A portfolio to provide a £40,000 annual income

“We would like to retire at age 65 with a £40,000-a-year income, but worry that’s a bit unrealistic given how late we came to the game and because we will rent for the foreseeable future,” says Emma. “We think we have a high-risk attitude and are prepared to suffer a 10 per cent fall in our investments  However, we do have the benefit of 27 years’ left to invest and we’d be happy eroding capital when 65 does come around.

“As well as the monthly £1,000, Tim gets a yearly bonus which we will mostly invest. We could also push monthly savings to £2,000 if we needed to.

“We’re relatively new to investing and were a bit foolish never to use pensions properly, but now have some savings, and Tim continues to save into his employer pension. Tim also has a self-invested personal pension (Sipp) but we have neglected this and have most of the assets in an individual savings accounts (Isas), and one each for the children.

“We started investing in funds, but have added stocks now, and also hold gold and silver. We tend to avoid the Alternative Investment Market (Aim). Our cash deposit has been neglected. We initially tried to have at least six months’ expenditure in cash, but we kept succumbing to the impulse to invest. We are learning to refrain on that front.

“Recently, we bought into Fundsmith Equity (GB00B41YBW71) and Lindsell Train Japanese Equity (IE00BJSPMJ28). I’m also wondering whether to buy the L&G ROBO Global Robotics and Automation ETF (ROBG) and iShares Diversified Commodity Swap UCITS ETF (COMM).

“Our main concern is that we do not know if our holdings have overlaps – and whether we’re paying more to hold the same stocks. We want to diversify really, plug any gaping holes in our portfolio and avoid any duplication.

“I also worry that we have too many funds and pay too much in fees and wonder whether it might just be easier with a range of tracker funds?”

Emma and Tim’s portfolio

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

THE BIG PICTURE

Rory McPherson, head of strategy at Psigma Investment Management, says:

You are totally doing the right thing by planning for the long term; 27 years away. There are two key areas you need to consider, one being financial plans and the other being the structure of your investment portfolio. 

To have an income of £40,000 a year is going to be difficult to achieve, but is not wildly unrealistic if you up saving to £2,000 a month. However, it is going to require a very aggressive approach to investing and, if you do not want to lose more than 10 per cent, this doesn’t stack up. Consider saving even more or perhaps having a less ambitious income target.

Tim is losing his personal allowance of £11,850 on all income over £123,700, and paying top rate tax on all income over £150,000. Discuss the potential to vary contributions into pensions and minimise the tax burden. This should be the first port of call for building an investment pot and would also be free of inheritance tax. You should also consider a Lifetime Isa for building up a retirement pot, but be aware of the associated constraints and locking money away – you won’t have access to it until 55 (in the case of the pension) and potentially 60 for a Lifetime Isa.

Laith Khalaf, senior analyst at Hargreaves Lansdown, says:

Having a goal for your retirement income is an important step. You should probably aim to revisit this target at least once a year and your numbers and consider if your requirements have changed. I don’t think a £40,000 income is out of bounds for you at all, as a rough rule of thumb you’d probably need a portfolio of around £1m to produce that. If you’re investing £12,000 a year for 27 years that’s £324,000 before bonuses, investment returns and employer pension contributions, plus what you’ve got in the pot already, so I think it’s well within reach.

You may need to think about your attitude to risk. You’re happy to accept a 10 per cent loss in value over a single year, but your portfolio could exceed that in a bad year – 10 per cent is a fairly modest market correction, a bear market is usually double that. Given you’re so far from retirement, you’ve got enough time to ride the ups and downs and shouldn’t be too worried about taking on additional risk.

If you really don’t think you could bear to watch your portfolio fall by 10 per cent, even though it will probably rebound, then it would be prudent to dial down the risk in your portfolio, although as I say I think you have the time horizon to maintain your current course.

Rebecca Williams, client director at Brown Shipley, says:

To achieve an income of £40,000 in retirement a lifetime cash flow plan will help you understand your current position, the impact of your proposed savings plan and, ultimately, whether your goal is achievable. If not, it will help you understand the shortfall and how to fill the gap or revise your plans accordingly.

A cash flow plan will also help you understand your attitude to risk and capacity to withstand losses – you say you are prepared to lose 10 per cent in any given year, but that doesn’t fit with a “pretty high” attitude to risk where the volatility and potential for losses could be much greater.

It is great that you are so focused on saving, but have you considered the financial security of your family if one of you fell ill or died? As the sole earner, Tim should check whether the benefits provided by his employer are sufficient to provide for Emma and the children. Emma’s role is also key in the long-term stability of the family’s finances. If she were unable to care for the children what impact would that have? You might want to consider a family income benefit policy to provide a regular income if one of you became seriously ill or died.

HOW TO IMPROVE THE PORTFOLIO

Rory McPherson says:

Given your desire not to lose more than 10 per cent you should consider a more balanced approach to investing. Your exposure is heavily weighted towards equities and I agree with the concern that there are too many holdings. Multiple holdings won’t push up the management charge, but it may mean you’re paying over the odds when it comes to transaction costs associated with investing your monthly sum and/or rebalancing.

You may also want to consider hedging part (say 50 per cent) of the currency exposure into euros given you spend half your time in Spain.

Core equity funds you could consider are the River and Mercantile Global Recovery (GB00B9428D30), which would balance out some of your growth and technology exposure, and Artemis Income Fund (GB00B2PLJJ36).

It would also make sense to build in some diversification and ballast. This could come from fixed income investments such as the GemCap Semper Total Return Fund (IE00BF1PSK44), which provides a decent yield of around 4 per cent and taps into the underlying strength of the US economy. This could be complemented by a holding in the MI TwentyFour AM Asset Backed Income Fund (GB00B9876293) to get exposure to European assets.

For ballast, holding funds such as the Jupiter Absolute Return Fund (GB00B6Q84T67) and Odey Odyssey Fund (IE00B4WL8048) would help prop up the portfolio should rocky times hit equity markets.

Five-year correlations of Rory McPherson's 'ballast' funds

Source: FE Analytics, as 29.09.2018

Laith Khalaf says:

There’s a lot to like about the portfolio, you are well diversified and have exposure to some quality fund managers. That said, there are a lot of small holdings, and you may want to think about the role of each, and consider consolidating some of them. Holding a broad, diverse portfolio is important, although you need to ensure it remains manageable. I wonder if your portfolio might be a bit difficult to keep a handle on.

The final step is to make sure that everything is as tax efficient as possible using pensions and Isas, but you’re already on top form in that respect. As your husband is receiving a bonus it may be possible for him to pay his bonus directly into his pension via bonus sacrifice – it’s worth investigating this possibility as it can lead to both tax and national insurance savings.

Rebecca Williams says:

You may also want to consider sacrificing some, or even all, of Tim’s yearly bonus into the pension, which would save on income tax at 40 per cent and National Insurance contributions. Due to his high level of earnings Tim should take advice on the total amount of pension contributions he can make in a financial year.

You should also consider making pension contributions in Emma’s name. Having all of your income in Tim’s name isn’t tax efficient as it means Emma’s personal income tax allowance and basic rate tax band can’t be transferred and will go unused. As it stands, Emma can contribute £2,880 each year to a pension, receiving 20 per cent tax relief, enabling her to make a total contribution of £3,600.