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Don't ruin your returns with Aim shares

Our reader should consider reducing his allocation to Aim shares
August 2, 2018, Tamsin Hazell and Richard Hunter

John is age 36, and he and his wife's salaries amount to £115,000 a year. Their total income can be as high as £150,000, although this varies considerably from year to year. Their home is worth about £485,000 and has an outstanding mortgage on it of £350,000. They hope to start a family within the next three years.

Reader Portfolio
John 36
Description

Isas invested in shares and funds, employer pension, residential property

Objectives

Pay off debts and be financially independent by 55, total return of 7 per cent a year.

Portfolio type
Investing for goals

"I aim to be financially independent by age 55 so that if I work after then it is for extra income rather than because I have to," says John. "I plan to have paid off our mortgage and debts by the time I am 55, and from that time have expenses of no more than £35,000 a year. We will use our home to fund any possible care costs when we are older.

"So assuming I live to about 85, I will need a sum worth about £1.25m by the time I am 55 from which I can drawdown £35,000 a year.

"I am targeting a return of 7 per cent a year with my investments until I am 40, 5 per cent a year between ages 40 and 50, and 4 per cent a year between 50 and 55. I will then seek to preserve the portfolio's capital so I can draw income from age 55.

"About 80 per cent of our non-pension portfolio is held within individual savings accounts (Isas) and we aim for all of it to be inside Isas from the 2019/2020 tax year. I have a defined contribution pension scheme currently worth £80,000, into which I and my employer contribute £17,000 a year in total. 

"We invest £1,250 per month. I and my employer contribute £700 into a shares in partnership and save as you earn scheme which matures in three years. And we put £550 per month into my wife's Isas, including £150 into a Lifetime Isa, equally divided between L&G Longer Dated All Commodities UCITS ETF (CMFP), iShares Core MSCI EM IMI UCITS ETF (EMIM) and iShares Listed Private Equity UCITS ETF (IPRV).

"I reinvest all the dividends we receive."

"When our children are born I will open Junior Isas for them into which I will invest £2,000 a year each until they are 18.

"I have been investing for about seven years, and over the last three my attitude to risk has been very high as my allocation to pre-revenue Alternative Investment Market (Aim) shares shows. I will continue to tolerate the possibility of my investment portfolio losing up to 40 per cent in any one year until I am 40.

"I really enjoy researching and selecting stocks, and I spend five to 10 hours a week reading investment books and magazines, and listening to three investment podcasts. However, I acknowledge that my current asset allocation which includes 42 direct shareholdings, some of which are pre-revenue Aim shares, may be putting my capital at unnecessary risk. So I am reducing my exposure to the Aim shares which currently account for about 30 per cent of my investment portfolio, and aim for them to account for no more than 10 per cent of it by the time I am 40.

"Between age 40 and 50 I would like to have 60 per cent of my investment portfolio in active funds and exchange traded funds (ETFs), and 40 per cent in direct shareholdings.

"For the past three years I have chosen shares in two ways. I have hunted for deep value but this has delivered mixed results, for example, I made a profit of over 200 per cent on Cambian (CMBN) which I no longer hold, but my investment in Capita (CPI) is down 40 per cent.

"I also try to invest in emerging technologies and resources, and many of my holdings in these areas have delivered gains of 300 per cent plus, for example, Versarien (VRS) which I no longer hold."

 

John and his wife's portfolio
HoldingValue (£)% of portfolio
Shares in employer14,9602.27
Direct Line Insurance (DLG)3,0880.47
GlaxoSmithKline (GSK)2,9640.45
Marston's (MARS)2,5700.39
Legal & General (LGEN)2,0830.32
Pets at Home (PETS)2,0170.31
National Grid (NG.)1,9710.3
Card Factory (CARD)1,9120.29
BT (BT.A)1,6640.25
Reach (RCH)1,6540.25
Saga (SAGA)1,5400.23
Tlou Energy (TLOU)5,1170.77
United Oil & Gas (UOG)4,5510.69
Europa Metals (EUZ)2,9260.44
Asiamet Resources (ARS)3,0900.47
FastForward Innovations (FFWD)2,2600.34
Capita (CPI)2,2280.34
Talktalk Telecom (TALK)1,9220.29
Communisis (CMS)1,6150.24
Harvest Minerals (HMI)1,5860.24
1pm (OPM)1,4160.21
Jangada Mines (JAN)1,2730.19
Interserve (IRV)1,0330.16
Utilitywise (UTW)1,0180.15
Ascent Resources (AST)9240.14
Angle (AGL)8700.13
Johnston Press (JPR)7340.11
URU Metals (URU)4770.07
Premier African Minerals (PREM)4740.07
Templeton Emerging Markets Investment Trust (TEM)2,9640.45
Dunedin Smaller Companies Investment Trust (DNDL)2,5090.38
Oakley Capital Investments (OCI)2,5090.38
NB Private Equity Partners (NBPE)2,1320.32
PRS Reit (PRSR)1,8820.28
JPMorgan European Smaller Companies Trust (JESC)2,0620.31
Merchants Trust (MRCH)4,7360.72
Regional REIT (RGL)1,9420.29
L&G Longer Dated All Commodities UCITS ETF (CMFP)1930.03
iShares Core MSCI EM IMI UCITS ETF (EMIM)4640.07
iShares Listed Private Equity UCITS ETF (IPRV)1840.03
SPDR S&P Euro Dividend Aristocrats UCITS ETF (EUDV)6450.1
Residential property485,00073.43
Employer DC pension80,00012.11
Cash3,3000.5
Total660,459 

 

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:

It's good that you're saving a lot, and via monthly investments. Your pension contributions, together with your other regular investments, mean you are on course to meet your objective of a £1.25m pot by age 55. However, this assumes an average real return of 4 per cent a year and there is genuine uncertainty around this prospect. It also assumes that you maintain your current contributions after you have children.

It is a good idea to save as much as you can into tax-efficient wrappers such as Isas and pensions. 

And it's important that longer-term investors reinvest dividends - not that you can do this with many Aim shares. With the FTSE All-Share index, over the long term around two-thirds of returns will probably come from dividends, and maybe more.

In principle it's a bad idea to own lots of shares in the company you work for. You are already investing your human capital in your employer, so if you add your financial capital you end up putting too many eggs in the same basket. However, these considerations are outweighed by your employer subsidy and a tax break. Just be careful that you don't end up with too much exposure to one company.

 

Tamsin Hazell, chartered financial planner at Succession Group, says:

Financial independence by age 55 is a great aim, but if you want to succeed in this you will need to be committed to saving and investing over the next 19 years.

You have built up a good pension fund, and your combined personal and employer contributions are healthy. When retirement planning, it is also important to factor in the State Pension which provides a guaranteed, inflation-linked income.  

However, pensions are just one type of retirement savings vehicle. They offer valuable tax relief but access to them is restricted. The minimum age at which you can draw from a pension is currently 55, due to rise to 57 by 2028. If you want the the option of retiring at age 55 it is important to hold sufficient assets, in addition to pensions, that you could draw on.

Holding as much of your investment portfolio as possible in Isas is a good plan. Where affordable, it makes sense for you and your wife to use your Isa allowances – £20,000 each for the 2018/19 tax year. As with a pension, all returns within an Isa are tax efficient. Your wife's Lifetime Isa, which benefits from a 25 per cent uplift from the government, is a great way to use up £4,000 of her annual allowance. But remember that you cannot access the savings in this type of Isa without incurring a penalty before age 60, unless you use the money to buy a first home.

It is very important to hold an appropriate amount of cash as an emergency fund to avoid the risk of having to draw on investments when they are at a lower value than you would like. Holding six months' worth of regular expenditure in cash is a good rule of thumb.

Taking a higher level of risk now and gradually reducing it in the lead up to your retirement is sensible, as timescale is key. The longer your time horizon, the more scope there is to ride out the ups and downs of investment returns.

You are managing a lot of direct share holdings at the moment and your equity exposure is high. Although you enjoy researching and selecting stocks, self-managing in this way is speculative and creates an extra layer of risk. So to increase diversification I suggest a core and satellite approach. This involves holding the majority of your invested money in collective funds alongside self-managed 'satellite' pots.

 

Richard Hunter, head of markets at interactive investor, says:

You have well-defined and well-planned overall financial objectives. But consider speaking with a qualified financial planner on your overall wealth planning for suggestions on these objectives. For example, on how to achieve further tax efficiency or a plan to increase mortgage payments to remove one of life's largest financial burdens as soon as possible.

But it is also good that you are spending a decent amount of time educating yourself on financial matters.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

It only makes sense to have high weightings to Aim shares if they have changed. I say this for a simple reason. Historically, Aim shares have massively underperformed main market shares. Over the last 20 years an investment in the FTSE All-Share index would have almost tripled your money. The same amount in Aim shares would have made less than 20 per cent. A major reason for this underperformance is that investors have tended to pay too much for the small chance of huge returns from speculative stocks, while under valuing the merits of dull slow growth.

It is possible that investors have wised up to the virtues of defensives. However, I don't see any evidence that they have stopped paying too much for speculative shares. And the recent good run in Aim shares suggests that they might yet again be overpriced. The ratio of the FTSE Aim index to the FTSE 100 index is at near a seven-year high, if we adjust for its long downward trend. Historically, this has been a lead indicator of poor returns on Aim shares.

That said, sentiment comes in waves and rising optimism can mean that overpriced shares become even more overpriced. If you are brave you can ride such waves using a simple 10-month average rule, as follows. Hold Aim shares when the Aim index is above its 10-month or 200-day average and sell them when it is below it. If you use this rule, apply it ruthlessly.

But my preference would be to own fewer Aim shares. It would be a shame if your returns were impaired by duff Aim investments so think about switching from these into main market stocks. Tracker funds can also be a good option.

 

Richard Hunter says:

You seem to have a good understanding of your attitude to risk and you have a strategy for changing your asset allocation according to your changing personal requirements in future years. Your stated risk appetite is high if you can stomach a loss of 40 per cent to your investment portfolio in any one year. But you could mitigate this possibility with a stop-loss order, whereby a holding is sold if it falls by a certain amount, for example, 5 per cent or 10 per cent.

Your target return of 7 per cent a year is punchy.

Smaller companies tend to plough profits back into the business to develop prospects further, instead of returning cash to shareholders via dividends. As such, you hold several companies that yield nothing and the investment portfolio's overall dividend yield is approximately 2.9 per cent. This contributes to the 7 per cent target but means you are relying heavily on your investments' capital performance.

I have counted the shares in your employer among those which do not offer a yield for the purpose of these calculations because you have not said which company this is. These account for a significant portion of your investment portfolio – 16.2 per cent.

The companies you hold which pay a dividend have a healthy average yield of 4.8 per cent, which compares favourably with the average current yield of the FTSE 100 – 3.8 per cent at the time of writing. However, the dividend cover of some of these is of concern. Dividend cover is effectively the number of times a company could pay a dividend to shareholders from current earnings. Generally, a dividend cover of 1.5 or above is seen as perfectly acceptable, whereas anything below 1 suggests that dividends are being paid from reserves which ultimately is unsustainable. However, in some cases the negative figure could be the result of an exceptional item that has reduced earnings such as an acquisition.

For example, Direct Line Insurance (DLG) is yielding 5.9 per cent with a cover of 1.4, Card Factory (CARD) is yielding 4.6 per cent with a forecast cover of 1.2 and Capita (CPI) is yielding 4 per cent with no cover at all, at time of writing.

Having over 40 investments is a touch unwieldy. If you decide to cut the number consider disposing of holdings which are worth less than £1,000, of which there are nine.

But overall this is a broad-based portfolio with reasonably good diversification in terms of business and geography, underpinned in places by some quality blue-chip names.