Go global for greater growth

Their individual savings accounts (Isas) are worth about £500,000 and mainly invested in direct shareholdings. The generate an income of about £25,000 a year.

“We want to keep around £400,000 in cash as a safety buffer so that we can take on more risk with our investments and sleep at night,” says Daniel. “We would also like not have to worry about money.

“When we retire in around eight years we would like to have an income of around £100,000 a year after tax. My final-salary pension will provide an income after tax of around £3,000 per month. We will also receive dividend income from our Isas, which at present is worth about £2,000 a month. And the interest we get from our bank accounts, in which we have more than £400,000, is worth about £500 a month. However, this will reduce when we use some of that cash to help our children buy homes.

"I also have a defined contribution (DC) pension worth around £58,000 that is increasing by £1,500 a month. 

"So that leaves a shortfall of about £3,000 a month. We should be able to partially cover that by investing surplus cash – we could maybe get a further £1,300 a month. That still leaves £1,700 a month. We think we will need to invest an extra £340,000 by the time we retire to cover this. But we should be able to cover a large portion of this from reinvested dividends and contributions to my DC pension.

"We will also receive our state pensions in a few years, and my wife has a small local authority pension that should pay out about £2,000 a year.

"We hold quite a lot of cash at the moment and are happy to continue to while Brexit unfolds. But we have around £320,000 that we eventually want to invest because the interest we get from it is less than inflation. And we expect to continue saving and investing because we hope to work up until retirement age. 

"We also think that having a DB pension is like having a bond with a value of around £2m, in effect de-risking our portfolio.

"But should we continue to invest in income-generating shares, or drip-feed money into exchange traded funds (ETFs) and active funds? Or should we consider investments that help to mitigate inheritance tax (IHT) as we have substantial assets that we eventually want to pass to our children?

"We also wondered whether going forward we should invest in growth rather than income investments, to balance our portfolio? 

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:

With your current assets, you are £3,000 a month short of your target retirement income. But you might be able to make this up if you invest £320,000 into equities, carry on making a £1,500 a month pension contribution, reinvest your dividends and have average luck with returns.

But do you really need a retirement income of £100,000 a year? You should be able to roughly estimate your retirement needs by assuming that your current spending rises more or less with inflation. You’ll save on work-related expenses such as commuting costs when you retire, but your extra time might tempt you to spend more. Your assessment of your retirement needs is highly subjective, and contains some uncertainty. But it need not be very arbitrary.

You think your cash needs investing because interest rates are less than inflation. This, though, is absolutely not an argument for switching into equities. The case for doing this is that expected returns on equities are higher than those on cash. This is because the dividend yield of the FTSE All-Share index is above average. If equities were overpriced, there’d be a good case for sticking with lots of cash.

Henry Fox, private client manager at Seven Investment Management, says: 

When implementing a financial plan, flexibility is of the utmost importance. And your current strategy will provide you with multiple options and structures from which to draw down funds in the future.

You should always hold enough cash to meet your priorities in the short term and enable you to feel comfortable when investing in markets. I think holding cash worth about two years of your income requirements, in addition to an emergency fund, is a good starting point. You can then draw from the cash in difficult market conditions and stay invested for longer.

Your Isas are likely to be a source of tax free income in the future. It would be sensible to invest your surplus cash in investments that you can offset against your annual capital gains tax (CGT) allowances. You could use these assets just now to fund your Isas each year, and further ahead as a further source of income. You do not have to purely derive income as yield from your investments and this allows you to diversify your strategy.

You are sitting on cash 'while Brexit unfolds’. There are always reasons not to invest, but in the context that you are investing for the longer term, I would urge you to focus more on your objectives rather than trying to time the market perfectly.  

It can be sensible to hold the highest risk assets in an account where you benefit from tax-free growth, so consider holding cash outside Isas. But during retirement, if you are drawing from your Isas, they may not be the best place for your highest risk assets. 

You should review your asset allocation regularly and diversify as you approach the time when you will rely on your assets to support your lifestyle.

George Steger, wealth manager at Investment Quorum, says:

You have a good handle on your finances and seem to be preparing well for the retirement you would like to have. But it seems early to take an IHT approach to the portfolio as this involves investing in typically higher risk small companies. Focus on your own retirement priorities first and foremost. Your DC pension will provide a method via which you can pass on wealth outside your estate. Drawing from this as a last income source will allow you to take on greater risk in the pension portfolio and allow this to grow, and give you the option of passing it onto your children. 

Adding to your Isas every year until you retire will create a very efficient tax-free source of income to draw on when you are retired. 

Making use of your annual CGT allowances to realise profits can be worthwhile, but don't let the tax tail wag the investment dog. Cutting winners for the sake of tax can work against you. 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You have a preference for divided-paying stocks. But consider why investor interest in some shares is such that they are on high yields. It is because they believe these shares to be less attractive than others. Usually, this is for one of two reasons. Either they think the stocks offer low future dividend growth, as is the case with Royal Mail (RMG) and the tobacco companies. Or they think these stocks are unusually risky. The risks are often cyclical risk, such as with Bellway (BWY) or the banks, or political risk, for example with National Grid (NG.).

If investors are correct, income-generating shares are no more attractive than others. But historically investors have been wrong. Large defensive stocks in particular have offered better growth than expected, partly because investors underappreciated the importance of monopoly power. This might be an argument for sticking with big pharmaceuticals and Royal Dutch Shell (RDSB).

But stocks such as PayPoint (PAY), Royal Mail and Bellway are probably a play on investor sentiment, so if this improves they could do well. For this reason, consider investing new money in tracker funds to diversify away from high yielders.

Your portfolio is unusually parochial in having little overseas exposure, with the exception of the considerable extent to which companies such as HSBC (HSBA), Royal Dutch Shell and GlaxoSmithKline (GSK) are global companies. But your lack of overseas exposure might not be massively expensive. In the short term, international markets rise and fall together. It is also possible that UK stocks are cheap relative to overseas ones or that sterling will rise, causing overseas stocks to underperform in common currency terms.

But these are not the only possibilities. Over longer periods, the UK’s lack of economic growth could cause domestic stocks to underperform. And because you work in the UK you are heavily exposed to the domestic economy. That justifies diversifying overseas, so consider some global tracker funds.

[See the IC Top 50 ETFs for suggestions on global equities tracker funds]

Henry Fox says: 

Your investment portfolio is very UK biased and focused on stocks with high yields. I appreciate the global nature of these companies, which is often mentioned in the context of currency volatility. But I would still suggest having exposure to other regions of the world. This would reduce your income yield, but you might benefit from a move away from a search for yield approach.  

You enjoy managing your investments, so it is not surprising that they are focused on UK equities. But you will need to delegate some of your assets to investment managers via funds or invest in ETFs so you can build up allocations to areas you are unlikely to be so familiar with.

You can expect to have large swings in the value of your Isas due to the high allocation to equities. So as you add the money realised from your recent property sale to your investment portfolio, you could add some exposure to other asset classes. Even our clients who invest along the lines of our adventurous approach hold some fixed income and alternatives.

George Steger says:

Although you view your DB pension as a ‘£2m bond’ that will provide around 40 per cent of your income needs, your investment portfolio is still highly concentrated in direct shareholdings and very focused on income yield.

You estimate that you need to invest an additional £340,000 between now and your intended retirement date. To achieve this capital sum and capital appreciation we would suggest increasing your exposure to growth investments. This could be done by investing in active funds or ETFs to reduce the day-to-day management you need to do. If you buy active funds, research the style and aims of the managers that run them as well as the funds' track records. 

Alternately, there are a vast number of ETFs with lower charges that track the returns of a huge range of sectors.

Your holdings are largely UK-listed. Although they have significant international earnings they could suffer if sentiment on the UK is negative.

And in today’s international world, increasing global exposure could provide greater opportunity for growth in a wider range of regions, particularly faster developing countries such as China. Index provider MSCI also continues to increase the weightings of its broader indices to Chinese A-shares and the Association of South East Asian Nations (Asean) countries. 

Also consider exposure to thematic investments that aim to profit from evolving consumer behaviour, for example by investing in the technology innovations that are key to these changes and are essential to the development of most industries. We like ideas such as robotics and automation, cyber security, new-generation technologies, healthcare, and energy sources such as batteries for electric and autonomous vehicles. The aim is to capture the business disruptors of tomorrow – companies that are changing the way consumers live and spend their money – whether online or in shopping malls.

Many of these companies are listed in the US, but there are opportunities elsewhere in places such as China, Japan and South Korea. This strategy is not without risk, but the rewards can be phenomenal.    

You could get exposure to such companies via Baillie Gifford Global Discovery Fund (GB0006059330). We also like L&G ROBO Global Robotics and Automation UCITS ETF (ROBG) and Smith & Williamson Artificial Intelligence Fund (IE00BYPF3314). 

However, if income is very important to you at this stage, consider Merian Global Equity Income (IE00BYM83J95) which provides global exposure, takes a total return approach and has a yield of around 3.15 per cent.

We are in a mature bull market, so your large cash position will allow you to take advantage of any market volatility and dips, such as the one in December, when you can buy good companies and assets at more attractive valuations.