Your portfolio has little chance of making 5% per cent a year

"We have sufficient income for our day-to day needs from our pensions and rental income,” says Peter. “We don’t have an extravagant lifestyle, but enjoy travelling and spoiling the grandchildren. We’d also like to have sufficient capital to fund care costs when we are older, if necessary, and leave a legacy to our family.

"So we’d like our investment portfolio, excluding our buy-to-let property, to generate a total return of 5 per cent a year, and to preserve its capital value as much as possible in case we need care when we are older. But we’d like to continue our far-flung holidays and fund them by cashing in investments, perhaps worth 5 per cent of the total capital value a year.

"Preservation of capital is a prime goal but I expect stock market turbulence. We wouldn’t like to lose more than 10 per cent in any one year and normally make use of stop-losses, which sometimes means we forego recoveries in our holdings.

"I try to keep the majority of our investment portfolio, excluding our buy-to-let property, in tracker funds and cash, alongside some active funds and direct share holdings that are mainly defensive in nature. I aim to have exposure to a geographically diverse range of equity markets, together with some companies that look like recovery stocks. But although I have been investing on and off for 30 years I am not always successful at finding recovery situations and have sold some holdings at a loss. I still hold Saga (SAGA), though, of which the price is lower than when I bought it.

"I have recently added L&G ROBO Global Robotics and Automation UCITS ETF (ROBG) and Legal & General (LGEN), and topped up my holding in GlaxoSmithKline (GSK). But I want to use our full annual individual savings account (Isa) allowances, and will probably do this by adding to our existing holdings, depending on movements in markets.

"My holding in Edinburgh Worldwide Investment Trust (EWI) is up 46 per cent since I invested in it so I may take some of the profit and redeploy it in another investment. In the next tax year, I’ll also sell some of our NS&I Premium Bonds and reinvest the proceeds in investments within our Isas."

Peter and his wife's investment 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:

As it stands, your investment portfolio, excluding the buy-to-let property, has very little chance of meeting your objective of a 5 per cent total return. This is because more than half of it is in assets that probably offer negative real returns – gold and cash. The NS&I Premium Bonds, for example, pay 1.4 per cent nominal interest on average which means that if inflation averages 2 per cent a year you need better than average luck just to get a zero real return.

To achieve a 5 per cent real return, with average luck, requires something close to a 100 per cent weighting in equities.

If all this seems to point to the need to increase your equity weighting, something else speaks against this. You don't want to lose more than 10 per cent a year. Being fully weighted in equities would, however, expose you to such a danger with around a one-in-six chance of this.

So you might want to consider raising your equity exposure a little, trading off the increased chance of a 10 per cent plus loss for better average returns – as long as you are comfortable holding more equities.

If you are, I suspect that now would be a decent time to increase equity exposure. Not only are we at that time of year when equities are cheap, but also at least two good lead indicators predict decent returns: the dividend yield on the FTSE All-Share index and foreign buying of US equities, although the global money-price ratio is still a little worrying.

If you wait for the new tax year before buying you might do so at higher prices. It is a good idea to use tax shelters but you cannot let the tax tail wag the portfolio dog. Don’t distort investment decisions for the sake of tax advantages.

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

You have sufficient income to meet your day-to-day living costs without relying on your investment portfolio. This means that you can take greater risks without impacting your future standard of living. However, capital protection is important as you and your wife plan to use the investment portfolio to fund care costs, if necessary, and holidays, and to provide inheritances.

You have £124,500 in cash or cash-equivalent holdings. This provides a strong degree of capital protection in absolute terms, although could be losing money in real terms after inflation is taken into account. This is because the bulk of this money is in NS&I Premium Bonds, although you hold some NS&I Index-linked Savings Certificates as well. The average return on Premium Bonds is currently 1.4 per cent a year, although most holders will be earning less. You need to have cash savings, although I think it is all right to sell some of your Premium Bonds to fund next year’s Isa allowances.

Rethink your stop-loss strategy which, while a defensive plan, smacks more of short-term trading than long-term investing. What matters is the long-term performance of your overall portfolio – not the short-term performance of individual holdings. Instead of selling if an investment falls, consider investing more via rebalancing, where you take profits from investments that have performed well and reinvest the proceeds in ones that have done badly.

Alan Solomons, chartered accountant and independent financial adviser at Alpha Investments and Financial Planning

Your goal of a 5 per cent annual return is achievable. However, this aim does not match your attitude to risk. You are comfortable losing up to 10 per cent in any one year. But stochastic analysis of the last 100 years of returns shows that with this level of volatility you could only expect a return of just over 4 per cent a year.

To get a return of 5 per cent a year over the long term you would have to be comfortable with losing 12.65 per cent in some years. Coincidentally, that is what my risk assessment software says your portfolio is designed to do. All these figures are with a 95 per cent confidence level, which means in 95 years out of a hundred you would not lose more than 12.65 per cent. It is possible to create portfolios with 95 per cent confidence that this would be achieved. Special software analyses your portfolio to ensure that it is within your tolerance limits.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

If you decide to increase your equity exposure a global tracker fund should be your first choice, unless you can do better. You do not need to find good specific investments to increase your equity exposure. 

One stock, GlaxoSmithKline, accounts for over one-fifth of your existing equity holdings. Although it is one of the least volatile stocks on the market this exposes you to more stock-specific risk than many investors have, and I’m not sure this is wise. Given that GlaxoSmithKline is one of the best-researched shares in the UK it’s hard to believe you know more about it than professional fund managers. So why have a greater allocation to it than many of them?

Also, your equity exposure has a greater allocation to Japan and emerging markets than that of many other investors. This means you are taking on the risk of a Chinese slowdown forcing shares down even further. I’m not sure this is wise, either. There is a risk of a further escalation in the trade war, rising US interest rates could hurt emerging markets and the slowdown in Chinese monetary growth warns of weak growth in that country. This would have nasty knock-on effects on Japan. Although I’m moderately optimistic about equities generally, I’d be uncomfortable with this exposure. Personally, I’d consider reducing it in favour of UK or European equities.

Patrick Connolly says:

You have £58,000 in physical gold. I understand the arguments for holding gold and some of the fundamentals needed for it to perform well are in place. There is continued demand from sovereign nations, uncertainty surrounding much of the global economy, significant geopolitical risks including escalating trade wars and the outlook for other assets is mixed.

But still consider reducing your weighting to gold, perhaps to a maximum of 10 per cent of your portfolio. Despite gold being considered a safe haven, its price has been volatile over many decades with investors making or losing large amounts of money over relatively short timescales. The price of gold reached over $1,800 (£1,387) in 2011, fell to around $1,100 at the beginning of 2016 and [at time of writing] stands at around $1,230. This is very volatile for a what is supposed to be a safe asset. Also remember that gold doesn’t produce any income, interest or dividends.

Over a quarter of your equity holdings are in direct share holdings, with about two-thirds of this in GlaxoSmithKline. Having a significant weighting in individual shares is high risk as GlaxoSmithKline's share price shows. It stood at 1,708p in June 2017, fell to 1,290p in March 2018 and [at time of writing] is around 1,500p. Consider selling your direct share holdings, and instead investing in funds or investment trusts.

You are considering taking profits on Edinburgh Worldwide Investment Trust because your investment in it has done well. This trust is managed by Baillie Gifford, an excellent growth manager, and it invests in smaller companies. When this style is in favour it performs well, but it can be subject to significant losses during bad times, as evidenced by a 16 per cent fall over October. It’s fine to hold this investment trust but it should be balanced by holdings with different investment styles such as value and different asset classes.

If you sell your direct shareholdings, and reduce your exposure to gold and Japan where you are overweight, you could reinvest the proceeds in other funds such as Investec UK Special Situations (GB00B1XFJS91) and increase exposure to Europe by topping up your existing holding in HSBC European Index (GB00B80QGH28). You could also diversify into other asset classes with funds such as Jupiter Strategic Bond (GB00B544HM32) , Rathbone Ethical Bond (GB00B7FQJT36) and Janus Henderson UK Property (GB00BP46GG64).