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'I worry about crash risk to £200k lump sum'

Our experts discuss how this reader can manage timing and diversification issues
May 16, 2019, Laith Khalaf and Adrian Lowcock

Gregory is 40 and married with a two-year-old son. He works in the public sector and gets a salary of £82,000 a year, which he doesn’t expect to go up a lot. His wife earns £90,000 a year and also doesn’t expect her earnings to go up much. Their home is worth £700,000 and has a mortgage on it worth about 50 per cent of its value. They keep their finances separate, but share costs such as housing, groceries and bills.

Reader Portfolio
Gregory 40
Description

Cash, residential property, pension

Objectives

Semi-retire at 60, build up fund to finance this and supplement eventual pension income, total return of 5% a year

Portfolio type
Investing for growth

“My retirement age is 67 and from that time my workplace pension will pay out £16,000 a year, according to the current valuation, and a small lump sum," says Gregory. "This pot is likely to grow in the coming years with ongoing contributions, although I could take an actuarial reduction in the pension and draw it from age 55. My wife has her own stakeholder pension arrangements.

"I would like to have the option of semi-retirement at age 60, before I can draw my occupational pension. I would then like to fully retire between the ages of 66 and 69, and enjoy a better standard of living. So I would like to build up some investments. 

"I recently sold an investment property, so have cash worth £200,000 to invest now, and then would hopefully invest £20,000-£40,000 a year for the next 20 years. I would like to make an average return of 5 per cent a year over a 20- to 40-year period.

"I will hold my investments in a self-invested personal pension (Sipp), individual savings accounts (Isas) and trading account. If and when I need to draw on my investments, I will first take my 25 per cent tax-free pension entitlement from the Sipp and then sell chunks of the investments for income. I may become more dependent on the Isa and Sipp investments – especially if something unexpected happens.

"I am thinking of constructing a portfolio of equities with a small allocation to bonds, mainly government ones. If there is a market correction I will sell some of the bond investments and use the proceeds to buy more equities. My workplace pension will provide a low-risk source of income if my investments underperform, so I feel that I can take on more risk.

"I have come up with the following model asset allocations for the Sipp and Isa portfolios:

 

Gregory's suggested Sipp allocation

Holding% of portfolio
Vanguard LifeStrategy 100% Equity Fund (GB00B41XG308) or HSBC MSCI World UCITS ETF (HMWO)60
Global smaller companies fund20
UK government bond fund 10
Global government and corporate bond funds10

 

Gregory's suggested Isa allocation

Holding% of the portfolio
FTSE 100 tracker 5
FTSE 250 tracker5
Active UK smaller companies fund 5
Low volatility global fund5
Passive global smaller companies fund5
Vanguard LifeStrategy 80% Equity Fund (GB00B4PQW151)35
Vanguard LifeStrategy 20% Equity Fund (GB00B4NXY349)25
UK government bond fund10
UK corporate bond fund5

 

"I plan to invest 30 per cent of the Isa portfolio in UK equity and bond funds in case I need access to cash and sterling is strong, so I don’t want it to have as much currency risk as the Sipp. However, my wife and I also keep about £30,000 each in cash for emergencies, in savings accounts with the highest interest rates I can find. And although the UK market looks attractive for a long-term strategy, I don't see many global growth companies listed here, so want to diversify away from the UK and sterling.

"Although I plan a 5 per cent allocation to corporate bonds in the Isa, I think they are very expensive, so I am not sure whether I should invest in them. I don’t see what their value would be in a major correction such as during 2007-08. And in any case Vanguard LifeStrategy 20% Equity (GB00B4NXY349) is in effect a global bond fund with a few equities. 

"I used to invest on and off, although haven’t done this for about five years. I had some UK and global holdings, but sold them after the vote to leave the European Union (EU) and the election of Donald Trump as US president in 2016, and also because I thought I needed the money for a house move. In the end I didn’t need the money for this and have missed out on significant increases in markets since then, especially in the US.

"I have never invested during a bear market, but think I could hold steady through a major correction. If markets fell between, say, 10 per cent and 30 per cent I would stay invested rather than panicking and selling. However, if I had just invested money and the market fell 20-30 per cent before I had made gains, this would unnerve me. So how can I invest my £200,000 lump sum without facing a major correction shortly after?

"I could drip-feed a fixed amount of money into the market on a regular basis, but I read that if you do this over a long period you could miss out on potential gains. So I presume I should just invest the money in one go and make sure it stays invested for 10 years or more. 

"I also don’t want to spend up to 10 hours a week reviewing my existing investments and choosing new ones – I would rather spend one hour having a quick read of Investors Chronicle. So I want investments that I can buy, hold and forget.

"I have followed financial and investment news for the past 10 years and am very impressed by John Bogle, the founder of asset manager Vanguard [which is known for its passive funds]. I would like to build a core of low-cost passive funds in my portfolios that buy the whole market, and maybe have a few small allocations to active funds alongside them for diversification."

 

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 are worried about the market crashing soon after you’ve invested. There’s no reason to suppose that a crash is more likely than usual in the near term: above-average dividend yields and recent record foreign selling of US equities are bullish signs. But we can’t rule it out. The obvious solution to this is to drip-feed your capital into the market, investing, say, one-sixth each month over the next six months. However, nobody can time the market perfectly. Although drip-feeding money into the market mitigates losses caused by a near-term crash, it also means you may miss out on gains if the market rises. You must decide which risk you want to bear – you cannot avoid both.

I’d also question your belief that you can hold steady through a bear market. Many people claim they can, only to throw in the towel. To see you through bad times, always hold cash. Remember that what matters is returns on your portfolio as a whole, which includes cash and your salary. Also bear in mind that falling prices and, in particular, a rising dividend yield usually mean higher expected returns in future.

 

Laith Khalaf, senior analyst at Hargreaves Lansdown, says:

Investing a big lump sum can be uncomfortable for the reason you suggest – the fear of a big fall just after you put money into the market. The only way around this is to drip-feed money in gradually, which is a prudent approach with such a large amount of money. And you will also be putting in £20,000 to £40,000 a year for a further 20 years, which is a mitigating factor. But as you aren’t comfortable investing your lump sum in one go, take your time in doing so.

Also make sure that as many of your investments as possible are held within tax-efficient wrappers such as pensions and Isas.

 

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

You have clearly thought about your financial future and, most importantly, your retirement. But there are a few things that you may want to revisit to ensure you are on the right track.

I understand your concern about investing just before a correction, but this is a risk you have to accept when investing. Diversification is the only way to minimise its impact. Trying to time markets usually involves sitting on the sidelines, watching the market continue to rally and becoming too fearful to invest when a correction happens. Pound cost averaging – investing a set amount of money on a regular basis – works mathematically, but it is time in the market that makes the biggest difference. And because you will be topping up your Isa and Sipp from your salary you will still drip-feed some money into the market.

Also consider your risk tolerance and perception of risk. Events such as Donald Trump’s election and the vote to leave the EU are just background noise for serious long-term investors. A 30 per cent fall in the market can feel just as painful no matter what the circumstances, especially if you see five to 10 years of growth wiped out in weeks.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

If you want a buy-and-forget strategy for the next 20-plus years, there’s a lot you cannot do. You can't back fund managers with a good track record because it's very unlikely that they’ll stay in their positions for another 20 years. You shouldn’t buy growth stocks because we cannot really forecast corporate growth – especially over two decades. And you shouldn’t invest in any direct shareholdings because over two or three decades even the strongest ones might be laid low by bad management or technical change. We cannot predict the pace or direction of creative destruction.

So you are right to focus on low-cost trackers. There are not many UK smaller company trackers, but there are plenty of active funds that invest in them. I would also caution you not to focus solely on quoted companies. It’s quite likely that the best growth opportunities, insofar as there are any, are in unlisted companies. So also consider a private equity investment trust.

You’re also right to want a global portfolio. The argument for this isn’t that the UK is a slow-growing economy with few good companies. It’s because the UK market accounts for less than 10 per cent of the world market. As nobody knows what the next two decades hold, we should back the field rather than any particular horse, and most horses are outside the UK.

But I’m not sure that bonds are a good idea. They offer negative long-run real expected returns. Their main virtue is that they insure us against some short-term stock market falls – those caused by fears of recession or heightened risk aversion. But your public sector job and pension are, in effect, bond holdings. And cash and foreign currency can provide protection in bear markets – sterling tends to fall in bad times, meaning that dollars and euros do well. I’d prefer a decent cash holding to a large bond allocation over the long term.

One issue is how well equities will do over the long run. History suggests that a 5 per cent real annual return is a realistic objective. But history perhaps flatters equities. For most of the past century, the things that equity investors feared have mostly not happened or ended happily, for example, worker militancy, political unrest, war, financial crisis and inflation. Historic returns have been flattered by many relief rallies. So it’s possible that future returns will be much lower than they have been historically. But there’s no way to tell how likely this is, so I think this is yet another reason to hold lots of cash.

 

Laith Khalaf says:

It sounds as though you’re well on your way to a wealthy early retirement, and you have given a lot of thought to your strategy. Your plan sounds pretty sensible, so I will simply offer a few suggestions to consider integrating into your plan.

Your bond allocation may be too high. If you’re investing in a forever fund for 20-plus years, a higher equity weighting might be in order unless you are particularly risk-averse. Bond prices are pretty high thanks to loose monetary policy, and it’s hard to see them making the returns that they've made during the past 20 years over the next two decades. They are a diversifier within an investment portfolio, but your planned Isa allocation includes over 40 per cent in bonds, when you count the Vanguard LifeStrategy funds' holdings in these areas.

I also think the currency positioning is worthy of further consideration. As a UK investor with bills in sterling, it’s difficult to fully insulate yourself from the fortunes of this currency. Even within the UK stock market, many companies make money and have costs overseas, for example Royal Dutch Shell (RDSB) and HSBC (HSBA) – the two biggest companies in the FTSE 100 index. Given the interaction between currency movements and stock market returns is so complex, dynamic and unpredictable, I’d be wary of letting this be a guiding principle in portfolio construction.

Instead, having a sensible spread of investments in the UK and overseas is likely to be more productive than trying to navigate the capricious trade winds of currency markets. I’d also point out that if you invest in tracker funds that invest based on global market capitalisation, you will end up with a portfolio heavily biased towards the US and the dollar, because that market accounts for over half of the world’s stock market value. However, the Vanguard LifeStrategy funds make an adjustment to beef up UK exposure for investors on these shores as it’s their home market, which is entirely sensible.

 

Adrian Lowcock says:

I would suggest keeping some cash aside for emergencies and unexpected expenses so that you are less likely to need to sell investments to cover these. As you wish to have the Isa and Sipp portfolio positioned differently from a risk perspective, I would suggest treating them as two separate portfolios. Doing this would mean that each one’s risk can be addressed in isolation.

Reducing costs to the bare minimum could be a false economy as this would mean primarily investing in passive funds, and potentially losing out on some gains from active funds. So I would suggest being a bit more flexible on costs.

But generally speaking, a core passive portfolio does sound appropriate for you, although there are areas where passives work better and areas where an active approach would be more suitable. For example, smaller companies tend to be a great area for active managers and, given the current economic outlook, a passive bond approach could be riskier than it seems. But passives can give a good core exposure to large companies in major developed markets such as the US or UK.

In general, passive funds do well in rising markets, while active funds can better protect investors in market sell-offs, although this depends on the managers who run the funds.

I would suggest the following asset allocations for your Isa and Sipp.

 

 

Adrian Lowcock's suggested Isa portfolio

HoldingOngoing charge (%)% of portfolio
HSBC FTSE All Share Index (GB00B80QFX11)0.0710
Legal & General International Index Trust (GB00B2Q6HW61) 0.1320
M&G Global Dividend (GB00B39R2Q25)0.9110
Standard Life Investments Global Smaller Companies (GB00BBX46522)0.7810
Newton Real Return (GB00BSPPWT88)0.75
ETFS Physical Gold (PHGP)0.395
Janus Henderson Strategic Bond (GB0007533820)0.6920
Threadneedle UK Equity Income (GB00B888FR33)0.8310
Liontrust Special Situations (GB00BG0J2688)0.8710

 

Adrian Lowcock's suggested Sipp portfolio

HoldingOngoing charge (%)% of portfolio
Legal & General International Index Trust (GB00B2Q6HW61) 0.1320
Fundsmith Equity (GB00B41YBW71)0.9510
First State Asia Focus (GB00BWNGXJ86)0.910
Fidelity Index Emerging Markets (GB00BHZK8D21)0.210
Jupiter Absolute Return (GB00B6Q84T67)0.855
ETFS Physical Gold (PHGP)0.395
Artemis Strategic Bond (GB00B2PLJR10)0.5910
LF Lindsell Train UK Equity (GB00B18B9X76)0.6810
Merian UK Smaller Companies (GB00B1XG9599)1.0310
Vanguard US Equity Index (GB00B5B71Q71)0.110