Your target return is too ambitious

"My wife and I would like to retire in six to eight years,” says Douglas. “We want to maximise the returns our investments make so when we retire we can draw an income from them of 3.5 per cent a year. We are also saving for our children’s education in my individual savings account (Isa), and they each have a self-invested personal pension (Sipp) and Junior Isa into which we make monthly contributions.

"In 2015 I transferred my employer pension to a Sipp because the funds it was invested in were performing poorly and it had high fees. I invest about £2,000 per month into the Sipp via salary sacrifice to maximise the contributions. My wife invests about £300 a month into her Isa, and we both top up our Isas if we receive bonuses.

"I want to grow my Sipp to a value of £500,000 so I am trying to make a return of 8 per cent to 10 per cent a year with my investments. I want the maximum possible growth from asset appreciation and dividends with an acceptable level of risk.

"I have a 1 per cent stake in my employer, from which the dividend payment is very good but this money is not held in the UK. I will have to sell this holding when I retire from the company so I can’t rely on this as a retirement income stream. We expect to use this money to purchase a new house. I have about £150,000 in foreign cash which I do not plan to repatriate. 

"My wife wants her pension and Isa to have a total value of £400,000 by the time she retires. She doesn't plan to draw from her defined contribution pension, which she got from a former employer, at age 55. She is risk averse but her Isa is only invested in Scottish Mortgage Investment Trust (SMT). 

"I would be prepared to lose 10 per cent of the value of my investments in a market correction. The correction in February didn't concern me, but I will be worried about my high equity exposure if the next correction is larger or more prolonged. Only 2 per cent of my Sipp is allocated to cash in contrast to 16 per cent of my Isa, although normally I try to allocate 5 per cent of each to cash. I am considering taking profits on some of the investments in my Sipp and Isa, and holding a quarter of each of them in cash. But to meet my growth target I need to stay invested and accept risk even as I approach retirement.

"In my Sipp I have recently reduced  Scottish Mortgage Investment Trust, JPMorgan Japan Smaller Companies Trust (JPS), North American Income Trust (NAIT), Monks Investment Trust (MNKS) and Murray International Trust (MYI) to lock in some profits. Because of my fear of a big market correction I thought it was prudent to lock in some gains. 

"I sold Rolls-Royce (RR.) in June when its share price was high and some of my holding in Kape Technologies (KAPE) when it hit a 52-week high in May.

"I avoid direct share holdings in my Sipp and Isa, which I rebalance once a year. I have 20 to 25 holdings in the Sipp to keep it manageable and have many of the same holdings in the Isa. I like conviction investing because it forces me to review my assumptions and prevents me from buying too many holdings. I trade the investments held outside tax wrappers more.

"To mitigate risk in my portfolio I buy investment trusts that are well diversified. These have given us good returns so we will continue to favour them. I have tried to diversify across geographical markets, and largely avoided trusts with a narrow focus and property trusts.

"I am underweight the UK and sold out of my Europe funds last year. I am more bullish on Asia Pacific and beginning to invest in emerging markets for long-term growth, although they are being negatively impacted by the strong US dollar. I make monthly contributions to emerging markets investment trusts and Henderson Far East Income (HFEL) because I think their lower prices are good buying opportunities. But I am not sure where to invest the extra monthly cash I have since we paid off the mortgage."

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:

Even if these were normal times, your target of an 8 per cent to 10 per cent annual return would be ambitious. And I fear that these are not normal times.

There are three worrying things about your emerging markets exposure. Chinese monetary growth has recently slowed markedly. This is a lead indicator of weaker output in the country, which would be bad for equities in China and the region generally as it would have a knock-on effect on Japanese smaller companies. Monetary growth has also been a good predictor of commodity prices in the past, so it is warning of potential losses on commodity and mining funds – traditionally, emerging markets have been highly correlated with mining stocks.

The US central bank, the Federal Reserve, will probably increase interest rates in the coming months. Even rises that have been well signalled have been bad for emerging markets in the past, unless bond yields rose.

And emerging markets share prices are now below their 10-month average. This has sometimes been a signal of a long bear market. Like most assets that are hard to value, emerging markets equities are prone to momentum.

The only thing that might mitigate this is that it is the time of year when risky cyclical assets traditionally do well. But I’m not sure how much comfort this is in light of these headwinds. So, personally, I would rather be more exposed to developed markets, although these also could be dragged down if emerging markets tank.

You are also worried about your portfolio, which in itself suggests the need for rebalancing. The point of wealth is to give you peace of mind, so if you don’t have this something is wrong.

Rob Burgeman, investment manager at Brewin Dolphin, says:

An 8 per cent to 10 per cent annualised return is optimistic in view of your desired risk profile. Since 1983 the FTSE 100 Index has delivered a total return of around 8.6 per cent annually and retail prices index (RPI) inflation has averaged 3.47 per cent a year.

The FTSE UK Private Investor Growth Index is probably a better representation of a portfolio than the FTSE 100. And since 1988, when the FTSE Private Investor Indices were created, that index has delivered on average 9.02 per cent a year versus 7.91 per cent for the FTSE 100 and 3.36 per cent for RPI inflation.

However, your Sipp is currently worth about £250,000 so, with contributions of £2,000 per month, a more modest growth rate of around 5.5 per cent could result in it hitting a value of around £575,000 in seven years, although markets do not work in straight lines.

Your wife is investing £300 per month so her investments, which are currently worth about £250,000, could grow to just under £400,000 in seven years’ time. 

Regarding a sustainable level of drawdown, 3.5 per cent is very realistic. An adjustment to the risk profile would be required to reflect the change in your capacity for loss, because in retirement it is far harder to rebuild capital. There should be sufficient growth in the portfolio for the capital to keep pace with inflation, creating a sustainable income in retirement. But it is important to remember that the value of investments can fall and you may get back less than you invested.

Paul Derrien, investment director at Canaccord Genuity Wealth Management, says:

Your growth objectives seem a bit ambitious in the current climate and could lead you to be overexposed to equities in a bid to generate this level of return. However, you seem to be employing the right investment strategy at present and have cash reserves – for example your overseas money – that could be used to increase your equity levels if there was a more dramatic sell off. This could be used to purchase investments in the same currency and there are many funds that would be suitable for this. 

Get the cash working and be disciplined about investing it in a falling market. Fixed interest investments are under pressure in a rising rate environment, but short-dated corporate index-linked bonds such as those issued by National Grid (NG.) and Severn Trent (SVT) should offer reasonable returns above inflation. 

Overall you have a very sound approach to your investments. The portfolios are well diversified and you have a good spread of asset classes with cash, NS&I Premium Bonds, a holding in your employer, equity investment trusts and some direct share holdings. You aren’t taking excessive risk and are doing what you can to reduce risk while markets are more uncertain.

Your wife has a former employer pension. If you haven’t already done this, it could be worth getting it reviewed as it might be beneficial to move it into a Sipp. And as she is a higher-rate taxpayer look into whether pension contributions would be worthwhile for her.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

I’m not sure you need to have great exposure to risky assets to meet your target. If you continue to save £2,000 a month for eight years, your Sipp – which is currently worth about £258,000 – should hit £500,000 with only moderate returns.

You could diversify its risk by shifting into more defensive equities – many investments trusts offer exposure to large defensive UK stocks. Or you could hold a global tracker fund or even a government bond fund that would diversify your portfolio away from emerging markets risk. If global investors' appetite for risk declines or if they anticipate weaker global growth, emerging markets would fall but bonds would do well. But if appetite for risk increases so too will enthusiasm for emerging markets and bonds will sell off. Losses on one would be offset by gains on the other. This would give you a more balanced portfolio than you have now.

These are ways to see you through the danger of bad times for Asia Pacific. But better times will come, which we might get advance warning of by a pick-up in Chinese monetary growth or prices rising above their 10-month average. Buying when prices are above this average and selling when they are below it means missing out on bounces in prices, but this is more than outweighed by getting into long bull markets.

Rob Burgeman says:

Investing a £150,000 Isa entirely in Scottish Mortgage Investment Trust is not compatible with a risk-averse investment approach. This trust, run by Baillie Gifford, has delivered phenomenal returns over the long term but is invested in listed and unlisted equities, has a large portion of its assets in technology companies, and is pretty volatile. It is a great investment if you have a long-term investment horizon but certainly isn't low risk.

Your Sipp is predominantly invested in funds but has a fairly aggressive asset allocation, with around 17.5 per cent in Japan, and about the same in Asia and emerging markets. This is substantially higher than the neutral position for a growth orientated fund. And around 17.5 per cent of it is in smaller companies.

We consider the investments you hold as fairly high risk. With the exception of City Merchants High Yield (CMHY), they are equity focused and there is nothing to provide ballast in stormier markets. However, the NS&I Premium Bonds and foreign cash could provide a measure of liquidity if required, though you say that you have no intention of repatriating the latter.

I suspect that so far your investments have done rather well. However, it is important to understand the risks you need to take to achieve returns. This is especially important as we may be reaching the end of the economic cycle and entering more volatile market conditions.

It will also be important to begin de-risking the portfolios as you reach the point when you start drawing from them. Pulling up at the edge of the cliff with the wheels smoking is not really a great basis for an investment strategy because certain events can derail even the most robust investment strategies. A greater exposure to less volatile assets such as bonds, cash, property and infrastructure can play a key role in reducing some of the risk inherent in global markets.  And income-producing assets compounding in a gross environment can produce excellent long-term returns.

Paul Derrien says:

You have too many funds, all of which hold a large number of investments. If you hold too many there is a risk that you will be over-diversified [and only achieve the return of a tracker fund], so it might be more cost effective to hold passive funds [if this is what you want to do]. And a number of your holdings are so small within the overall context of the portfolio they will have no material effect on its overall performance, so these should be sold or added to.

You seem to have a buy-and-hold strategy with some of the funds, maybe because you are buying them for their style rather than performance. Some of your funds haven’t performed well so if you plan to reduce the number it would be worth conducting a full performance review.

In a declining market, investment trusts' share prices often fall more than their net asset values. Although this can have a negative shorter-term impact it can also provide enhanced buying opportunities.

Your investments seem to be compatible with your stated risk profile, but as your wife is risk averse, having her entire Isa in one fund is not a good idea. Investing this in three funds with different styles would reduce that risk.