Cheap ways to diversify globally

"We enjoy good health, but have an expensive lifestyle, that includes keeping dogs, horse-riding and walking,” says Charlie. “We estimate that we will to need to draw about £15,000 from the portfolio every year to cover regular expenditure in excess of our pension income.

"We think our NS&I Index-linked Savings Certificates, which are linked to retail price index inflation (RPI), should generate about £16,000 tax free this year, which is enough to cover our income shortfall this year. I intend to cash in enough certificates each year to cover any income shortfall, while reinvesting all equity dividend income. So I think we should be able to sit out even the most extreme market events without losing any sleep – I think I could tolerate a Wall Street crash scenario.

"We make full use of the individual savings account (Isa) allowance and plan to 'bed and Isa' the direct share holdings with the highest dividend yields in April each year."

"Assets worth about £550,000 are held in two Isas, one in my name and one in my wife's, and we retain all dividends within these tax wrappers," continues Charlie. "The rest of the investments are held in a joint investment account." 

"I think it makes sense to plan around a 30-year time horizon. But perhaps in around 20 years we will need our financial affairs managing. We have arranged Power of Attorney in respect of our financial affairs with a local firm of solicitors but they are not investment managers.

"As a result of a recent inheritance, about 85 per cent of the equity investments in our portfolio by value are now in UK equities, so I am concerned that our allocation to the home market is too high. I am considering reallocating the portfolio as follows over the medium to long term: UK 50 to 70 per cent, US 15 to 30 per cent, emerging markets 0 to 15 per cent and rest of the world 0 to 10 per cent.

"I would allocate to these areas with dividend income as it comes in and by gradually selling off our direct share holdings, making use of the annual CGT allowance, and reinvesting the proceeds.

"I plan to mostly get exposure to these areas via index tracking or exchange traded funds (ETFs), but wondered how to go about selecting the best ones. I have been investing for more than 40 years but have only recently started investing in ETFs, of which there seems to be a large number listed in London, so am feeling my way in this area.

"During the last year I have sold small holdings in Wm Morrison Supermarkets (MRW), United Utilities (UU.) and Shire (SHP), and trimmed a large holding in Royal Dutch Shell (RDSB). And unless its price goes up I will ditch IMI (IMI), as my allocation to this is too small to be meaningful. I plan to sell all the direct share holdings by 2040 and be wholly invested in index trackers. But at present I am reluctant to sell UK equities yielding about 3.5 per cent on average especially if this results in reinvesting in US tracker funds yielding significantly less, at a time when that market may be due a correction. Where could I hold the dividend income in the short term while I wait for the US equity bubble to pop?

"I recently have added to my holdings in SPDR S&P US Dividend Aristocrats UCITS ETF (USDV), Invesco EQQQ NASDAQ-100 UCITS ETF (EQQQ), Legal & General (LGEN), Lloyds Banking (LLOY) and CVS (CVSG).

"And I am thinking of adding to my holdings in Fidelity Emerging Markets (GB00B9SMK778), Legal & General Global Emerging Markets Index (GB00B4KBDL25) and the US ETFs.

"I also wondered if it would be more tax efficient, as well as a more enjoyable use of our capital, to sell 40 per cent of our UK equity investments and use the proceeds to help finance a move to a more expensive property?"

Charlie and his wife'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

Alan Miller, chief investment officer of SCM Direct, says: 

You could be paying less in charges than you currently do, some of the index trackers are quite expensive. For example, M&G Index Tracker (GB0031110843) has an ongoing charge of 0.51 per cent whereas Lyxor Core Morningstar UK NT UCITS ETF (LCUK), which invests across 97 per cent of the UK market by size, has a charge of just 0.04 per cent a year.

Paul Taylor, chief executive officer of McCarthy Taylor, says:

With regard to protecting against downside risk in equity markets, historically residential property has not fared well in periods of rising interest rates, although past performance is not necessarily a guide to the future. We also think that residential property is overpriced and Brexit may lead to a further correction, with London prices having fallen already. We have very little exposure to residential property within our portfolios.

Commercial property, however, is not necessarily correlated with interest rates, so we would have an allocation to commercial property in the portfolio. One of the ways we currently get our clients' exposure to this asset is Legal & General UK Property (GB00BK35DT11). 

HICL Infrastructure Company (HICL), meanwhile, is UK focused and holds up well in down markets. It has a yield of over 5 per cent.

Jason Witcombe, chartered financial planner at Progeny Wealth, says:

I would be reluctant to cash in any NS&I Index-linked Savings Certificates. These provide a tax-free return, keep pace with RPI inflation and are backed HM Treasury. I try to think of portfolio construction in quite simple terms: mixing defensive assets such as cash and bonds with growth assets such as equities and property to achieve the desired blend of risk and reward. NS&I Index-linked Savings Certificates are an excellent defensive asset and, as they are no longer on general sale, think carefully before you cash them in.

The possible house move should be more of a lifestyle than financial decision. You are in an excellent financial position and if a more expensive property would give you a better standard of living, then consider it. 

Equally, it looks like you could afford to increase your annual expenditure without making much of a dent in your capital. Even if you don’t want to spend more money on yourselves, you might want to start making some charitable donations during your lifetimes, perhaps setting up a charitable trust, rather than dealing with that solely through your wills.

Your financial position gives you a huge amount of choice, and the more that you both have clear objectives around your goals, values and aspirations, the better use you will make of the money.

HOW TO IMPROVE THE PORTFOLIO 

Alan Miller says:

Given 85 per cent of the your equity exposure is in UK stocks, you're right to diversify; emerging markets, Japan and Europe offer good value.

However, I would be very nervous about Invesco EQQQ Nasdaq-100 UCITS ETF because many tech stocks are very fully valued at present. One of the two largest stocks in the NASDAQ index is Amazon (US:AMZN), which has risen 74 per cent so far this year and is valued on 116 times its 2018 earnings.

I would also sell M&G Index Tracker, which has underperformed the FTSE All-Share in four out of the last five 12-month periods, and charges significantly more than most of the other tracker funds in your portfolio.

I would look to take advantage of the huge gap between so called growth stocks and value stocks, in terms of performance and more importantly valuation. Over the past year the average global growth stock has risen in US dollars by 19 per cent against just 8 per cent for the average value stock. You can get exposure to value stocks via Vanguard Global Value Factor UCITS ETF (VVAL), an actively managed global equities ETF with a charge of 0.22 per cent. It selects shares based on various fundamental measures of value and the average price/earnings ratio of its holdings is just 10.3 times, while their earnings growth rate is around 8.9 per cent a year.

NS&I Index-linked Savings Certificates protect against significant rises in inflation. There are various possible economic scenarios that might give rise to this, including a hard Brexit or a change of government.

You could consider redeploying some of the 9.5 per cent of the portfolio you hold in cash deposits in an ETF that tracks shorter term US corporate bonds, hedged back into sterling to avoid currency risk. UBS Bloomberg Barclays US Liquid Corporates 1-5 Year UCITS ETF (hedged to GBP) (UC82) tracks bonds with an average maturity of just 3.3 years.

Paul Taylor says:

Better geographical diversification of your equity exposure would be beneficial. 

We tend to avoid investing in broad emerging markets funds because we prefer to select the countries we believe have the most potential for growth such as China and India, while avoiding the likes of Russia and Latin America. Since these markets are not as efficient as developed ones we use actively managed rather than passive funds. Funds we like for getting exposure to these areas include Fidelity China Consumer (GB00B82ZSC67), which has returned 78.53 per cent versus the Investment Association (IA) China/Greater China sector average of 63.24 per cent over five years (as of 13 September). It has an ongoing charge of of 1.01 per cent.

We also like Schroder ISF Indian Equity (LU0264410993), which has an ongoing charge of 1.36 per cent.

As well as UK and US exposure, we would suggest allocations to Japan, Asia Pacific ex-Japan and Europe.

You could achieve further diversification by adding exposure to commodities. We do this via Invesco Physical Gold ETC (SGLP) which tracks the performance of the gold price and has a net expense ratio of 0.29 per cent. Gold has recently traded near its one-year low.

Legal & General UK Index Trust (GB00B0CNGM05) and M&G Index Tracker both track the FTSE All-Share Index. However, Legal & General UK Index has an ongoing charge of 0.1 per cent whereas M&G Index Tracker's A  share class has one of 0.51 per cent. The difference in charges goes a long way to explaining why Legal & General UK Index outperformed M&G Index Tracker over the past five years. An even cheaper option is Vanguard FTSE UK All Share Index (GB00B3X7QG63) which has an ongoing charge  of 0.08 per cent.

Jason Witcombe says:

I agree with having a more globalised investment approach in your portfolio, but retain a reasonable home bias to the UK. An allocation of 50 per cent to 70 per cent to the UK seems high, though, particularly as the UK stock market is dominated by a few very large companies. For example, the largest five companies in L&G UK Index Trust account for more than 25 per cent of its assets. Its largest sector allocation, financials, also accounts for around 25 per cent of its assets.

Investments in overseas assets should simply aim to follow the asset allocation of a global ex-UK index. This way, the overseas equities would be diversified across companies, sectors and countries in line with their market capitalisation, without you needing to make any active decisions around which companies, countries or sectors to buy or sell.

You might also like to include some commercial property exposure for extra diversification, and some value and small companies exposure to try to boost long-term returns.