- They could do this by holding higher-yielding investments
- Or they could hold growth focused ones and sell chunks of them
Sipp and Isas invested in funds and shares, cash, residential property.
Tax efficient income of £27,000 a year from investments, average annual total return of 6% plus, fund possible future care costs, leave assets to children, rationalise investments so that they require little maintenance.
John is age 68 and his wife is 65. He earns about £20,000 a year from a consultancy role but this could stop in the near future. He also receives State Pension of about £9,000 a year and his wife will start to receive it this year.
They have four adult children who are financially independent.
Their home is worth about £475,000 and mortgage free.
“We would like an income of £27,000 a year from our investments and some growth,” says John. “I would like an average annual total return of at least 6 per cent a year via fairly reliable income and growth. We would like our children to inherit the majority of our wealth, although this will be unlikely if we need to go into residential care in later life.
"My self-invested personal pension (Sipp) is worth about £377,700 and in drawdown. I have already taken my 25 per cent tax-free lump sum. All our other investments are in individual savings accounts (Isas). Is there any particular benefit to taking income from the Sipp or Isa?
"We also have NS&I Premium Bonds as an emergency cash fund and from which to draw on in lean years for our investments.
"I have been investing about 30 years and experienced dips in my investments’ value of up to 20 per cent, but markets have always come back. And I believe that in the long term equities outperform bonds, so I have tilted our portfolio to the former. For example, I recently sold half of our holding in Allianz Strategic Bond (GB00B06T9362) and used the proceeds to top up Impax Environmental Markets (IEM), and sold iShares Corporate Bond Index (GB00BKF2KH76) and used the proceeds to top up Legal & General Global Technology Index (GB00BJLP1W53).
"I have also recently invested in Fidelity China Special Situations (FCSS), although since then its share price has fallen significantly.
"Now that I've hit retirement, I'd like to simplify and improve our portfolio so that it requires little maintenance other than an annual review. We have around 30 holdings, but I think that we have too many funds and should reduce the number to six to 10. However, with financial publications such as Investors Chronicle highlighting 20 or more funds and shares every week, it’s easy to fall into this trap but not as easy to know which 10 funds I should whittle our holdings down to.
"That said, if our holdings are better performing funds in their given areas, surely having the current number is better than tracking indices via passive funds?"
|John and his wife's total portfolio|
|Holding||Value (£)||% of the portfolio|
|Fundsmith Equity (GB00B41YBW71)||71,963||8.90|
|Monks Investment Trust (MNKS)||50,773||6.28|
|Legal & General Global Technology Index (GB00BJLP1W53)||49,922||6.17|
|Montanaro European Smaller Companies Trust (MTE)||45,766||5.66|
|NS&I Premium Bonds||40,000||4.95|
|Royal London Sterling Extra Yield Bond (IE00BJBQC361)||34,886||4.31|
|Baillie Gifford Global Discovery (GB0006059330)||34,304||4.24|
|Invesco Monthly Income Plus (GB00BJ04JZ25)||33,579||4.15|
|Impax Environmental Markets (IEM)||32,944||4.07|
|RIT Capital Partners (RCP)||32,946||4.07|
|BlackRock World Mining Trust (BRWM)||31,197||3.86|
|BMO Private Equity Trust (BPET)||28,993||3.59|
|Baillie Gifford Global Stewardship (GB00BYNK7G95)||26,312||3.25|
|Tritax Big Box REIT (BBOX)||22,836||2.82|
|Troy Trojan (GB00BZ6CNS31)||22,394||2.77|
|Invesco EQQQ NASDAQ-100 UCITS ETF (EQQQ)||21,382||2.64|
|Legal & General Global Health and Pharmaceuticals Index (GB00BJ2JPG83)||18,489||2.29|
|Templeton Emerging Markets Investment Trust (TEM)||17,982||2.22|
|Rathbone Global Opportunities (GB00BH0P2M97)||17,794||2.20|
|Allianz Strategic Bond (GB00B06T9362)||17,662||2.18|
|Fidelity Asia Pacific Opportunities (GB00BQ1SWL90)||16,565||2.05|
|Warehouse REIT (WHR)||16,381||2.03|
|Bluefield Solar Income Fund (BSIF)||16,028||1.98|
|Baillie Gifford Japanese Smaller Companies (GB0006014921)||15,145||1.87|
|Lindsell Train Global Equity (IE00BJSPMJ28)||13,694||1.69|
|First Sentier Global Listed Infrastructure (GB00B24HJL45)||13,369||1.65|
|Watkin Jones (WJG)||10,314||1.28|
|Duke Royalty (DUKE)||10,002||1.24|
|Fidelity China Special Situations (FCSS)||9,867||1.22|
|Regional REIT (RGL)||8,394||1.04|
|Barratt Developments (BDEV)||4,991||0.62|
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 should be able to meet your target income of £27,000 a year. This would entail taking 3.4 per cent from your portfolio each year. With average luck, though, real returns should be slightly more than this so your portfolio could grow very slightly over time, leaving a decent amount for social care, if needed, or bequests.
One issue here is your lack of cash other than NS&I Premium Bonds which poses the question, why hold bond funds instead of cash? Bond funds would do better than cash if investors were to become more nervous or worried about the world economy. In such circumstances, bond funds would be nice insurance against falling share prices. But they would underperform cash if inflation proves worse than expected, investors’ appetite for risk increases or the world economy exceeds expectations. Net, there might be a case for such funds as protection against some of your cyclical holdings such as housebuilders, miners and emerging markets. But they can lose money – and at the same time as shares do badly if, contrary to my expectations, inflation proves more problematic than markets currently think. Personally, I’d rather hold my assets in cash than bonds.
You are right to want to reduce your number of fund holdings. When you add a share to a portfolio you reduce the portfolio’s dependence on just one stock’s performance. But as you reduce this risk you add systemic risk – the portfolio’s dependence on the market’s returns. When you combine funds, you accelerate this movement away from stock risk and towards systemic risk. A portfolio of many funds, therefore, carries lots of market risk. This means that its performance will be similar to that of a tracker fund except that you pay higher management fees for it. You mitigate this effect by holding some sector funds but even these would fall together in bad times.
It’s easy to fall into the trap of owning lots of funds simply because there are so many of them. To resist this, change your perspective. If you look from the bottom-up, it looks like there are hundreds of good funds, and over a year or two hundreds will beat the market. But because the winners in one period might well be losers in the next, fewer will have great long-term performance. Hendrik Bessembinder, professor of competitive business at Arizona State University, has shown that just 1 per cent of shares account for all the global equity market’s gains since 1990. Beating the market in the long-run has thus required a fund manager to identify just a handful of superstars. That’s a tough job. Of course, we don’t know whether the future will be the same as the past, but this warns us that long-term outperformance is difficult.
Instead, think from the top-down. If you had a global tracker fund which is, in effect, a fund of all equity funds, what would you want to add? Private equity funds offer exposure to unlisted companies and there might be a case for emerging markets, though not, perhaps, at a time when US interest rates are rising. And you could consider one or two sectoral plays. But as a long-term investor you need very few funds.
Nicholas Sinclair-Wilson, chartered financial planner at BRI Wealth Management, says:
It would be beneficial to examine your objectives and needs from a broader perspective, before considering your investment strategy and individual holdings.
You currently need your investments to produce an income of £27,000 a year but consider how this amount might change in the near term. For example, will you need less than £27,000 a year from your investments when your wife is receiving her State Pension and will you need more if your consultancy role ends? These factors have a bearing on your required rate of return. And although you would like an annual return of at least 6 per cent, knowing what you actually need is crucial.
You would also like your children to inherit the majority of your wealth. Based on the information you have provided, the size of your estate falls within your own and your wife's combined inheritance tax (IHT) allowances of £1m – although it is quite close. This assumes that your property or the value thereof, is eventually passed to your children, and neither you or your wife have made gifts in the past seven years. Your Sipp is not included in your estate when calculating IHT so could be a tax-efficient way to pass on wealth to your children. Therefore, depending on the above, you may wish to prioritise drawing an income from your Isas and preserve the Sipp. Or you could draw an income from your Isas and Sipp, lowering the required rate of return.
There are generally two approaches you can take with a decumulation strategy. You could either draw the natural income generated by your investments or withdraw the growth [by selling shares and units in holdings].
If you draw the natural income you will need to hold high-yielding investments and – ideally – the income generated will match your required return. By taking the natural income you reduce the potential for capital erosion during periods of market volatility.
Getting your income from growth would suggest having a more balanced investment selection which would provide a real return but at the risk of losing capital in a falling market. Your Sipps and Isas, which have a value of about £787,570, would need to generate an average return of 3.84 per cent a year to do this. This assumes that you draw proportionately from the Isas and Sipp. I have assumed that you would pay basic rate tax at 20 per cent on withdrawals from the Sipp so you would need to take £16,200 a year from it to produce an income after tax of £12,960. Withdrawals from Isas are tax free so you could take £14,040 from these.
Your investments have limited UK exposure which would be a natural source of higher income. Funds such as Man GLG Income (GB00B0117D35) and/or LF Gresham House UK Multi Cap Income (GB00BYXVGT82) are options if you decide to get the amount you require from natural income. If you want to increase your property exposure, LXI REIT (LXI) yields over 4 per cent and could act as an inflation hedge.
For your healthcare allocation, you could switch out of Legal & General Global Health and Pharmaceuticals Index (GB00BJ2JPG83) into BB Healthcare Trust (BBH) as it pays an amount equivalent to 3.5 per cent of its net asset value each year as a dividend.
Also consider adding further infrastructure exposure as it typically offers a yield and some capital growth. Ways to get exposure to this asset include ARC TIME UK Infrastructure Income (GB00BP50HT79).
In terms of capital growth, you have a fair amount of exposure to the technology sector which in recent years is where most growth has originated. But Legal & General Global Technology Index is very concentrated in Apple (AAPL), Microsoft (MSFT), and Alphabet (GOOGL) [see pie chart]. Switching to a more diversified technology fund may reduce risk and offer better growth over the longer term.
Your investments have limited exposure to emerging markets which, arguably, are the driver of future growth. Baillie Gifford Emerging Markets Growth (GB0006020647) might be a suitable choice for exposure to these regions.
We don’t believe that you need to significantly reduce your number of holdings. But you should watch the size of your allocation to certain funds such as Fundsmith Equity (GB00B41YBW71) which accounts for 8.9 per cent of your overall portfolio.