How should I invest a £100,000 inheritance?

David is 36 and self employed, but doesn’t earn much regular income. He lost a part-time job during the pandemic so is studying for a financial qualification and hopes to find a new job. His home is worth about £550,000 and has a mortgage of £321,000 for which he makes monthly repayments of £1,004. He also has a buy-to-let property worth about £450,000 with an interest only mortgage of £216,000, for which he makes monthly repayments of £250. As well as this, he has a lodger in his main home so most of his income comes from his properties.

“I hope that my income will rise to at least £40,000 a year, says David. “But I have recently inherited a sum of £100,000 so in the meantime I will use that to support myself financially and invest for the long term.

“I plan to keep £20,000 of it in cash in case I start a family in the next few years. I will invest the remaining £80,000 in my self-invested personal pension (Sipp) and individual savings account (Isa) over the next four to five years, gradually drip feeding money in to reduce the risk of large market corrections or crashes during this period. The value of the holdings should rise over time, particularly the growth-oriented funds.

“My Sipp is fully invested and my Isa is about 60 per cent invested. I reassessed my portfolios at the beginning of the year and have recently drawn up a new asset allocation plan for the Isa. I aim for it to have a balance between value and cyclical, and growth funds. It will be geographically diversified and have a medium risk profile. And I would like it to have exposure to commodities and include wealth preservation funds. I’m concerned about valuations, especially of growth stocks which have grown rapidly over the past decade – especially last year. I believe that these companies have long-term potential but also that a lot of future growth is priced into them.

"I prefer not to hold a lot of cash because of the potential for inflation but don’t want to take excessive risks with the money I'm going to eventually add to my Isa. So, until I can transfer it into the Isa, I will invest it conservatively within a general investment account. I may put some of it into wealth preservation funds. I will also put some into potential income sources like Gresham House Energy Storage Fund (GRID) and HICL Infrastructure (HICL), and private equity or property funds such as Civitas Social Housing (CSH) and Residential Secure Income (RESI). 

"I’d like my Sipp to have exposure to venture capital because the trend of companies staying private for longer is likely to persist. My preferred way of getting exposure to this would be Schiehallion Fund (MNTN) because its manager, Baillie Gifford, has a great track record in this area. I would also consider Draper Esprit (GROW), IP Group (IPO) and Chrysalis Investments (CHRY).

"However, I'm concerned that if I have so many holdings my portfolios will be over diversified.

"I also have a small pension from my previous employer as I realised in my early 20s that I need to save regularly and invest in a pension. But I currently only save 10 per cent of my income a month into pensions because the income from my rental properties doesn’t count as earned income, meaning that the most I can put in each year is £3,600.

"When my work situation is a bit more stable I would like to have a repayment rather than interest only mortgage on my buy-to-let property."

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

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

You are right to drip feed cash into equities. Doing this means that you invest more when prices are low because a sum of say, £10,000, will buy more of an investment when its price is lower than when it is higher. It is a partial solution to the problem of market risk.

At least two data indicate the risk of a market fall: the FTSE All-Share index's dividend yield is low and MSCI World index's ratio to the global money stock is high. Both have been lead indicators of falling prices in the past.

I would caution you against taking big bets on the commodities cycle. One useful lead indicator for this is the growth in the M1 measure of money stock in China. Fluctuations in this have been good predictors of that country's economic growth, and demand for and prices of commodities. Just now, M1 growth is weak which suggests weak commodity prices.

So market risk is significant and you cannot diversify it away by holding equities alone.

You are over diversified. You only need one fund to diversify across equities in developed economies – an exchange traded fund which tracks MSCI World index. If you add an emerging markets and frontier fund you are fully diversified. I fear that you are doing no better than this but still incurring excessive costs by holding so many active funds. Fees compound horribly over time: for example, an extra half percentage point of charges over 10 years could easily cost you over £700 for every £10,000 invested.

So I suggest that you simplify your portfolios and replace expensive funds with cheaper ones.

I’d also caution against wealth preservation funds. In terms of risk-adjusted returns, these do little that you cannot do yourself cheaply by holding a mixture of equities, cash, gold, bonds and foreign currency. But be careful: past returns of balanced portfolios might not be a guide to what they deliver in future. Many have made good risk-adjusted returns, partly because bonds have done well for years, and partly because bonds and gold have often risen when equities have fallen, allowing investors to spread risk easily. It’s possible, though, that both these trends will go into reverse. If interest rates rise, equity and bond prices could fall at the same time.

One useful protection against this is cash, which might be less vulnerable to inflation than other assets. Potential losses on cash are limited to the real interest rate, but potential losses on bonds or equities are greater.

It is reasonable to consider private equity funds because these might offer better exposure to future long-term corporate growth than listed equities, many of which have gone ex-growth. But beware of their risks. Like property funds, private equity funds can be illiquid, so don’t buy them if you think you might need to raise cash quickly. They also incur fund manager risk because just one or two stellar holdings can make a big difference to their returns. For this reason, it makes more sense to diversify across private equity funds than it does across listed equity funds.

Gordon Hay, client director at Handelsbanken Wealth & Asset Management, says:

You are already taking a number of very productive steps by saving into your Isa and building your pension at an early stage in life.

The Office for National Statistics places average life expectancy for someone of your age today at 88 years, with a one-in-10 chance of surviving to age 99 or 100. Depending on when you plan to retire, this could mean that your retirement funds need to last between 30 and 40 years. So it is very important to create a long-term financial plan which includes your retirement and post-retirement goals, and ensures that you are saving in a tax-efficient manner.

An evaluation of your financial situation to help make this plan should include a cash-flow analysis to ascertain how much you need to accrue over time to meet your long-term financial goals. It is not unusual for this process to find that to achieve your objectives, you need to take a higher or lower level of risk than you thought was right. Your financial plan should be reviewed regularly as your circumstances and priorities are likely to evolve.

Given your interest in financial markets and sustainable investing, it could also be worth reviewing your investment strategy. Your investment portfolio could help to meet your long-term objectives as well as incorporating sustainable investment credentials.

When investing, it is very important to understand the level of risk you are taking in exchange for potential reward, as well as the mix of assets needed to achieve this. This means not only considering what types of assets you hold, but also how they are diversified across geographies and industry sectors.

You are self-employed but hope that your income will increase to at least £40,000 per year when you get a new job. At present, most of your income comes from rental properties and you would like to move to making capital and interest repayments on your buy-to-let mortgage. This would increase your monthly repayments and a wealth manager could advise you on the impact of such an increase in your outgoings. The Financial Conduct Authority deems this an area for regulated mortgage advice so ensure that you speak to a qualified, regulated mortgage adviser when the time comes.

You cannot contribute more than £3,600 a year to a pension, including tax relief, as you are not paying income tax. But when your employment position changes you may have scope to increase the annual amount you contribute to pensions, which is typically a worthwhile move.

Your plan to invest most of the £100,000 you have inherited in your Sipp and Isa makes sense, and should use your tax allowances efficiently. We also recommend maintaining an easily accessible cash reserve to cover unforeseen expenses, normally worth around six months’ worth of your expenditure. Given the current annual allowances for Sipps and Isas, your money should be fully invested in these in around four years. Phasing your entry into financial markets should also help to reduce market timing risk, as you will avoid investing all your funds at a market peak.