How should I invest to protect my wealth in real terms?

Sandy is age 62, retired and receives an index-linked pension of £44,000 a year. His home is worth about £950,000 and he also owns a home abroad worth about £550,000. Both properties are mortgage free.

"I think that I have enough assets for most eventualities so my main investment aim is to protect my existing level of wealth in real terms," says Sandy. "I am investing to meet any unplanned large expenses such as later life care costs, and to provide decent bequests to numerous godchildren and charities which are identified in my will.

"I have no dependents, and once I receive my state pension of about £9,000 a year from age 66, I should have sufficient income to meet my regular expenses. I will in due course sell both of my properties and reinvest in one larger UK property of about the same total value.

"I fully use my annual individual savings account (Isa) allowance and hold £264,000 of my tracker fund investments in this kind of wrapper. I hold also tracker fund investments worth £80,000 in my self-invested personal pension (Sipp), in particular UK and infrastructure funds which have higher dividend yields. I reinvest all the income I receive so hold the accumulation units of the funds I invest in.

"I don't hold LF Ruffer Total Return (GB00B80L7V87) in a tax-efficient wrapper because its annual yield is low, due to its emphasis on bonds. I hold it directly with Ruffer which helps me make maximum use of my annual capital gains tax (CGT) allowance by shifting some of my holding into an essentially similar fund towards the end of the tax year.

"I am broadly happy with my investments' performance and asset allocation, which is roughly 65 per cent equities, 20 per cent defensives and 15 per cent cash.

"My attempts to invest in government bonds via tracker funds have been unsuccessful. So although I am generally not attracted by active funds, for the defensive component of my portfolio I rely on LF Ruffer Total Return. Although it is heavily invested in bonds, it has successfully used derivatives and other protections to perform well in recent market downturns.

"But I still feel that I should hold other wealth preservation funds rather than just rely on LF Ruffer Total Return. But do most wealth preservation funds have an investment trust rather than open-ended fund structure, meaning that I would have to accept additional risk from changes in their premiums or discounts to net asset value (NAV)? What other open-ended wealth preservation funds are there?"

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

Tim Latham, chartered financial planner at Equilibrium Financial Planning, says:

At the end of July, LF Ruffer Total Return's yield was 1.85 per cent and 1.85 per cent of £412,000 – the amount you have in this fund – is £7,622. But the annual tax free dividend allowance [for investments outside tax efficient wrappers] is £2,000, and any dividends received in excess of that are added to your income and taxed at your marginal rate – 8.75 per cent for basic rate and 33.75 per cent for higher rate taxpayers.

Basic rate taxpayers have a savings allowance of £1,000 a year and higher rate taxpayers £500. Interest from savings in excess of these amounts is taxed at your marginal income tax rate – 20 per cent for basic rate taxpayers and 40 per cent for higher rate taxpayers. Due to the size of your cash holdings and interest you may be receiving on this, [some] may be taxed.

You could instead take the tax-free income you receive from investments within Isas, and gradually move the unwrapped holdings into Isas and pensions. You can contribute up to £20,000 each tax year to Isas and, even though retired, £2,880 to pensions which with tax relief amounts to £3,600, until you are age 75. Your pensions' value appears to fall within the lifetime allowance of £1,073,100 with a defined benefit pension of £44,000 a year (which equates to a value of £880,000) and £80,000 Sipp.

You have cash savings worth £246,000 and, based on your potential gross income need of £53,000 a year, this is equivalent to between four and five years' worth of your expenditure. Generally, it is suggested that retirees hold six months to a year's worth of their expenditure in cash. So your cash allocation could be on the high side, particularly as you expect that your upcoming house move will be roughly cost neutral – unless you have any extra expenses or make gifts over the next three years. And as a good proportion of your investments are in defensives, your cash allocation appears overweight.

With inflation recently hitting double-digit figures, cash is likely to be losing its purchasing power each year. So consider how much cash is surplus to your requirements, and invest it to try to get a higher return and combat the impact of inflation on your assets, to protect their value in real terms. With a more detailed understanding of your needs, desires and risk tolerance, and appropriate advice, the overall split of your assets could be rebalanced to a more suitable position for preserving wealth in a high inflation environment.

When you start to receive the state pension at age 66 you will become a higher rate taxpayer. At present, you could take income of up to £6,000 a year gross from your Sipp and continue to be a basic rate taxpayer. But any further income should be generated from your Isas or unwrapped investment accounts. 

From age 66, your Sipp will be the least efficient source of income, if you need more than what you get from your index-linked and state pensions. And Sipps are deemed to be outside your estate for inheritance tax (IHT) purposes so you could name your godchildren as beneficiaries to receive it after you pass away.

There are a number of good open-ended defensive funds available. And although investment trusts can experience more volatility due to trading at premiums or discounts to NAV, some investment managers use alternative investment strategies, such as hedging, which can produce a less volatile return than equities.

You can fund later life care by self-funding. Or you can buy a long-term care annuity from an insurance company, whereby the income shortfall between your guaranteed pension income and cost of care is met by the insurance provider in return for a lump sum. For example, you could pay a £100,000 lump sum and receive £15,000 a year for the rest of your life while in care.

As well as being medically underwritten, a long-term care annuity provides greater piece of mind for your relatives as the income is guaranteed. But it would not be good value if you pass away early as the insurance would have been overpaid.

The average stay in a care home is roughly three years and the average cost is between £60,000 and £70,000 a year. Considering the value of your assets and it being unlikely that you will need to draw an income from your liquid assets in four years' time, I don't see the cost of care materially changing your financial plan.

Richard Watson, wealth management consultant at Mattioli Woods, says:

There are several things that you could do that might put you in a better position to pass funds to your godchildren while ensuring that you retain access to capital.

It is right to start IHT planning while aiming to keep enough capital in case there is an emergency. If you leave at least 10 per cent of your net estate to charity, you may be eligible for a 36 per cent IHT rate on the net assets in your estate [as oppose to the usual 40 per cent rate].

You could make use of the small pension annual allowance you have available, provided that you have some lifetime allowance still available. You should be able to contribute up to £2,880 a year to your Sipp and would be moving this money into an incredibly tax-efficient wrapper which is outside your estate for IHT purposes. You could continue to do this until age 75, so move £34,560 net into your Sipp and reclaim a further £8,640 in income tax relief over the 12 years until you reach that age – the basic rate of income tax is reclaimed by your Sipp at source. This could save up to £15,552 in IHT at the 36 per cent rate so benefit your godchildren.

It might make sense to start using annual gift allowances if you do not do this already. You can make a gift of up to £3,000 a year or use the small gift allowance of £250 for multiple recipients. You would also get to see the difference that the gifts would make to your godchildren. Gifts to charities are exempt from IHT, but if you leave more than the £325,000 nil rate band allowance to your godchildren, IHT planning may be wise.

Other options for mitigating IHT include offshore bonds and discretionary gift trusts, but these wouldn't enable you to retain as much access to capital as you currently have.

Consider taking out a life or critical illness cover insurance policy. Although you can draw from your portfolio, a critical illness cover policy can act as a buffer between potentially high capital expenditure following a diagnosis of ill health or terminal illness, and the rest of your portfolio. However, at your age this may be expensive for the level of cover required.

Active funds can provide useful diversification away from markets in general. The alpha [excess return versus the market] generated by the very best fund managers is often more in falling markets, even when taking their funds' fees into consideration.

LF Ruffer Total Return is a sensibly run fund with a positive long-term record but your exposure to it is high.