Invest more in pensions

"We will not need to draw a retirement income from our investments, but I want to use mine to allow me to retire earlier than age 65," says Susan. "My goal is to accumulate enough capital to provide a sufficient income for three years so I can retire at age 62. My final-salary pension does not start paying out until I am 65 and I plan to defer drawing from pensions until that age, if possible.

"I need a large enough sum to provide an income of about £30,000 a year for three years, so I am aiming to have about £90,000 in 12 years' time, which I will draw down in lieu of a pension. My portfolio is currently worth about £35,000 and I invest £200 a month into it. I hope to achieve growth of 4 per cent a year, which should help me accumulate almost £90,000 at my current rate of investing.

"I also have a small self-invested personal pension (Sipp), mainly to benefit from tax relief. I prefer to invest mostly in individual savings accounts (Isa) because I could withdraw funds from them if necessary. I also have a cash Isa worth £15,000 for emergencies, into which I invest £50 a month. It has an interest rate of 0.9 per cent.

"As I have 12 years until I draw from my investments I think they can have a higher risk profile than in, say, five years. I could tolerate losing 10 per cent to 15 per cent in any given year at present.

"I have tried to diversify the portfolio geographically in terms of the funds I hold and, for example, recently invested in Stewart Investors Asia Pacific Leaders (GB0033874768). 

"I put small amounts into individual shares, some of which do well and others which don't, but this is mainly for fun. Recent purchases include Chromic (KMK) and I recently sold Hikma Pharmaceuticals (HIK).

"In terms of future investments, I like the look of infrastructure and environmental funds, so I am thinking of investing in NextEnergy Solar Fund (NESF) and Impax Environmental Markets (IEM), as well as Phoenix Spree Deutschland (PSDL).

"I am trying to reduce my UK exposure because of concerns on Brexit, and am investing more in global funds. I also avoid tobacco and the arms industry where possible."

Susan'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:

Your objective seems feasible. If you invest £200 a month for 12 years your portfolio will grow to around £90,000 in 12 years' time, if you get a 4 per cent average annual return. Adjusting for inflation, which is what matters over long periods, this is what you should get with average luck from an equity-heavy portfolio.

But I am worried by the composition of this portfolio. It's overdiversified, with more than 40 different holdings. This means your shares and fund selections are largely a waste of time.

Because the average size of the investments is small, even if one of these doubles in price over 12 months – which would be a fantastic achievement – it would add only 1.2 percentage points to your overall returns. That's only the difference between a moderately good and moderately bad day. This means that the day you take money out of the portfolio will make more difference than stock or fund selection.

Overdiversification is also expensive. It means you incur dealing fees on individual stocks. And you pay fund fees without the benefit of additional returns. In an overdiversified portfolio, even if a fund beats the market its contribution will be largely diluted away.

Your stock selections are "mainly for fun". This poses the question: why should you be paid for having fun?

I'm also unsure how wise it is to minimise UK exposure. Our economy's growth prospects are not good. And UK stocks have less monopoly power and less of what Warren Buffett calls 'economic moats' than US companies. This, I suspect, is a major reason why the UK has under-performed the US in recent years.

However, years of underperformance means that UK valuations are now low relative to much of the rest of the world. So perhaps the UK's poor prospects are fully priced in or maybe even over-discounted.

I am not wholly convinced by infrastructure funds. These carry political risk in the UK as a Labour government wouldn't be keen on the private sector making big profits from infrastructure projects.

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

You need to ensure that you have enough income to cover the period from when you retire at age 62 until your final-salary pension starts to pay out at 65, and that your final-salary pension is sufficient to cover your expenditure between 65 and when your state pension starts to pay out at 67.

You are targeting an income of £30,000 a year between age 62 and 65. A sum of £90,000 is required to achieve this in today's terms, although if you want this amount in real terms, taking inflation into account, then you should aim for a lump sum of about £120,000. To reach £120,000 in 12 years you would need investment growth of 6.5 per cent a year after charges or to increase your monthly contributions to £350.

You have about £38,000 invested in your Isa and pension, and are saving £200 each month. If you achieve your target growth of 4 per cent a year after charges you should have a lump sum of about £94,500 at age 62.

For most people the best approach to long-term savings is a combination of pensions and Isas. You prefer Isas because they allow you to withdraw money from them if you need it. However, you are missing out by not investing more in pensions.

A major benefit of pensions is initial income tax relief at your marginal rate on contributions. As some of your income is likely to be subject to higher-rate tax, you would benefit from 40 per cent tax relief on this amount.

Pension freedoms also mean that you could access the money in your Sipp from age 55 – in only five years' time.

25 per cent of your pension fund can be withdrawn tax-free and the rest is taxable at your marginal rate. However, if your sole or main income between ages 62 and 65 comes from your Isa portfolio, these payments would be tax-free, so you would be a non-taxpayer. This would mean you could make further withdrawals from your pension with no tax to pay.

Tanya Pein, investment adviser at In2 Planning, says:

Good predictors of success are planning ahead and articulating clear financial goals, so you are already well on your way. Your growth target is not in real terms so do factor in inflation, which is predicted to rise over your 12 year investment period and may be exacerbated by Brexit transition and departure factors.

Also to review what progress you are making towards your target at least annually so you can adjust your plans in good time when necessary. There are three main things you can do to help stay on target: increase your savings rate of £200 per month; take more risk, but accept that you may undershoot your target if things don't go well; or reduce your income target of £30,000 per year.

Set a strategic asset allocation that is in line with your attitudes to investment risk, and document your reasons for this, which you can revisit when you conduct your annual review.

As well as your financial goal you have ethical concerns, and prefer your retirement income not to include profits from the tobacco or arms industries. You also wish to do good at the same time as trying to make money by investing in environmental and infrastructure funds. It is very common to express ethical preferences in supermarket and other shopping, so logical to also include these preferences in your investment portfolio. After all, they are part of how you live your life and what legacy you leave to the next generation.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

To better organise this portfolio, one option is to put £200 a month via direct debit into a global equity tracker fund, and/or an ethical equity fund. And. if you don't want a 100 per cent weighting to equities, a bond fund. And leave them alone.

If that sounds too boring, there are other things ways in which you could improve this portfolio, such as simplifying it. Start by taking a very sceptical view of higher-charging funds: are there strong reasons to justify their fees? What are they offering you that your other assets don't? Do they produce higher returns or reduce portfolio risk? Exposure to a particular market segment is not in itself necessary. 

Also, make sure that momentum works in your favour: cut losers and run winners.

Patrick Connolly says:

You have far too many portfolio holdings. Although you acknowledge the benefits of diversification, having so many investments makes the portfolio unwieldy. And investing small amounts in individual shares means your dealing costs will be higher.

It is concerning that you have so many direct shareholdings that you buy mainly for fun. You need to decide whether you are serious about achieving your retirement goals and, if you are, I would suggest selling all of your small individual shareholdings.

You can take a reasonable degree of risk, although not excessive amounts. And you could achieve your goals by holding between six and eight funds.

The passive funds in your Sipp are good choices. But if you are concerned about holding tobacco or arms companies then consider global ethical funds such as F&C Responsible Global Equity (GB0033145045), Janus Henderson Global Sustainable Equity (GB00B71DPP64) and Vanguard SRI Global Stock (IE00B76VTN11).

To provide extra diversification you hold funds such as Fidelity Moneybuilder Income (GB00BBGBFM09), Jupiter Strategic Bond (GB00B2RBCS16) and M&G Property Portfolio PAIF (GB00B8FYD926), which are all good choices. You could also consider Rathbone Ethical Bond (GB00B77DQT14).

Tanya Pein says:

Since basic rate and higher taxpayers have a yearly £1,000 and £500 tax-free allowance on interest from cash, holding this asset within an Isa is not a priority with interest rates so low. So you could hold £15,000 for emergencies in a general savings account, taking advantage of the higher interest rates available from several building societies and banks. You could then convert your cash Isa into a stocks and shares Isa, boosting your investment returns. But follow the Isa rules carefully when making the switch to ensure you do not lose your Isa rights.

Then consider the management of your portfolio. You have about 20 funds and 20 direct shareholdings, and 40 is a high number of investments to review on an ongoing basis. So I would suggest having around 20 diversified investments, at most, in a global portfolio, otherwise you will have to devote a large amount of your leisure time to monitoring these.

There are a number of funds covering many asset classes that allow you to express ethical values. They include ones that exclude the tobacco and arms industries, funds that integrate environmental, social and governance (ESG) factors into their stock selection, and ones that focus on a strongly performing sustainable area such as renewable energy. The growth rate of such investments has outperformed the market in the last few years, and this trend looks set to continue. So it could be a sound investment approach to take, both from a financial and personal satisfaction point of view. Promising sectors for you to consider include infrastructure, water, timber, renewable energy and environmental protection.

Also consider investing in areas you are interested in learning about. If you're spending time managing the portfolio yourself, it should at least be enjoyable.