- These investors want to make gifts to their family and charities, and mitigate IHT
- They should first work out what they can afford to give away without detriment to their financial security
- They should also consider reducing their number of holdings
Isa, Sipp and general investment account invested in funds, cash, residential property
Cover possible care costs, spend more on travel, fund junior Isas and cover education costs for grandchildren, mitigate IHT liability, make gifts to family and charities
Philip and his wife are age 70. They receive an income of £70,000 a year, £50,000 of which is from former workplace pensions with the rest from state pensions and rental income. They have children and four grandchildren. Their home is worth about £500,000 and they have a buy-to-let property worth about £300,000, both of which are mortgage-free.
“We live very comfortably within our incomes and normally save £20,000 a year,” says Philip. “We are in good health but have factored potential care costs into our savings. We were spending a lot on overseas holidays before the outbreak of Covid-19 and hope to resume doing that soon.
"We have gifted our children £40,000 in the past couple of years and started Junior individual savings accounts (Isas) for our grandchildren. We have also committed to funding private education for them, and will probably have to start paying for this in five to six years' time. I estimate that we will need to contribute £250,000 towards this. When we cash in our investments to cover this we hope that at least one of us survives for seven years after.
"Since we retired in 2015, the growth of our investments has surprised us and between 2005, when we started investing, and 2021 our equity investments have, on average, made returns of 10 per cent a year. However, a sizeable sum is building up so inheritance tax (IHT) is a concern. We have not yet taken any capital from our investments and reinvested all the dividends we received. These amounted to around £13,000 last year.
"But making more occasional gifts, helping to pay for our grandchildren’s education and expensive overseas trips will reduce the size of our estate. We might also make monthly gifts from income to our children and are thinking of donating to several charities. Also, equity returns for the rest of this decade might not be as good as in recent years.
"We continue to move unwrapped investments into our Isas each year, but wondered if we should continue to run our self-invested personal pension (Sipp)?
"We have been through two big market falls, which will happen again. So, at our age, should we begin to protect our wealth, for example, by investing in Capital Gearing Trust (CGT)? We could live for another 15 years or more as my parents lived into their 90s.
"We have kept about £100,000 to £120,000 in cash since we retired because we think it is a good diversifier and doing this allows us to sleep easy at night. But we don’t have exposure to bonds because we consider that our former workplace pensions and rental property are a good proxy for these.
"We invest in both equity growth and equity income funds focused on a variety of geographic regions. We enjoy being active investors and do not invest in passive tracker funds, although have never bought direct shareholdings.
"We sold several equity income funds following our Investors Chronicle Portfolio Clinic review in 2016. And more recently we have sold holdings in JOHCM UK Equity Income (GB00B8FCHK57) and Artemis Income (GB00B2PLJH12). We reinvested the proceeds of these sales in existing holdings and new positions in Rathbone Global Opportunities (GB00BH0P2M97) and Baillie Gifford American (GB0006061963).
But about a quarter of our investments are still exposed to the UK. Although several of our UK funds have done well, is this too much and, for example, should we continue to hold Finsbury Growth & Income Trust (FGT)? We also have more than one fund focused on some areas, such as US smaller companies.
"When investing, we used to be influenced by fads and press coverage of fast-growing funds. But often by the time these funds had attracted such attention we had missed the boat. So we tend to largely leave our investments alone, although review them annually.
"We also try not to be emotionally attached to investments. They can become like friends – especially those that have always delivered.
"We used to have too many holdings and cut the number in 2016. Should we do this again?"
|Philip and his wife's total portfolio|
|Holding||Value (£)||% of the portfolio|
|Scottish Mortgage Investment Trust (SMT)||106,196||7.69|
|Fidelity European Trust (FEV)||64,983||4.71|
|Schroder US Smaller Companies (GB00B7LDL923)||61,740||4.47|
|Fidelity Special Values (FSV)||59,528||4.31|
|RIT Capital Partners (RCP)||53,585||3.88|
|abrdn UK Smaller Companies Growth Trust (AUSC)||52,314||3.79|
|JPMorgan American Investment Trust (JAM)||47,200||3.42|
|JPMorgan European Discovery Trust (JEDT)||42,895||3.11|
|JPMorgan US Smaller Companies Investment Trust (JUSC)||39,189||2.84|
|Rathbone Global Opportunities (GB00BH0P2M97)||36,921||2.67|
|Stewart Investors Asia Pacific Leaders Sustainability (GB0033874768)||33,894||2.45|
|Finsbury Growth & Income Trust (FGT)||32,725||2.37|
|North American Income Trust (NAIT)||31,287||2.27|
|Scottish American Investment Company (SAIN)||30,320||2.2|
|Liontrust Special Situations (GB00BG0J2688)||30,000||2.17|
|JPM US Equity Income (GB00B3FJQ482)||29,607||2.14|
|Baillie Gifford American (GB0006061963)||26,708||1.93|
|JPM European Investment Trust - Income (JETI)||26,573||1.92|
|Mid Wynd International Investment Trust (MWY)||24,256||1.76|
|Fidelity Global Dividend (GB00B7GJPN73)||23,668||1.71|
|Schroder UK Mid Cap Fund (SCP)||23,039||1.67|
|Schroder AsiaPacific Fund (SDP)||22,332||1.62|
|TR Property Investment Trust (TRY)||22,294||1.61|
|JPMorgan Japanese Investment Trust (JFJ)||20,281||1.47|
|City of London Investment Trust (CTY)||19,578||1.42|
|IFSL Marlborough Special Situations (GB00B907GH23)||10,000||0.72|
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 avoid bonds because you think your pensions are a good substitute for them – and this is right. Think of the income from your former workplace defined-benefit pensions as being like the income from a bond because both are yields from a safe asset. And given low yields, the asset is a hugely valuable one. With such a large safe asset, your heavy equity exposure elsewhere is sensible.
As your income is more than sufficient for your needs, you are in effect investing for your children’s and grandchildren’s benefit. This too justifies lots of equity exposure, although not because your portfolio has a long-term investment horizon. There’s often no strong reason for a long-term investor to hold more equities than a short-term investor. Rather, it is because you are sharing risk with other people so are pooling it.
Because of all this, I’m not sure that you need wealth protection in the form of a fund like Capital Gearing Trust. It has delivered nice and relatively stable returns, but in recent years pretty much any portfolio of gilts, equities and overseas assets would have done so. And the performance of many balanced funds could have been achieved by any investor who held equities, gilt and gold funds.
But these conditions might not continue. If UK and US interest rates rise, bonds and equities could sell off at the same time, meaning that balanced funds will not do so well. Given that your whole portfolio is reasonably secure anyway, I’d not bother with wealth protection funds.
Your equity holdings are a little overweight in the UK and this market represents less than 10 per cent of global equities. But I’m not sure how great a problem this is. Although the UK market probably offers less long-term growth because it is dominated by larger mature stocks, US stocks in particular are on high valuations and perhaps more vulnerable than others to significant rises in bond yields. That’s a case for sticking with UK stocks: although they will fall if US ones do, their downside might be less.
I suspect there’s also a case for sticking with Finsbury Growth & Income Trust – or at least something like it – and not just because [at time of writing] it is on a nice discount to net asset value. It has a bias to defensive stocks and these tend to do well over the long run. This might be because some fund managers avoid stocks that could underperform a rising market or because investors under-rate dullness. Whichever it is, you should stick with defensives.
Also maintain your habit of reviewing your portfolio only once a year because this helps you to avoid being tempted by passing fads. Also avoid “becoming friends” with funds – your love of them is never reciprocated! The strategy of selling when prices fall below their 10-month average is useful here. It’s not perfect, but protects investment portfolios from the long deep bear markets that follow overvaluations and really destroy wealth.
Harry Finster, portfolio manager at Sanlam UK, says:
Succession planning by gifting assets to your family is an excellent way of reducing your estate’s IHT liability.
Subscribing to four Junior Isas each tax year is achievable from your annual excess income. Although these gifts would exceed your annual gift allowances of £3,000, they would become IHT exempt in seven years’ time.
Using bare trusts to set aside assets to cover your grandchildren's education costs would reduce your estate while ensuring safe transfer of wealth to underage family members. Although initially liable to IHT, the assets become exempt after seven years. Gifting your non-Isa assets now would offer five to six years of future growth to potentially increase the value to £250,000.
Sipps can be passed to your spouse or direct beneficiary free of IHT, so are worth funding or maintaining. Isas remain within your estate after you die but can be protected with an Aim IHT service that offers exemption from this tax after you have invested in it for two years. There are also other IHT mitigation schemes worth looking into.
Consider [professional] advice to help you navigate the next period of your lives. Efficient succession planning, accurate risk management and appropriate wealth preservation are difficult to achieve, but financial specialists are well-placed to assist you in achieving your goals.
Annualised capital returns of 10 per cent prove that your strategy has been working. But although your focus on capital growth has worked over the past decade, your risk exposure is an area of your strategy worth reviewing. To suitably manage risk, it is essential to establish your financial capacity for loss and your psychological ability to tolerate and willingness to take risk. We call this your risk profile.
You have no debt, annual excess income of £20,000, a large cash buffer and a portfolio from which you have not yet taken capital or income. This is a strong financial foundation from which to focus on the future wellbeing of your family. You have the capacity to continue taking your current level of risk, especially given your investment time horizon. You have been comfortable remaining invested throughout the global financial crisis of 2008-09 and the Covid crisis, so have the psychological ability to take this risk. But do you actually need to take this much risk?
De-risking your investments may reduce your concerns about limited future equity returns and assist with the wider issue of value protection. And these changes can be easy to implement.
Analysing the underlying exposure of your investments is crucial for accurate risk management. Some 88 per cent of your liquid wealth is in equities. The 21 per allocation to UK equities is an overweight because the UK market accounts for 'less than 5 per cent of MSCI World Index. Reducing your allocation to UK equities would help to mitigate the risk of continued underperformance compared to global markets. Your US and global exposure, 25 per cent and 23 per cent allocations respectively, are well-allocated.
The number of funds within your accounts is a concern. To avoid duplicating exposures, consider reducing the number of funds you hold and using some of the proceeds from their sales to introduce bonds, more property and alternative investments.
Bonds offer better capital protection and lower price volatility than equities. Property funds such as TR Property Investment Trust (TRY) offer equity-like returns with consistent income streams. Alternative assets such as macro funds, hedge funds, commodities and infrastructure are a diverse range of investments with wide-ranging return profiles that can be tailored to your preferences. These asset classes lower the correlation of your returns to equity markets.
A direct investment strategy could be a good option for you both. Although it increases stock-specific risk, a well-managed portfolio of this kind can reduce overall risk, increase investment transparency by reducing the number of duplicated holdings and improve allocation control. It also reduces the costs of investment because you are not paying fund fees. This can enable you to construct a well-diversified, cost-effective, targeted investment strategy.
I think that your £110,000 cash allocation is too high. At present, cash returns are negligible so holding about 50 per cent of your annual income – £35,000 – in accessible cash would be more appropriate.
Dennis Hall, chartered financial planner at Yellowtail Financial Planning, says:
Giving assets away is the most effective way to mitigate IHT. You also see the impact of any gifts you made while you’re still around. If the bulk of your giving is done after you die, you never get to enjoy seeing the results.
It is difficult to work out what you can give away during your lifetime without detriment to your financial security. This is something a financial planner using cash flow modelling can help you with, although you could try modelling it yourself if you’re comfortable with spreadsheets and happy making assumptions about the future.
The assets in your Sipp are outside your estate so leaving them there avoids your beneficiaries having to pay 40 per cent IHT. A problem might be the level of charges incurred because this Sipp is relatively small with a value of around £55,000. It could be more effective to draw down from the Sipp, if you can do this tax-efficiently, and gift the proceeds to your children or charities, as long as you survive for seven years.
Also be mindful of cognitive decline: as we get older, although we might feel as bright as a button our cognitive abilities decline and we rarely anticipate this in enough time to do something about it. Simplifying your investment portfolio to, for example, a few proven investment trusts with a mandate similar to your own might prevent heartache and headaches later on.
I have significantly simplified my own investment portfolio by embracing trackers. I rarely use active management, and only in areas where I believe trackers are under-represented such as private equity and infrastructure. I understand the appeal of active management, but by the time you’ve paid the charges and diversified your portfolio, are you really going to outperform the index over the long term?
An average annual return of about 10 per cent since 2005 is pretty much what MSCI World Index would have returned. By comparison, the UK index has returned less. Given your allocation to the UK of around a quarter of your investments, something has been delivering above-average returns to make up for the UK’s relative underperformance – but not enough to beat the world index. Outperformance of funds such as Scottish Mortgage Investment Trust (SMT) must have made up for underperformance elsewhere.
This is where diversification works for and against you. It dampens the highs of the best funds while protecting against the lows of the worst funds. As Carl Richards, author of The Behavior Gap, said "you’ll never make a killing, but never get killed".
That said, you clearly enjoy your active portfolio and have broadly matched the returns available from trackers so I reckon you’re committed to it. The challenge is to understand what it is you like about active funds and what your investment philosophy really is. You’ve learned not to follow fads, but what are your core beliefs?
Your investments have a bias to the UK, but what about the rest of the world? I follow market cap, which makes life easy. Having a clear investment philosophy and objectives also makes portfolio construction easier and prevents investments from being driven by other people’s agendas, such as asset managers promoting their latest fad. Also be honest with yourselves: how much of your past returns have been due to luck and how much due to skill? Luck has been in abundance over the past few decades, skill less so.
While I’m a fan of tracker funds, I admire conviction managers like Terry Smith, Nick Train and Keith Ashworth-Lord, who run a relatively small number of holdings within their funds. They don't hide behind diversification.
I think the same approach should apply to investment portfolios, so you should further reduce your number of holdings. Choose the markets and/or sectors to which you want exposure, and for each select the manager and or fund that best encapsulates your investment approach. This would avoid duplication of exposures and the diversification that dampens returns.