Match your strategy to your risk appetite

"I invest for capital growth and reinvest dividends," says Anthony. "This year I want to build an eight-foot extension onto my home, and make adjustments to the kitchen and dining room. This should cost about £30,000 but my parents will pay half of this. I also want new carpets and wallpaper, which should cost about £5,000.

"I want to pay my children’s university tuition fees, an expense which should start around 2028. And I would like to pass money onto my children, grandchildren and even later descendants.    

"My aim is to have a highly effective strategic asset allocation to achieve significant capital growth without excess risk – I've read that 90 per cent of portfolio returns come from strategic asset allocation. So I'm I seeking to outperform via a portfolio of investment trusts because I've found some that consistently outperform tracker funds, often with less risk.   

"I'm aware that I should treat the strategic asset allocation for my Isa and Sipp portfolios differently, taking on more risk in the Sipp. However, if I make substantial gains I'd like to use the results of my outperformance sooner than the Sipp's maturity horizon in 30-plus years.  

"My Isa and Sipp are mostly invested in equity funds. I have been bearish on bonds for five years and continue to be concerned about these as quantitative easing is ending – I think this asset will lose money in the next three years.

"I rebalanced my Isa and Sipp at the start of 2018 after spending six months researching and choosing asset classes and allocations. Allocating with most markets at all-time highs makes it tricky to find value, however I'm overweight Japan and Europe, and believe that smaller companies outperform their larger rivals over the long term. These are unusually good times for markets, and I aim to sell out of the market once the end of this cycle comes, but haven't planned how yet.

"I both fear missing out on investment opportunities and buying too high. And I am concerned when markets go down more than 7 per cent in a month, although I would be prepared to lose up to 15 per cent in any given year. But if an investment lost more than that I would consider that it's time to sell it.

"I own one share to remind myself that I'm better off choosing quality managers of established investment trusts because I don't have the training, resources, experience or confidence to invest directly in equities."

Anthony'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:

The big problem with this portfolio is the mismatch between your asset allocation, which is mostly in equities, and your appetite for risk. You're prepared to lose up to 15 per cent in a year. Your lack of risk tolerance is not unreasonable. You don't seem to be making regular contributions to your Sipp and Isa which deprives you of a possible hedge against falling prices – the ability to buy when prices are depressed and expected returns are high.

I fear that you misinterpret the claim that strategic asset allocation accounts for the bulk of portfolio returns. The asset allocation decision that matters is how you allocate your wealth between risky assets such as equities and safe ones such as cash. This is because if the market falls significantly, so too will pretty much all shares and funds which invest in them. What's more, most investors diversify across shares and funds, thereby diluting the impact upon their portfolio of share or fund selection.

From this perspective, your high equity weighting is equivalent to an ultra bullish view on world equities.

It's very possible that the market will bounce back from its recent spill as investors realise that fears of higher inflation and interest rates are overdone. And the dividend yield on the FTSE All-Share index is above its long-term average, which points to an above-average chance of decent returns.

But at least two lead indicators of returns on global equities are sending worrying messages: the ratio of global share prices to the money stock has been high recently, as has foreign buying of US equities. And I'm not sure that lead indicators are positive enough to justify so high an equity weighting.

There are some other indicators you might want to consider.

Investment trusts' discounts and premiums to net asset value (NAV) have been good indicators of investor sentiment. A high premium or low discount on a trust can be a sign of excessive optimism, hence of a fall not just in the trust itself but in the shares it holds. What matters here is the discount/premium relative to the trust's own history as there are many reasons why discounts vary across trusts. This argues for reducing exposure to those trusts whose discounts are unusually low.

Then there's the 10-month rule. If a fund's price falls below its 10-month or 200-day moving average, it might be a sell signal. Mebane Faber at Cambria Investment Management has shown that following such a rule would have beaten a buy-and-hold strategy with the S&P 500: the same has been true in recent years for the FTSE All-Share index.

Such a rule can get you out of equities before protracted bear markets so protects you from the worst losses. It does this at a price – you miss out on possible profits from buying on dips. Where markets are driven by sentiment and momentum, however, the gains from avoiding serious bear markets outweigh the losses from missing out on dips. This is especially true of those assets that are most sensitive to investor sentiment, such as biotech and technology stocks.

So you might well be taking on too much risk. Consider reducing it.

Philip Milton, chartered wealth manager at Philip J Milton & Company, says:

Your pension is your best option at the moment as tax relief is the best investment return you'll ever receive and the whole pot is accessible at age 55. However, I would suggest not touching it at that point and spending other assets first. Even with zero earnings you can still contribute £2,880 a year plus tax relief to a pension.

A target of about  7.5 per cent a year, in theory, is not greedy.  A balanced portfolio should be able to generate a yield of 3 per cent to 4 per cent a year even now, so with some inflation and economic growth the extra 3 per cent is not a great challenge over a sensible timescale. 

If a balanced allocation – money from a wide basket of different financial assets produced regardless of short-term capital movements – generates enough income to pay the bills when added to other income, then you should be comfortable. There is also great scope for the capital to look after itself and grow to help fund costs such as replacing items, university and helping your children. 

Your portfolio is mainly allocated for growth at higher risk so attaining around 7.5 per cent should be easier, but subject to greater short-term fluctuations along the way. However, your strategy doesn't reflect your risk aversion. Be wary of confusing pure gambling with investing – by all means have a few pounds invested in more speculative assets but don't think that a spivvy penny share is part of a balanced strategy – it's the icing on the cake, perhaps for a bit of fun. If you cannot handle losses above a relatively small sum, you shouldn't invest in certain areas, many of which you hold.

So either change how you view the overall strategy or reform your approach to avoid doing the wrong things. Sometimes when a direct stock halves you should buy more, rather than panic and sell. 

You seem to be more driven by momentum rather than fundamentals, and while this strategy has worked well over the last few years it doesn't mean it will continue to. 

Peter Savage, chartered financial planner at Fairstone Northern Ireland, says:

Based on your time-specific objectives, I would increase your cash allocation to provide for the expenses you will face later this year, which are more than you currently have in cash. You don't want to have to encash your assets after a sudden market fall when the portfolio has fallen in value. You are investing in areas that in volatile markets could easily breach your capacity for loss. By selling out at a potential 15 per cent loss in any one year you may miss out on the recovery – especially if it's not a full market crash.

Whether you invest your Isa and Sipp in the same way depends on your investment objectives. For example, if you are investing for retirement with your Isa as well, then a similar approach would be suitable. This would mean you have money in two different tax wrappers and help you to withdraw income more tax efficiently. But if you have expenses such as paying university fees, which will occur before you can access your Sipp, then you may want to have different strategies in your Sipp and Isa. But again, this depends on your time horizon.

For your ultra long-term objectives, investing in the Sipp and using the death benefits to leave capital to your children and grandchildren would allow the capital to remain outside your and future generations' estates, thus avoiding any potential inheritance tax liability.

HOW TO IMPROVE THE PORTFOLIO

Philip Milton says:

I don't think you are sufficiently diversified. We would spread your money far more widely to try and reduce risk and access more opportunities. For example, you could take some value punts via exposure to Turkey, Russia or Latin America – areas that could double or halve. If you only have a small amount in them your portfolio's overall downside won't be huge if they fall, but each £1,000 to the upside is a meaningful part of the overall return.

Why have the same holdings in your Isa as in your Sipp? This means you spread risk less. No one fund manager can be the best for ever, and there are plenty of different styles and choices to choose from. You could take very long-term views with some things and shorter ones with others.  

Establishing a business can cost money so you may require a greater safety net and cash reserve at this stage to help the venture prove itself.

Some capital preservation is an essential component in a portfolio. If you don't want bonds consider areas that could give you a better uncorrelated income return, for example, funds focused on reinsurance assets or peer-to-peer lending. Options include P2P Global Investments (P2P), Ranger Direct Lending (RDL), SQN Asset Finance Income (SQN) or SQN Secured Income (SSIF). 

I like investment trusts, but bottom-fish and don't chase trendies. I buy good assets at a discount to the market which looks like it is not justified. If the discount doesn't narrow I still get the return on more than the investment I made. And if the discount comes in it is like a bonus. 

I wouldn't invest in most of what you hold as I think there are better opportunities. I might hold BlackRock Frontiers Investment Trust (BRFI) in the Isa. I would consider having BlackRock Smaller Companies Trust (BRSC) in the Sipp but I think there are other discount plays that are attractive in that area. I would hold JPMorgan European Smaller Companies Trust (JESC) but not add to it.

Peter Savage says:

It is true that the majority of returns are based on asset allocation. And global investment trusts such as Scottish Mortgage (SMT) and Monks (MNKS) allow your portfolio to benefit from their managers' expertise in asset allocation. They also diversify your portfolio and reduce risk. 

Investment trusts have outperformed passive funds recently but they have a risk that the latter doesn't – gearing – taking on debt. Gearing can increase returns when markets are rising but also increase losses when markets are falling.

You have a large exposure to smaller companies, and although they have had a number of all time highs in recent years they are more volatile than large caps because they are riskier businesses. Periods when it's better to be invested in smaller companies include when the economy emerges from recession as they can respond to a positive environment more quickly. But it may be better to invest in more large-cap stocks in periods of volatility or when you need more stability, especially when economies turn.

Increasing your exposure to UK stocks would reduce your portfolio's currency risk. You aim to sell out of the market once the end of this cycle comes, but haven't planned how to. It is difficult to time the market so consider introducing more defensive and conservative investments gradually, such as Temple Bar Investment Trust (TMPL). This would increase your UK equity exposure, reduce currency risk and allow you to lower the volatility of your portfolio during the downturn of the cycle.