Do I need to reduce my equity exposure as I approach retirement?

Louise is 52 and has always been self-employed. She has a daughter aged 16. Louise's home is worth about £1.6mn and she will have paid off the mortgage on this by the time she is 60.

"I would like to retire at 60 on an income of £30,000 a year,” says Louise. “I am hoping to fund this with my investments and by selling my house when I am 60. I will also use the proceeds of the sale to buy myself a flat and give my daughter a decent-sized deposit to buy her first home when she is in her early 20s. But this should still leave me with £300,000-£400,000 with which to top up my investment income, although ideally I would only like to take £300,000 so that I can give more to my daughter.

"I will also continue to save £30,000 a year for the next eight years into my self invested personal pension (Sipp), which is currently worth about £110,000, and individual savings account (Isa), which is worth about £92,000.

"I am happy with a medium to high level of risk, and keen to maximise the value of my investments so that I can afford to give more to my daughter. However, I’ve read that I should be reducing my exposure to equities and buying bond investments as I approach retirement. But as I will probably draw down income from my investments rather than cashing them in to buy an annuity, and remain invested, do I need to worry less about moving out of equities?

"I've been investing for 10 years, although feel that I am still very much a novice and don’t know what I’m doing. I would describe the way I invest as chaotic, and am concerned that I have far too many funds and shares that I bought after reading tips. Examples of recent additions to my portfolio are BHP (BHP), iShares Core FTSE 100 UCITS ETF (ISF) and HSBC MSCI World UCITS ETF (HMWO). I also tend to tinker with my portfolio too much.

"Although my portfolio has largely performed well, I fear that this is more luck than judgment. And over the first two months of the year its value fell 10 per cent as markets seem to have entered a more volatile period. So I’m keen to simplify things and take a more methodical approach. Half the time I wonder whether to just sell everything and reinvest the proceeds in a Vanguard LifeStrategy fund."

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 should be able to meet your main objective. If you save £30,000 a year for the next eight years, increased in line with inflation, and your portfolio achieves a real total return of 4 per cent a year, you’ll have around £550,000 in today’s money by the time you are 60. With an extra £300,000 from the sale of your house you should have around £850,000. Speaking in terms of today’s money, £30,000 is only about 3.5 per cent of this a year, so you should be able to generate that income via drawdown while leaving your capital intact, on average.

Your portfolio is also quite well-diversified as it does not just include mainstream UK-listed equities but also has exposure to big tech via Invesco EQQQ NASDAQ-100 UCITS ETF (EQQQ), Scottish Mortgage Investment Trust (SMT) and Fundsmith Equity (GB00B41YBW71) (see chart). And it has exposure to more cyclical assets such as emerging market funds and mining stocks, although these are highly correlated so regard them as the same asset.

You might, however, be able to achieve such diversification more cheaply. Global tracker funds are in effect funds of all equity funds which give you instant equity diversification at a low cost. And costs matter: over eight years, even an additional 0.5 percentage point of annual management charges could cost you over £500 for every £10,000 you invest. If you hold several actively managed funds you risk diluting your returns as diversification reduces your chances of big gains as well as big losses – but not fees. So think very carefully about the actively managed funds you hold. Only keep them if they add something to your portfolio that exchange traded funds (ETFs) or similar cheaper active funds do not.

In this context, you should not follow tips. Instead, consider what a stock or fund adds to your portfolio. If you are already content with, say, your exposure to emerging markets, why would you need another emerging markets fund?

The case for you switching into bonds is that you are approaching the so-called 'retirement risk zone' – the years just before and after retirement. During these years a fall in share prices is nasty because you don’t have enough subsequent years of working and saving to recoup the losses. So you need protection against them.

However, this protection does not need to be bonds. Cash could do just as well, depending on why equities fall. And you have other ways of adjusting to a fall in the market. You could downsize your home to a greater extent or give your daughter a smaller share of the proceeds from the sale of your current home. But don’t bank on house prices rising much in real terms in the coming years.

You could also budget on letting your wealth run down in retirement. Even with zero real returns over the next eight years you’ll have a retirement pot of over £700,000 in today’s money. Taking £30,000 a year from that would see you into your 80s – even if we get a further two decades of zero real returns.

So don't worry too much about moving into bonds. As long as you keep on saving and investing, you’ll be OK.

Alex Brandreth, chief investment officer, Luna Investment Management, says:

Based on some market growth assumptions and your future contributions, your future income objective of £30,000 a year from age 60 should be achievable with a well-diversified portfolio. My calculations suggest a portfolio yield of around 3 per cent, on the basis that these assumptions are correct.

You are only invested in equity markets, so we would classify you as a high-risk investor. Your portfolio is also very concentrated so requires further diversification. For example, you have seven direct shareholdings, but we would typically look to diversify across around 30 different direct shareholdings. And some of these are in volatile sectors, for example Anglo American (AAL), BHP, Sylvania Platinum (SLP) and Thungela Resources (TGA) are mining companies. So I would actually classify you as a very high-risk investor, which doesn’t match your stated level of medium to high risk.

This point is closely linked to your question about whether you should be reducing your exposure to equities and adding bond investments as you approach retirement. If you wish to draw down your income rather than buy an annuity you can have a higher weighting to equities. But there’s another reason why you should reduce equity exposure and that is to meet your stated risk objective. Doing this would help to diversify your portfolio, and you can reduce its risk in a number of different ways.

You could buy bonds. At this point in the interest rate cycle, it might be appropriate to consider strategic bond funds, which can allocate to different types of credit such as government, investment-grade and high-yield bonds – as and when they see opportunities. These funds can also manage interest rate exposure, a key attribute as it looks as though interest rates will continue to move higher over the next year.

You could also buy alternative assets. For a medium to high-risk investor, we would buy infrastructure, absolute return or hedge, property, music royalties and perhaps private equity funds and structured products. The purpose of doing this is to hold investments that are less correlated to the stock market over the long run, and improve your portfolio's diversification and reduce its risk.

Your portfolio currently has a high level of risk, which doesn’t match your objective. So diversify across different asset classes such as bonds and alternatives, as well as reviewing individual holdings.