Saving to escape the rat race

"I would like to step down from the corporate world within the next five years and work for a charity or do something by myself, in which case I would like to maximise the income from my portfolio," says Jeremy.

"I have been investing my group personal (work place) pension, which my employer also contributes to, in BlackRock Aquila (50:50) Global Equity Index Fund (GB00B00C0M74) for the past seven years. I could change the allocation and the investment of this money but the choice of fund provider is limited.

"A fifth of my portfolio is invested in Scottish Mortgage Investment Trust (SMT) which has been a very strong performer, but I feel it may be time to move some of that money into more defensive investment trusts or fixed interest investments as I don't have much invested in bonds."

Jeremy's portfolio

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

The key question you must ask is: how close am I to getting my desired income when I retire? It's this that determines whether you are indeed light in bonds and overexposed to equities.

If you were to retire today, this portfolio would probably get you a pre-tax income of just over £40,000 a year without, on average, having to eat into your capital. Sadly, though, there's substantial uncertainty around this as we don't know what returns will be over the rest of your lifetime. If you're willing to run down your wealth and not leave a bequest the feasible income is much higher.

If you're happy with such an income – or if you think you can top up your future income simply by saving more in the next few years – then there's a strong case for shifting out of equities towards safer assets to reduce the substantial risk of cuts in future income. With your current allocation of over 80 per cent in equities, there's probably around a one-in-five chance of some sort of loss in real terms over the next five years.

The more lavish you want your retirement to be, the more tolerant you will need to be of equity risk, or the happier you will be to postpone retirement if we do enter a bear market, the higher your equity weighting should be.

However I suspect you're not happy with such a high equity weighting and the point of having wealth is to give you peace of mind. If you don't have this, you've got the wrong asset allocation.

David Liddell, chief executive of IpsoFacto Investor, says:

Your portfolio has an asset allocation split of roughly 80 per cent in equities, and 10 per cent in each of fixed income and cash. So you may have a bit more in fixed income – bonds – than you think, although admittedly some of this exposure may be at the riskier end. The yield from your investments is approximately 1.6 per cent, so well below what might be achieved by a portfolio with an income objective. 

The geographical exposure of the equity portion is 31 per cent North America, 26 per cent UK, 19 per cent Europe, 8 per cent Asian emerging markets, 6 per cent Asia ex Japan, 5 per cent Japan, and 5 per cent other emerging markets.

You need to make decisions on the asset allocation and geographical exposure including diversification, and tax and pension planning where some professional advice may well be warranted. These decisions are related in terms of the extent to which you take any of your pension benefits in the form of an annuity. All decisions should take account of your overall financial situation, other assets and liabilities.

If you want to live off the income from your investments within the next five years it would usually be advisable to start reducing risk. The difficulty for all investors currently is that it is not obvious whether equities or bonds are the more risky investment. Both have had good runs: the FTSE All-Share's total return since 2008 is 143 per cent, although admittedly from the depths of the financial crisis. And 10-year gilt yields which are inversely related to their price are close to all-time lows at 1.3 per cent. If interest rates return to more normal levels both asset classes will be susceptible to considerable volatility, but bonds will not necessarily be a safer haven than equities. 

It is likely to be preferable from an income and inheritance tax point of view to take income from your individual savings account (Isa) ahead of your self-invested personal pension (Sipp). Consider using part of the 25 per cent tax-free lump sum from your pension to fund future Isa investment.

Consider getting some advice on whether to take some of your group personal pension as an annuity when you retire, assuming this is after age 55 and annuities are better value at that point. This would allow you to have a higher degree of equity risk in the rest of your portfolio over the longer term. 

Ben Yearsley, director at Shore Financial Planning, says:

Because all of your investments are held in a pension or Isa you can make changes to your portfolio without having to worry about capital gains tax. And you will also be able to draw some tax-free income in retirement.

The fund in your group personal pension should be a cheap, low-cost way of accessing global equities. This is a decent core holding for the next few years but when you retire it would make sense to transfer this pension to your Sipp so you can manage your pension in one place.

Your portfolio is worth £1.2m, and with further pension contributions and market growth over the next five years, you could grow it to about £1.6m. If you took a 3.5 per cent annual income from it this would give you approximately £56,000 a year pre-tax. Income from your Isa will be tax free and some of your pension income may be too.

The earlier you retire, the less income I would take from your investments and pensions. You could live for another 30 years or more so you need your wealth to carry on growing. Taking 3.5 per cent strikes a balance between getting an annual income and still having the prospect of growth. If you maximise the income you might have a better standard of living initially, but if your income doesn't grow and keep pace with inflation over time you will become relatively poorer.

For this reason, and because you no longer have to buy an annuity when you retire, the traditional portfolio theory of switching from equities to bonds in the run up to retirement is no longer relevant. As many retirees will rely on their investments and pensions for much longer, equities and real assets should account for the bulk of portfolios much further into retirement than they used to.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Even if you are overweight equities, it doesn't follow that you are light bonds which face risks of their own. Granted, some of these risks would be offset by rising share prices, for example, if investors become willing to take more risk or if they expect faster economic growth. But not all bond risks are of this type. For example, if the US central bank, the Federal Reserve, tightens monetary policy faster than expected or the UK shifts to a mix of looser fiscal and tighter monetary policy, we might see bond prices fall without any offset rise in equities.

Such risks mean you shouldn't necessarily increase your bond holdings. Instead, a safer way of locking in your wealth would be to have more cash. An easy way to do this would be to shift some of your pension fund into a money fund.

You could trim Scottish Mortgage at a time when it is trading on a high premium to net asset value. This is because a low discount or high premium relative to a trust's own history can be a sign that sentiment towards the trust and its assets is unusually high. And positive sentiment tends not to last. You could switch some of your holding in it to cash.

David Liddell says:

The advantage of managing your own Isa and Sipp is that you can take a gradual and opportunistic approach. We would advise constructing a plan to switch your more concentrated lower-yielding positions into higher-yielding investment trusts on a regular basis, either monthly or quarterly. But if interest rates start to go up significantly then it may be worth looking at some further exposure to bonds as well.

We would also suggest increasing the UK exposure a little as the main benefits of weaker sterling in terms of holding international stocks may already have been achieved, although the potential impact of Brexit still casts a shadow over the UK domestic economy.

Your portfolio has some strong performers in it such as Scottish Mortgage Investment Trust but we would suggest that you start reducing it because you generally do not want to have much more than 7.5 per cent of your assets in any one holding. Reduce Scottish Mortgage over a few months and reinvest in a combination of, for example, JPMorgan Global Growth & Income (JPGI), Securities Trust of Scotland (STS), Lowland Investment Trust (LWI) and Temple Bar Investment Trust (TMPL).

We would also reduce exposure to RIT Capital Partners (RCP) and British Empire Trust (BTEM), and reinvest in higher-yielding trusts over a period of time.

You could also eventually replace TR European Growth Trust (TRG) with European Assets Trust (EAT), and Templeton Emerging Markets (TEM) with Utilico Emerging Markets (UEM) and Aberdeen Asian Income Fund (AAIF).

Also consider some commodity exposure as a hedge against inflation.

We think that BlackRock Aquila (50:50) Global Equity Index, depending on the level of charges, is not a bad way to get diversified global exposure. 

Ben Yearsley says:

I don't think your overall asset allocation is very wrong with about 10 per cent in fixed interest, although I'm not sure I would have that much. While I don't think interest rates in the UK are going to increase that much in the near future I cannot get too excited by the prospects for bonds. For most investors, and those who don't need a specific level of income, strategic bond funds are ideal as their managers have the flexibility to invest across the bond spectrum. You already hold M&G Optimal Income (GB00B1H05486), and could also consider Jupiter Strategic Bond (GB00B544HM32), Artemis Strategic Bond (GB00B2PLJS27) and Kames Strategic Bond (GB00B00MY367). I don't have a problem with M&G UK Inflation Linked Corporate Bond (GB00B460GC50), but would probably sell the other two bond funds and switch the proceeds into the ones I have suggested.

I agree that the Scottish Mortgage position is too large as this is a high-risk trust, albeit an excellent one. I would look to ensure that no holding accounts for more than 10 per cent of your portfolio.

You could reinvest the proceeds from reducing this in an equity income fund such as Standard Life Equity Income Trust (SLET) run by Thomas Moore. I like that he invests in dividend growers rather than just the biggest payers today. You could also reinvest the proceeds in Foresight Solar Fund (FSFL) which has a large portfolio of renewable energy assets, about half of which are inflation linked, a useful attribute if inflation continues to be a problem. It also yields over 5 per cent.

Holdings which account for less than 1 per cent are too small to make a difference so don't really add anything. If they are historic holdings and you still like them then add more. And if not sell them. You need to think about what you are going to do with Ruffer Investment Company (RICA), Electra Private Equity (ELTA) and Fidelity Asian Values (FAS). 

If you decide to remove Fidelity Asian Values I would consider adding Schroder Oriental Income Fund (SOI), managed by Matthew Dobbs and Jupiter Emerging & Frontier Income Trust (JEFI), managed by Ross Teverson. I am a big believer in Asia and emerging markets for long-term investors, and Schroder Oriental Income – which I have just bought myself – is another source of income.

You could increase your holding in Personal Assets Trust (PNL) which is a great long-term, more cautious investment.

Worldwide Healthcare Trust (WWH) invests in an interesting area – the long-term trend in healthcare is positive with ageing populations, and advances in healthcare and biotech. But this holding is not a meaningful position size so consider doubling it.

Why have you got two individual shares in your portfolio? Either have at least 15 shares or sell these holdings.