funds and two China funds.

Your portfolios are also not yet large enough to be invested in direct share holdings. If the cost of a share trade is, for example, £7.50 plus taxes, the cost of £200 investment is 3.5 per cent plus another £7.50 on the way out. I suggest only investing in direct share holdings when a portfolio is large enough to support an investment of at least £2,000 in each company. Small holdings really need to work hard to make a meaningful contribution.

I suggest selling the direct share holdings, as they also require a lot of research and monitoring, and their transaction costs will have a big impact on your portfolio's ultimate returns.

Because you hold so many funds the best performing ones only make a small contribution to your portfolio's overall performance. Your portfolio needs a structure and would benefit from a more concentrated approach which you can build on in time.

Each portfolio could be focused on a global equity fund as the core holding, complemented by more specific funds to boost returns and provide further diversification.

An allocation of around 5 per cent to gold is a good amount to hold as an insurance policy which could protect your portfolio during volatility. Gold funds tend to invest in mining companies so their performance, at least in the short term, can be equity like. They can also sometimes benefit more from a rising gold price than an ETC which follows the gold price more closely.

But due to the size of your portfolios, for now I would take for a broader approach to protecting capital.

The following allocation is an example of how a diversified portfolio about the size of your Sipp could be allocated. Trojan Fund (GB00BZ6CNS31) has exposure to gold, property and bonds so could help to preserve capital and diversify. These holdings could be topped up, and new funds added to provide specific exposure to the US, Europe, Japan and emerging markets. Setting up a regular monthly savings plan would allow you to do this with minimal oversight.

Adrian Lowcock's example of a diversified small Sipp portfolio