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Don't focus on what you can't control

Our reader should structure his portfolio around the likely demands on it
January 11, 2018, David Liddell and Jason Witcombe

David is self-employed and his income is erratic, but his wife has a state sector job with a steady income and final-salary pension scheme. They have three children and would like to move to a bigger house, but can't find something they both want and can afford.

Reader Portfolio
David 47
Description

Sipps, Isas and cash

Objectives

Buy a bigger house and save for children

Portfolio type
Investing for goals

"We have an interest-only mortgage of £280,000 and we have started putting aside £1,000 every month to pay this off," says David. "Similar houses to ours sell for around £1m. 

"It is possible my income could go down, although probably not all the way, and we pay for some childcare. So a plan based on some presumed level of income would now be sensible. 

"We are pretty flexible about where the children go to school and will keep using state schools if they get good offers. If not, that will change our financial situation. 

"With our investment portfolio, our objective is to maximise the total return over a period of 10 to 20 years. We hope not to spend any of the money we have set aside for the children in the next 10 years, or any of the other money for 15 to 20 years.

"The children's portfolio is largely our money that we have saved with the broad intention of it being for them. We only started investing four years ago and even more recently with the children's money because my wife is reluctant to trust the stock market. 

"But I have now got to the point where use of my self-invested personal pension (Sipp) is limited by the taper.

"I learnt a lot in the first few years of investing, including realising that I don't have the time or skills to invest in individual shares. 

"These portfolios were built up quite quickly on the basis of what made sense at the time, and in part reflect the various platforms they are held on. I am gradually rationalising these, for example I'm about to transfer Legal & General UK 100 Index Trust (GB00BG0QPG09) – my entire pre-2010 savings – into an equivalent product.

"I am considering significantly reducing risk by switching Vanguard LifeStrategy 100% Equity (GB00B41XG308) and HSBC Global Strategy Dynamic Portfolio (GB00B849DT80) into funds with 60:40 equity: fixed income splits.

"I'm also thinking about significantly increasing the percentage of the portfolios allocated to absolute return funds, and maybe putting a lot of our cash into absolute return funds, in the hope of beating inflation. And I am thinking of putting some money into fixed-income tracker funds.

"I would also like to know what to do with significant additional sums available for investment with markets as high as they are."

 

David and his family's portfolio

HoldingValue (£) Percentage of portfolio (%)
Legal & General UK 100 Index Trust (GB00BG0QPG09)13,3003.31
Vanguard LifeStrategy 100% Equity (GB00B41XG308)10,8002.69
Witan Investment Trust (WTAN)11,4002.84
Standard Life Private Equity Trust (SLPE)8,1002.02
TR European Growth Trust (TRG)9,9002.47
iShares FTSE 100 UCITS ETF (CUKX)16,4004.09
iShares Edge MSCI EM Minimum Volatility UCITS ETF (EMV)7,6001.89
Unicorn Mastertrust (GB0031218018)8,3302.08
Herald Investment Trust (HRI)7,4001.84
RIT Capital Partners (RCP)15,5003.86
JPMorgan Japan Smaller Companies Trust (JPS)6,4001.59
F&C Global Smaller Companies (FCS)6,1001.52
TB Evenlode Income (GB00BD0B7C49)6,1001.52
Worldwide Healthcare Trust (WWH)5,8001.45
Vanguard Global Value Factor UCITS ETF (VVAL)5,4001.35
Blackrock Frontiers Investment Trust (BRFI)5,4001.35
Lloyds Banking (LLOY)5,1001.27
Henderson Smaller Companies Investment Trust (HSL)11,1002.77
CQS New City High Yield Fund (NCYF)4,4001.1
LF Woodford Equity Income (GB00BLRZQC88)5,4001.35
Legal & General (LGEN)3,4000.85
Standard Life Investments Property Income Trust (SLI)2,1000.52
HSBC Global Strategy Dynamic Portfolio (GB00B849DT80)18,1004.51
HSBC FTSE 250 Index (GB00B80QG052)12,4003.09
HSBC FTSE All Share Index (GB00B80QFX11)14,0003.49
Baillie Gifford Japan Trust (BGFD)10,3002.57
Templeton Emerging Markets Investment Trust (TEM)7,0001.74
Baillie Gifford European (GB0006058258)4,9001.22
International Biotechnology Trust (IBT)4,8001.2
HSBC European Index (GB00B80QGH28)4,7001.17
Oryx International Growth Fund (OIG)4,7001.17
Baillie Gifford Corporate Bond (GB0005947857)4,2001.05
Finsbury Growth & Income Trust (FGT)4,0001
BlackRock Commodities Income Investment Trust (BRCI)4,0001
Utilico Emerging Markets (UEM)2,3000.57
F&C Responsible UK Equity Growth (GB0033396481)1,2000.3
Royal London Ethical Bond (GB00B8K6PK81)1,0000.25
db x-trackers MSCI Japan Index UCITS ETF (GBP hedged) (XMJG)1,0000.25
Personal Assets Trust (PNL)8150.2
Junior Isas invested in global tracker funds8,0001.99
Children’s bonds3,0000.75
NS&I Premium Bonds58,45014.57
Cash57,00014.2
Total401,295 

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

James Norrington, specialist writer at Investors Chronicle, says:

Investing is personal, so worry about your circumstances rather than what you can't control. The important question isn't whether markets can go higher or when will the crash come, but rather whether you have the capacity to stay invested and can avoid having to crystallise losses. Your income is already uncertain and it could fall significantly in a period of economic turbulence, so the risk in a downturn is having to sell holdings at a loss to meet expenses and liabilities as they arise.

You have taken advantage of low rates to borrow cheaply as inflation eats away at the capital value of your mortgage, which is a smart strategy while rates are low. 

One option that might be appropriate for you is an investment bond. This product has an element of life cover. This is appropriate given your family and mortgage situation, and would allow you to take advantage of investment growth. You can also take up to 5 per cent of the initial investment each year for 20 years and defer taxation. This is not tax-free, but it means you can take income when you need it and/or defer the tax to years when you are in a lower rate band. But first speak to an independent financial adviser about whether this would be suitable.

 

David Liddell, chief executive of IpsoFacto Investor, says:

It is difficult to sort out financial priorities when you have so many competing demands on your budget, and this may be compounded in your situation as your future income is more variable. 

You want to maximise your investments' total return over 10 to 20 years, but you may need to draw on your savings sooner, for example to move to a bigger house and possibly pay school fees. If you think you are going to use any existing savings in the short to medium term – five years' or less – then you should keep that amount in low-risk assets, preferably cash.

New home and school fees aside, and assuming your wife's final-salary pension scheme is satisfactory, your two main priorities should be saving for your own pension fund and building up a pot to pay off the mortgage in the most tax-efficient manner. 

Even if you are caught by the pension taper this should still allow you to put aside £10,000 per tax year and presumably more if your income dips. This would require you to hold back reserves of cash in excess years. Under current legislation, you can access 25 per cent of the value of your Sipp from age 55 tax-free, so this could be put towards paying off your mortgage, depending on circumstances. A Sipp could also be passed to your wife and then children free of any inheritance tax.

You and your wife could each contribute £20,000 into an Isa each tax year – £40,000 in total. And if you need the cash you can take it out of an Isa tax-free. 

 

Jason Witcombe, chartered financial planner at Evolve, says:

The standard pension annual allowance is £40,000 a year, but since the last tax year this has been reduced on a tapered scale once adjusted income exceeds £150,000. And when your income exceeds £210,000 the allowance is just £10,000 a year.

However, you can also carry forward any unused allowance from the previous three years. Given the generous tax relief that you receive on pension contributions it would seem logical to keep maximising these opportunities. But good record keeping is essential – particularly where you have a tapered allowance.

Your wife could enquire as to whether she could make pension top-ups via her employer. She might be able to increase her defined-benefit pension by buying added years or added pension, but the options will depend on which public sector scheme she is in. Alternatively, she may have access to a money-purchase scheme, which would allow her to build up a pension fund alongside her final-salary scheme. The tax relief she would get will depend on her income.

Your wife is "reluctant to trust the stock market." It is normal for spouses to have differing views on money, but it is important to agree on a household strategy. I would recommend that you try to set some investment rules you both agree on.

For example:

What level of cash balance will you target, given a possible house move, possible school fees, fluctuating income and eventual mortgage repayment?

With the surplus, what balance between growth and defensive assets suits your combined profile best?

How big a UK bias do you want?

Do you want to increase use of ethical and socially responsible funds?

Do you prefer the idea of active or passive funds, or a bit of both?

 

HOW TO IMPROVE THE PORTFOLIO

James Norrington says:

Bonds are incredibly expensive and increases in interest rates mean capital losses for bond funds. With rates tightening, and quantitative easing policies being tapered or unwound, it seems likely that there is only one direction for bond prices in the short term. You aren't able to take pension benefits for at least another eight years and, assuming that you are going to retire later than 55 anyway, I would not be too concerned about rebalancing your Sipp away from equities.

A reason not to switch more of the general portfolio into fixed income is that outside Isa wrappers, if you are a higher-rate taxpayer you will have to pay 40 per cent tax on any income above the first £500 in interest, and if you are an additional-rate taxpayer 45 per cent. 

With the general portfolio, I'd watch out for duplication of funds and check how your managed funds compare with cheaper index trackers. Some managed funds are a good idea, as with passive strategies you have a greater allocation to certain companies just because they have a large market capitalisation. But a mixture of passive funds for cheaper core exposure to international equities, and managed funds to tilt the portfolio towards particular strategies and take advantage of expertise, can be a good strategy.

 

David Liddell says:

The key is to find the right asset allocation to suit your circumstances. It is useful to start by looking at your overall investment position. Your biggest asset by far is your house, which net of mortgage is worth about £720,000. Your investment portfolio, minus the £47,000 cash reserve, is roughly 69 per cent in equities, 12 per cent in alternatives and fixed interest, and 19 per cent in cash.

There is nothing wrong with having some  NS&I Premium Bonds as part of your cash buffer but, on average, these are unlikely to yield a real return.

You have a relatively high number of different holdings, although this partly reflects your different pots. 

The equity component of your investment portfolio has an allocation of about 31 per cent to the UK, 30 per cent to other developed markets and 8 per cent to emerging markets. This segment is well diversified geographically, but for long-term equity growth I think you could afford to allocate more to emerging markets. JPMorgan Emerging Markets Investment Trust (JMG) is a fairly solid performer, and some exposure to the technology-heavy Baillie Gifford investment trusts – Scottish Mortgage (SMT) and Monks (MNKS) – might also be warranted.

With this size of portfolio I would hesitate before adding too many mixed-asset funds such as the 60:40 equity:fixed income ones you are considering. It is quite possible that with both equities and fixed income having had such a good run, and the current momentum in the global economy possibly leading to higher interest rates, that both components of such funds will fall. So it would be better to have separate exposure to equities and fixed interest, which would at least give you the choice of whether you sell down the exposure or add to it. If you want a 60:40 equity-fixed income allocation for your overall portfolio, I would do it yourself. Consider such funds as Jupiter Strategic Bond (GB00B4T6SD53) and Fidelity Strategic Bond (GB00BCRWZS59) for increasing the fixed-interest element.

The problem with absolute return funds is that very few of them achieve their objectives. We like 7IM Unconstrained (GB00B75MS619) and Newton Real Return (GB00BSPPWT88), but these should be considered as part of your equity portion rather than as diversification. For a more conventional absolute return fund consider Standard Life Investments Global Absolute Return Strategies (GB00B7K3T226), which after going through a rocky period has improved of late.   

You have a plan to invest as much as you can afford each month in proportion to your chosen asset allocation. This could be altered according to circumstances with ideally more being invested in equites if there is a decent market sell-off.

 

Jason Witcombe says:

I agree with your decision not to invest in individual shares and applaud your interest in index funds. Costs eat away at long-term investment returns and partly because of this many active funds don't beat their passive peers.

I'm not a fan of absolute return strategies because of the fees, and the underlying investment strategies can be particularly complex. I wouldn't view them as an alternative to cash.

The portfolio has quite a large UK bias. The extent of this bias is a personal decision, but it does mean that, perhaps unintentionally, you are likely to be overweight in some industries and underweight in others when compared with a more globally diversified portfolio.