Keep saving to benefit from greater protection

"I am aiming for growth of 5 per cent a year with my self-invested personal pension (Sipp) portfolio, but I'm not going to make any further contributions to it," says Shaun. "I will use the rest of the portfolio to generate £18,000 a year, increasing ahead of inflation, to maintain my current lifestyle.

"I am thinking of retiring when I am 67, and have a final-salary pension that will pay me £2,491 a year and a defined-contribution pension [with a current value] of £85,000. 

"I know I am too diversified and need to rationalise my investments as all I'm doing is replicating the performance of a balanced fund. But what should I sell? Many of my holdings have performed pretty well. Would an MSCI World Index tracker be the best place to invest my pension just now, or should I buy managed funds and investment trusts?

"I am looking to reduce my bond investments because they offer limited growth and a stagnant income. I need around £1,000 a month for the four months when I'm not working. I also feel that I should divest of my large holding in Invesco Perpetual Monthly Income Plus (GB00BJ04K042) as the money could be better used.

"And I hate the performance of the venture capital trusts (VCTs) I hold.

"I have been investing for 22 years and added to my positions through the financial crisis, although I wouldn't consider adding large sums of money to non-defensive funds at present. During financial tension I just turn off the financial news and don't read newspapers. I am aware that investments could make unlimited losses, but ultimately believe that well-managed companies are attractively valued. I think I would be prepared to lose up to 40 per cent.

"I have enjoyed seeing my dividend payouts grow to £17,000 a year and fully subscribe to the notion of dividends being the major source of stock market returns. I am quite content with my current level of income, although want it to marginally improve year on year.

Growth stocks are of little interest to me. I recently sold Biotech Growth Trust (BIOG) and bought Worldwide Healthcare Trust (WWH), because biotech growth is volatile and I want to invest in more established companies.

"I have also recently bought LF Woodford Income Focus (GB00BD9X7109) – I am happy to take a contrarian bet on its manager Neil Woodford at present. And I have added to LF Woodford Equity Income (GB00BLRZQC88) as it is a defensive fund with some investments that have growth potential.

“I am considering investing in Perpetual Income and Growth Investment Trust (PLI), F&C Managed Portfolio Income (FMPI), Henderson High Income (HHI), Baillie Gifford Managed (GB0006010168) or Witan Investment Trust (WTAN), and adding to P2P Global Investments (P2P).”

Shaun'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

Chris Dillow, Investors Chronicle's economist, says:

You don't want to make any further contributions to your Sipp portfolio, even though you are quite young. This deprives you of a big way of diversifying risk.

A key reason why some people needn't worry so much about stock market falls is because they can top up their wealth out of their wages. People who save regularly will automatically buy more shares when prices are low. In this way, falling prices are offset because future returns will be higher on a higher stock of wealth.

By not saving you are depriving yourself of this protection. This makes shares riskier than they would be if you were saving.

In this context, it would be dangerous to dump bonds. They offer little income and low prospective returns in normal conditions. But that's not the point of them these days. Their function is to offer some insurance against stock market falls triggered by falls in investors' risk aversion or growth expectations. Complaining that bonds don't pay well is like complaining that your home insurance policy hasn't paid out – it's not supposed to in good times.

Colin Low, managing director of Kingsfleet Wealth, says:

It is good that you have specific objectives, especially as these involve a specific level of income at a defined point in time. These are something that a lot of investors would benefit from.

You should consider adding to your Sipp as this is a no-brainer for obtaining additional returns at no extra cost, subject to you being within the annual allowance limits. Even for basic-rate taxpayers, to invest £100 only costs £80, so they are obtaining 25 per cent growth on the value of their investment from day one.  

You can also take 25 per cent of the value of the fund free of tax at the point of crystallisation. Increasingly, we see people building tax-free cash into income planning through retirement, which assists overall tax-efficiency.

Ben Willis, head of research at Whitechurch Securities, says:

Your investments are comfortably matching your goals at present. The underlying performance of your Sipp portfolio has well exceeded your stated 5 per cent a year growth goal. You can tolerate a high level of risk and with your stated retirement date still more than 20 years away, your Sipp is well positioned to continue in this vein.

With your investment portfolio, you are looking to generate £18,000 a year increasing at least with inflation. I have assumed this is an income target. Your portfolio has a historic yield of around 4.3 per cent and generates an income exceeding £15,000. This is just shy of your target, but your total returns will have far exceeded this figure so you could meet any shortfall with capital. Ultimately, you are more than able to generate the £4,000 needed to cover your four-month salary income hiatus.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Without the partial security that comes from saving, the trade-off between security and decent returns is especially acute for you.

There is a potential answer here – defensive stocks. Higher-yielding defensives have for years made better than market returns with lower volatility than the market. Sticking with LF Woodford Equity Income Fund therefore makes some sense – although there are many other equity income funds that invest heavily in big defensives, some of which you hold, such as Finsbury Growth & Income Trust (FGT).

LF Woodford Equity Income top 10 holdings (%)

Source: Woodford Investment Management as at 31 December 2017

Finsbury Growth & Income top 10 holdings (%)

Source: Frostrow Capital as at 31 December 2017

However, this is not a perfect solution. These funds still carry market risk: if or when shares generally fall significantly so too will defensive funds.

And the good long-run performance of high-yielding defensives might be partly due to investors holding underpriced companies operating in areas with barriers to entry. Examples include big brands such as Diageo (DGE), Reckitt Benckiser (RB.) and Unilever (ULVR), and utility companies and oil majors. That underpricing might now be eliminated, in which case future performance won't be so great.

This latter consideration rules out investing solely in higher-yielding defensives. I would hold them alongside a global market tracker.

Although you are unhappy with your VCTs' performance I would consider some form of unquoted equity fund such as private equity investment trusts. These are a play on the possibility that future growth will come from as yet unquoted shares.

To simplify this portfolio, my first step would be to dump anything with high charges unless you have very good reason to believe the fund manager could beat his benchmark. My second would be to run winners and cut losers: there is shorter-term momentum in many assets. This means dumping anything that drops below its 10-month or 200-day moving average.

And there might be a further reason to follow that rule. In the absence of regular savings and given your reluctance to own bonds, you need some way of protecting yourself from serious bear markets. A policy of cutting equity exposure when markets drop below their long-term moving average does this, albeit at the expense of missing out on the profits of buying on dips.

Colin Low  says:

This portfolio is so diverse that you might as well own every asset on the UK stock market. In which case often a lower-cost passive fund could be a good alternative. But you appear to like the idea of active management and have some high profile investment managers in the portfolio. So rationalising it to 10 to 12 holdings in proportions that achieve an appropriate level of investment risk may be a better structure.

You also have a conviction in investments managed by Neil Woodford. But there are many strong investment managers in the markets in which he invests so consider whether you really want to have all your eggs in one basket. I would suggest reducing your holdings in Mr Woodford's funds and considering other managers.

I can understand your view on fixed income and bond assets, and accept your way of ignoring a falling market. But there are still ways of mitigating portfolio volatility which do not solely rely on fixed-income assets. It would be worth investigating wealth preservation funds run by managers such as Pyrford, Ruffer and Jupiter.

Ben Willis says:

Although your investments are largely achieving your objectives, you recognise that your portfolio is too diversified and needs some streamlining. 

You have 11 holdings in your Sipp and about 40 in your other accounts. You could rationalise the number in your Sipp by cutting one of the funds run by Neil Woodford. I would keep Woodford Patient Capital Trust (WPCT) as it is trading on a high single-digit discount to net asset value and not triggering its performance fee, so is very cheap.

The VCTs have been walloped by Brexit sentiment and you may as well hold them for the dividend tax breaks. However, a number of positions account for less than 1 per cent of your portfolio, such as JPMorgan Chinese Investment Trust (JMC) and Scottish American Investment Company (SCAM). I question as to whether they are making meaningful contributions to the total return. I suggest selling these and reinvesting the proceeds in the established, higher-yielding equity income positions to enhance the portfolio yield.

I agree that Invesco Perpetual Monthly Income Plus is a big overweight, but it is a rich source of yield and contributes nearly 10 per cent of the overall income. I would trim it back to account for around 5 per cent of your assets and use the proceeds to top up Jupiter Monthly Income (GB00B4M78461). This fund also maintains diversification via fixed-interest exposure and offers a comparable yield.

I would look to have just 25 positions in the non-Sipp portfolio with a focus on existing holdings that deliver attractive total returns. I would stick to actively managed funds: with many global equity indices reaching record highs, investing with proven stock selectors could be wise going forwards.