Maximising capital to help the younger generation

"I have become increasingly aware that my generation has benefited enormously from generous tax treatment of private pension purchasers, and the guaranteed annuity rates during the 1970s and 1980s," says Damond. "This has resulted in my ability to assist the younger generations of my family to achieve their aspirations in the very different financial climate today. I have gifted a property to my family, but avoided having many property investments to avoid management and liquidity issues. But I enjoy managing my financial affairs.

"My primary investment approach has always been to spread my investments, minimising tax liability where possible. Even now, I still invest annually in a stocks and shares individual savings account (Isa) – basically like many a wartime child I am a saver not a spender.

"I would be prepared to lose about 5 per cent and would like to know what you consider my risks to be. I would also like your views on whether I should consult a financial adviser."

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

Chris Dillow, Investors Chronicle's economist, says:

Using your annual Isa allowance is a good idea. I also like your awareness of liquidity risk – too many investors overload on property because they neglect the danger that it will become hard to sell, especially in a downturn.

You ask whether you should consult a financial adviser. I'm not sure advisers could greatly improve your general asset allocation as this is basically sound. But good advisers are invaluable when it comes to helping with tax affairs.

Patrick Connolly, certified financial planner at Chase de Vere, says:

You have investments and cash worth about £1.2m excluding your residential property. While this is quite a significant portfolio, having 35 separate holdings is too many. It makes the portfolio unwieldy – especially if you are not using platforms to consolidate the holdings – and you might struggle to run a portfolio with so many holdings. 

>As one of your objectives is to help the younger generation you might want to consider a cash-flow plan

And with so many different investments it is difficult to have a clear understanding of your overall asset allocation strategy and positioning. This creates the danger that you end up with a collection of individual funds picked in isolation, rather than the right overall investment blend to meet your objectives and attitude to risk.

If you want to continue running the portfolio then you could do this effectively with a maximum of about 15 underlying holdings, which would still achieve a sufficient level of diversification.

When looking at your overall portfolio, your starting point should be to consider your personal circumstances, financial objectives and attitude to risk. This will include the level of income you require and if there are any amounts of money you are happy to pass to future generations while you are still alive to reduce a potential inheritance tax (IHT) liability in the future. You have already used potentially exempt transfers and could do this again, although there are also gift allowances you could use which are free of IHT. Depending on your and your wife's needs, making gifts out of normal expenditure that don't affect your standard of living can be ignored for IHT purposes regardless of their size. This could be a tax-efficient way to pass on assets.

You have nearly £400,000 invested in onshore and offshore investment bonds using some trust arrangements. These can have tax advantages, especially for higher-rate taxpayers taking income or those aiming to manage a potential IHT liability. However, they are not tax-efficient for everybody and can have high charges, so you need to ensure they are appropriate for you. Review the suitability of onshore and offshore investment bonds, and your IHT position and options, and if you are not entirely sure of what you are doing then get some independent financial advice.

Rebecca Williams, client director at Brown Shipley, says:

As one of your objectives is to help the younger generation you might want to consider a cash-flow plan to help you and your wife analyse your income requirements in retirement, what assets you need for your own financial security and what you can afford to give away. A cash-flow plan is effectively a personal balance sheet taking into account all assets, liabilities, income streams and spending.

Ordinarily, you need to survive for seven years from the date of making a gift for it to be effective for IHT purposes, but as an alternative you could consider Business Relief schemes that offer IHT benefit after two years. Investing in Alternative Investment Market (Aim) stocks is a well-known way to access Business Relief, although this may be too risky for you. There are other schemes that target capital preservation that may be more suitable.

You are sensible to use your Isa allowance each year, but some of the funds held outside Isas are income funds. These would be better held inside an Isa because income tax rates on interest and dividends, over and above your dividend allowance, are higher than capital gains tax. But although Isas are tax efficient they form part of your estate when you die and are subject to IHT.

Also ensure that you and your wife have up-to-date wills.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

I applaud your bias towards defensive equities. Funds such as F&C UK High Income Trust (FHIB), Invesco Perpetual High Income (GB00BJ04HQ93) and Evenlode Income (GB00B40Y5R17) have a big weighting in these. This is welcome, not so much because such stocks protect you from a downturn – if the market falls these will too, albeit by less – but because defensive stocks tend over time to beat the market. Just be aware that if or when this happens, it is because of a long-standing tendency and not just because their fund managers are skilled stock-pickers. 

But your big weighting to higher-yielding bonds exposes you to the risk that short-term interest rates could rise, in which case safer bonds might sell off. And this might have a knock-on effect on corporate bonds. But if we judge your portfolio as a whole – which is the only way we should – perhaps this isn't a great problem. The losses on bonds might be offset by gains on equities because the circumstances in which interest rates and bond yields rise are ones in which the global economy is doing okay, which should benefit equities.

A second danger is that in an economic downturn default risk would increase, resulting in losses for corporate bonds even if there are no defaults among your holdings. This might not be offset by falling government bond yields dragging down corporate yields. Remember that high yield bonds pay high yields for a reason – to compensate for their extra risk.

However, my concern here is mitigated by the fact that you seem quite light in cyclical stocks, with the possible exception of your smaller companies funds MI Chelverton UK Equity Income (GB00B1FD6467) and Unicorn UK Income (GB00B00Z1R87). So, overall, your losses would probably be moderate.

A bigger issue is fees, but you should be able to get exposure to the assets you have at a lower cost. There are many corporate bond exchange traded funds (ETFs) that generally have lower charges than actively managed funds.

There are low-cost active funds which invest in defensive stocks such as City of London Investment Trust (CTY) which has an ongoing charge of 0.43 per cent, although this typically trades at a premium to net asset value. 

Patrick Connolly says:

From an investment perspective you are likely to need combination of income, capital growth and protection. Your current portfolio is heavily focused on equity income and fixed-interest funds. This is logical in view of your quest for income, although you need to ensure that you aren't duplicating too much of your exposure by holding many similar funds. It could be that your portfolio isn't as diversified as you think.

Consider adding property funds and some growth-orientated investments. Growth funds would spread risk further and you also have the option of taking capital withdrawals if necessary.

So, review your objectives, reduce your number of holdings and look to provide further diversification.

Rebecca Williams says:

You have a relatively high weighting to cash and NS&I products in your portfolio. The cash is likely to be making a very low return in which case inflation is eroding its spending power. I would suggest keeping an emergency fund of at least three months' income, but for cash above this level you may want to consider other options to improve the return.

At the moment your portfolio appears to be wholly invested in professionally managed active funds. You could consider adding tracker funds to your portfolio, which are a cheaper way of replicating the performance of a stock market index and a good way to get exposure to markets while controlling costs. A combination of tracking and active funds will reduce overall charges.

You wouldn't be comfortable if your investments fell in value by more than 5 per cent, so I'd suggest investing no more than 40 per cent in equity funds. A cash-flow model would help to show the effect of a fall in markets on your portfolio, and test your tolerance and capacity for continued investment risk.