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Small share holdings won't make a meaningful contribution to overall returns
March 21, 2019, Ian Forrest and Adrian Lowcock

Richard is 43, divorced and earns £75,000 a year as an airline pilot. His salary should increase every year, so at age 50 he will earn around £95,000 a year and at 60 £120,000. His workplace pension currently has a value of about £45,000, and for every 6 per cent he pays in, his employer contributes almost 16 per cent. Richard has recently sold his house and is renting because he has relocated due to a job change. 

Reader Portfolio
Richard 43
Description

Pensions, Isa and trading account invested in shares and funds, cash

Objectives

Retire at 60 on £50,000 a year, save up a deposit to buy a home, support two children 

Portfolio type
Investing for goals

“I want to retire at age 60 on an income of around £50,000 a year in today’s money,” says Richard. “I used to serve in the armed forces and the pension I accrued when doing that will provide at least £18,000 a year from age 55, and is index-linked. I have already taken my 25 per cent tax-free entitlement from it. That means I need to generate a further £32,000 a year from my current employer pension and assets.

"I also want a deposit for a house worth about £450,000. And if all goes to plan with current partner, we may need to support two children. I am also planning for my own security in old age. I expect to inherit two mortgage-free properties from my parents worth around £300,000, and I may use these to fund care costs when I am older.

"But I’m flexible about the age at which I retire, particularly as I could work part-time, and am willing to work beyond 60 to fund the lifestyle I want and pay off my mortgage, if necessary.

"I have built up cash worth £200,000, most of which is in individual savings accounts (Isas). I am now looking to invest it for the long term to meet my goals. I’m keen to manage the portfolio myself as I want to learn and avoid hefty management charges.

"I assume I should be aiming for growth rather than income at this stage of my life. And I understand the need to take higher risk at an earlier age, but do not wish to be reckless with my hard-earned cash. I would like to balance risk by having a global portfolio made up of investments with different risk levels, including some speculative punts, medium-risk investments and safe havens. I am not currently contributing to my self-invested personal pension (Sipp) but plan to invest it in high-risk punts, and have more moderate risk in my employer pension.

"I am prepared to lose 10 to 15 per cent of the value of my investment portfolio in any given year. But I would question how and why it happened, and how I react would be determined by whether it was due to me making poor investment decisions or because there is a global downturn.

"I don’t chase trends and I don’t usually invest in oil, mining or foreign-exchange plays. I think there might be a change to ‘the old guard’ – it is questionable whether BP (BP.) will successfully transition to the renewables market, or Imperial Brands (IMB) and British American Tobacco (BATS) will make up for lost cigarette sales with next-generation products such as vapes. Companies like this might disappear.

"I try to see the big picture. For example, macro movements such as the emergence of India as a global player led me to invest in Fidelity India Focus (LU0457960192). I think sectors such as healthcare, pharmaceuticals and renewable energy will do well, so I would like to invest in funds with exposure to these areas, and fintech. I would also like to diversify my investments geographically – I travel with work, and I see the value and opportunity of investing globally.

"I bought my first house at age 21 and have been trading equities since the morning after the Brexit referendum. I’m doing okay but not making great returns. I’ve been ‘momentum trading' [buying and selling according to the strength of recent price trends] for the past two years, but now I’m targeting value and quality shares.

"I might make some contrarian bets – I don’t think Brexit will bring Armageddon to the UK economy, so there are some undervalued shares and bargains on UK markets. For example, I have recently invested in GlaxoSmithKline (GSK), HSBC (HSBA) and Aviva (AV.). I would not have considered investing in these last year, but now think they are solid companies that are undervalued. But I believe that the momentum cycle is coming to an end.

"I hold my short-term direct shareholdings such as ITV (ITV) and LPA (LPA) in a trading account, and longer plays such as Boku (BOKU) and Eckoh (ECK) in an Isa.

"I have limited experience of investing in funds, but have been trying to learn by having some exposure to these. For 10 years I invested £300 a month in Invesco High Income (GB00BJ04HP86) and Fidelity India Focus. But I thought markets had peaked, so reduced my holdings in them in stages over the past six months. I hold the proceeds in cash and will reinvest some of them in an Isa in the new tax year in April."

 

Richard's portfolio
HoldingValue (£)% of the portfolio
Fidelity India Focus (LU0457960192)5,0001.84
Augmentum Fintech (AUGM)5200.19
Aviva (AV.)5000.18
Bango (BGO)7900.29
Boku (BOKU)5550.2
British American Tobacco (BATS)5100.19
Eckoh (ECK)7050.26
GlaxoSmithKline (GSK)4900.18
HSBC (HSBA)4900.18
Imperial Brands (IMB)5000.18
ITV (ITV)4500.17
Lloyds Banking (LLOY)5000.18
LPA (LPA)1700.06
Royal Bank of Scotland (RBS)6100.22
Ryanair (RYA)5500.2
SafeCharge International (SCH)9000.33
Sopheon (SPE)12000.44
Spectra Systems (SPSY)2400.09
Current employer pension45,00016.56
ReAssure NM Overseas Equity Pension (GB0006255227)12,0004.42
Cash200,00073.62
Total271,680 

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE READERS' CIRCUMSTANCES.

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You’d like an income of £32,000 a year from age 60. This would require a portfolio of around £800,000. If we ignore your likely property inheritances, you have only £271,680. If we assume investment returns of 4 per cent a year in real terms and pension contributions of £16,000 a year, you will fall slightly short.

So you should make additional voluntary contributions to your pension, if you can. It also means you should move your £200,000 cash into equities as otherwise you’ve no chance of a positive real return.

Your job is a valuable asset. It is relatively safe in economic terms and, like a bond, offers a guaranteed income. This is a way of diversifying equity risk, because if there is a stock market fall you can top up your wealth with extra savings from your salary.

 

Adrian Lowcock, head of personal investing at Willis Owen, says:

You have a number of potentially conflicting and uncertain goals, as you are trying to save enough to retire early at the same time as planning to start a family. This means you will need to be flexible with your investments and financial planning. But you have made a big step in the right direction by setting out your goals and listing your finances.

You first need to decide what size of deposit you want for your house purchase and try to establish when you’ll be in a position to make that purchase. If the purchase will be within a few years the money you set aside for a deposit should stay in cash. Some of this could be held outside an Isa because as a higher-rate taxpayer you can earn £500 in interest on cash before you have to pay tax on it. This money should be held for the purpose of buying a house.

You then need to move as many of your investments and remaining cash inside Isas as quickly as possible. The annual Isa allowance is currently £20,000, so this could be done fairly soon. Isas allow you to benefit from the growth and income of investments free of tax. Building up a portfolio of investments inside Isas will help you start and support a family while building a retirement pot. 

Isas are often overlooked for retirement, but investors can draw an income from them free of income tax, unlike pension income which is taxable.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

With regard to what to invest in, there’s a simple answer – a global equities tracker fund. New investors make the mistake of thinking they need to acquire knowledge and expertise before investing. You don’t. You can piggy-back off others. A global tracker fund is, in effect, a fund of all equity funds, because it is a basket of stocks the average investor believes is fairly priced.

You also need some kind of strategy. But I would be wary of looking for value stocks. The argument for doing this is that investors are very bad at spotting long-term earnings growth – they underestimate the extent to which it is random. This means they often wrongly believe a stock has gone ex-growth – even though it hasn’t – so demand a high yield on it. For a long time, tobacco stocks were in this position until they began to fall in 2017.

But that highlights the problem with such stocks – the market is not always wrong. You are absolutely right to worry that some companies will disappear – even large companies can find themselves on the wrong side of creative destruction. In the long run, however, it’s difficult – almost impossible – to predict which these will be. This means we must be very careful before deciding that a company is undervalued – it might instead be cheap for a good reason.

But valuations matter in another way. The yield on the aggregate market has in the past been a great predictor of longer-term returns: higher yields mean higher returns and lower yields mean lower returns. So the FTSE All-Share index's dividend yield can indicate when we should be in the market, and when not. As it is now above its long-term average it suggests that we should be in the market.

This is not the only indicator that can predict returns. Foreign buying of US equities can be a good signal, for example, large purchase volumes of these can be a sell signal. The ratio of prices to their 10-month average and the ratio of global share prices to the developed world money stock can also predict returns. Most of these indicators are now telling us to be in UK and global equities.

But this won’t always be the case. A benefit of investing Sipps or Isas in tracker funds is that you can cheaply reduce your equity holdings when these signals turn bearish, so keep watching them.

 

Ian Forrest, investment research analyst at The Share Centre, says:

You have more than enough cash for your current needs, and to cover a deposit for a new house worth about £450,000. So I would put that to work right away so you can increase your portfolio's overseas exposure and because returns on cash are likely to be less than inflation for some time.

Given your age, you should be weighted more towards growth-orientated assets, although you are right not to be reckless with regard to risk. So a limited number of companies and funds would be the best strategy, and you should hold these in an Isa to protect them from any potential capital gains tax.

I would agree that India is one of the most attractive emerging markets. But investing in a fund that focuses on one market – even as large as India – is a higher-risk strategy. It would probably be more sensible to opt for a fund that invests in several emerging markets such as JPM Emerging Markets (GB00B1YX4S73). Its holdings provide exposure to markets including China and Brazil – as well as India.

Healthcare is also a good choice because this sector is enjoying growth but also has some defensive qualities. Polar Capital Healthcare Opportunities (IE00B3NLDF60) aims both to preserve capital and seek long-term growth. Its investments are mostly listed overseas, with around two-thirds in the US where many healthcare companies should benefit from recent tax reforms.

The mining sector is cyclical and more volatile than many others, but BlackRock World Mining Trust (BRWM) would increase your overseas exposure, provide growth and increase your exposure to funds. You could manage its volatility by making regular investments into it over a period of time.

Striking a balance between risk and return should always be at the heart of an investment strategy, as well as keeping an eye on costs. You have a number of very small Alternative Investment Market (Aim) stocks in your portfolio, and many of these holdings have a value of less than £1,000, with some less than £500. Because of this, consider what impact the transaction costs are having on your returns, as well as the fact that these companies are high risk. It might make more sense to hold a fund that invests in smaller companies.

 

Adrian Lowcock says:

You want to have a balanced portfolio. The best way to achieve this is to have a mixture of different types of investments – as well as different strategies. Although growth is the most obvious approach, equity income and value investments also have their benefits. Having exposure to different styles can help to protect your portfolio from falls in the market. 

I would caution against trying to call the top of the market as too many investors do this too early and often miss out on some good gains, and then re-enter the market again at the top. It is better to be invested for the long term than try to call short-term market movements.

The investments outside your company pension fund are a mix of different assets, but the portfolio lacks structure. The individual shareholdings are too small to make any meaningful contribution to the portfolio's overall performance, even if their performance is exceptional.

As you are in the early stage of investing, it would be best to build a core investment portfolio to which you could add riskier satellite investments later.  A core portfolio could include exposure to global equities, smaller companies and emerging markets, as well as offering some capital protection. An example of such a portfolio is as follows:

 

Adrian's suggested portfolio
Fund% of portfolio
Lindsell Train Global Equity (IE00BJSPMJ28)10
M&G Global Dividend (GB00B39R2Q25)10
Schroder Recovery (GB00BDD2F190)10
Merian UK Smaller Companies (GB00B1XG9599)10
Artemis Income (GB00B2PLJH12)10
Fidelity Emerging Markets (GB00B9SMK778)10
Artemis US Equity (GB00BMMV4S07)10
Janus Henderson Strategic Bond (GB0007533820)20
Newton Real Return (GB00BSPPWT88)10