Your asset allocation risks losses

"We would like to retire in three years’ time when we are 50,” says Cynthia. “We feel that an income of £40,000 a year will provide us with a good lifestyle and intend to take this from our portfolio’s natural yield. My target total return is 5 per cent a year and we are currently reinvesting the dividends we receive.

"We hold investments worth £640,000 in my self-invested personal pension (Sipp) and worth £220,000 in individual savings accounts (Isas). We are using our full Isa allowances each year and intend to continue to do this to reduce our tax liability. When I can access my Sipp at age 55 I intend to take the 25 per cent tax-free portion and draw down the income from the remainder.

"My husband also has a stakeholder pension worth £32,000, but we intend to leave this untouched until we are 60. He has already accrued his entitlement to the full state pension from age 67, and I intend to pay five years’ additional contributions to obtain a full state pension.

"We also want to help our daughter financially until she finishes university so that she is not left with additional debts.

"I have been investing since 2011 and I would describe my attitude to risk as medium to high. I would not be too concerned with a loss of 20 per cent to 30 per cent in any given year, but a loss of 50 per cent would worry me. If this were to happen after we had retired our strategy for dealing with it would be to draw on our cash and gold, and reinvest any dividends received from our investments while the market is low.

I recently sold part of my holding in HL Multi-Manager Special Situations Trust (GB0030281066). I reinvested the proceeds in Vanguard Emerging Markets Stock Index (IE00B50MZ724) and Henderson Smaller Companies Investment Trust (HSL) as my strategy is to have global tracker funds as the core of the portfolio, alongside some actively managed funds that give exposure to a number of geographies. In the next tax year I will sell a further portion of my holding in HL Multi-Manager Special Situations.

"And I want to increase my exposure to Japan and Asia.

"I also have some direct shareholdings in large companies that produce a decent dividend income.

"I have tried to diversify across different asset classes to decrease risk. We have physical gold worth about £60,000 in case there is a severe market downturn, even though it does not produce any income. But I am not sure if this is a wise strategy.

"I also have an endowment policy that matures in 2021, from which I expect to receive about £30,000.

"I review the portfolio in detail once every 12 months as I do not want to keep changing it, and I intend to stay invested for at least 30 years."

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 ask whether it’s wise to hold gold, given that it pays no income. Its prospects are not good. If global bond yields rise, which is possible if the world economy grows well, gold’s price might fall because it pays no income. When interest rates are low, the lack of income from gold isn’t a huge sacrifice. But as yields on bonds or cash rise, gold becomes more expensive to hold so its price falls.

The case for gold is an insurance policy. If we get a serious global downturn, fears about global growth would drive down bond yields and drive up gold prices. Better still, when global investors get really nervous they tend to sell the pound, so gold rises in sterling terms.

As you are holding relatively few bonds, allocating around 2.7 per cent of your portfolio to gold seems reasonable to me. It might lose you money if the global economy does better than expected, but in such a scenario your equity holdings are likely to more than offset its losses.

Your equity holdings are well diversified internationally but don't have much US exposure. This is sensible only on a longer-term view. In the short term, by which I mean several months, global stock markets tend to rise and fall together. It’s only over the longer term that some significantly outperform others. So international diversification makes more sense for long-term investors than short-term ones.

Rory McPherson, head of investment strategy at Psigma Investment Management, says:

You hold your investments in tax-efficient wrappers. I’d also suggest seeking financial advice so that you are as tax efficient as possible when drawing down money. For example, your Sipp is outside your estate for inheritance tax purposes, an important consideration when planning for this at a later stage.

A return of 5 per cent after inflation and fees is not realistic at this stage in the market cycle. We think that equity returns are going to be more like 5 per cent before inflation is taken into account. This is due to fairly full valuations and lower growth over the next five years than over the past five. So trim your return expectations.

Rachel Winter, associate investment director at Killik & Co, says:

Your expectations for total return and income seem realistic, and you appear to have a good understanding of your appetite for risk. I agree with your strategy of conducting a portfolio review on an annual basis, as excessive trading and switching can eat into returns.

Your pension income combined with the natural yield of the portfolio should generate the £40,000 a year that you require, so your cash balance appears high. If we include the NS&I Premium Bonds, you have over six years’ worth of expenditure in cash. Generally we advocate holding six months’ worth of expenditure in cash unless you have a specific call on capital.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Rethink your attitude to big dividend-paying stocks. Dividends from investments held outside Sipps and Isas, over your annual £2,000 allowance, incur tax. And a focus on dividend income would mean you are under-using your capital gains tax (CGT) allowance, which is £12,000 for the current tax year. What matters is total returns as you can create your own dividends by selling a portion of an investment, offsetting any tax against your CGT allowance if the investment is held outside a Sipp or Isa.

There are also only a handful of big dividend-paying stocks, which means you risk overconcentrating your portfolio. City of London Investment Trust's (CTY) 10 largest holdings include HSBC (HSBA), Diageo (DGE), Unilever (ULVR) and Royal Dutch Shell (RDSB), which you also hold directly. And Lindsell Train Global Equity (IE00BJSPMJ28) had 8.3 per cent and 7.6 per cent of its assets in Unilever and Diageo, respectively, at the end of April.

Such exposure has paid off in recent years. This is because a few years back investors were overly pessimistic about the growth prospects for big dividend-paying stocks and underappreciated the importance of what high-profile US investor Warren Buffett calls economic moats – sources of monopoly power that come from big brand names or high capital requirements. But stocks don’t often stay cheap forever. In this case, there’s a danger that investors have wised up to these stocks' merits so they might be overpriced. Even if this isn’t true just now there might come a time when it is. 

One solution to this might be to simplify your portfolio a little by having a core global tracker fund alongside a few specific plays, as you intend. One virtue of such simplification is that it would make it easier to reduce your equity exposure when necessary. I suspect that the outlook for world markets is okay for now so your big equity holdings are justified. But this will not remain the case.

Rory McPherson says:

You have a very low allocation to fixed income, and a very high weighting to UK large-caps and overseas equities, which incur currency risk. A low fixed income weighting is consistent with a fairly high risk appetite, and your holdings in physical gold and cash provide your portfolio with some ballast. But the asset allocation is veering towards being entirely in equities, which puts it at risk of losses closer to 50 per cent, rather than the 20 per cent to 30 per cent you could tolerate. Although many parts of the fixed income markets are extremely expensive at the moment, managers such as TwentyFour Asset Management offer outstanding products with good return prospects and portfolio diversification properties, such as TwentyFour Monument Bond (GB00B3V5V897) and TwentyFour Corporate Bond (IE00BSMTGG87). These funds have their currency exposure in sterling so would reduce your portfolio's currency risk too.

Income in sterling is important, but large UK companies derive the majority of their earnings from overseas and many of the funds you hold are global in nature. Holding funds with a sterling hedged share class would help to address this issue. Some iShares funds offer hedged share classes, and we also like Legg Mason IF RARE Global Infrastructure Income Fund (GB00BD3FVT86), which offers a sterling hedged share class and targets a yield of 5 per cent.

Rachel Winter says:

Your combination of passive and active funds makes sense. Passive funds and exchange traded funds (ETFs) are good for investing in large companies and liquid markets, and help to keep overall portfolio costs down. But there is a much greater discrepancy in performance between different smaller companies and emerging markets stocks, so for these areas it is worth employing a selective approach via active funds, instead of buying the whole market via tracker funds.

It’s good that you plan to increase your exposure to Asia, which should be the engine of future global growth.

But your gold weighting is a little high. This asset has been volatile in recent years with, for example, those who invested in 2012 sitting on a 30 per cent loss. Gold does not pay an income and does not always rise in times of equity market weakness. I agree with holding relatively cautious investments that can support your portfolio's value in a falling market, but consider replacing some of the gold with sovereign bonds or investment-grade corporate bonds that will at least pay a small amount of income.

That said, you hold physical gold, which is far safer than buying synthetic gold ETFs that replicate the price of gold using derivatives. Synthetic ETFs are a relatively recent development and it is unclear how they would perform in times of market turbulence.

Some of your direct equity holdings appear large in comparison to your fund holdings and I would question how sustainable some of their dividends are. Vodafone (VOD) recently cut its dividend by 40 per cent. And GlaxoSmithKline (GSK) has recently not had a sufficient level of earnings to cover its dividend so has had to pay it out of retained earnings from previous years, which is not sustainable. HSBC has also exhibited lacklustre growth of late, so I would question how long it can sustain a 6 per cent yield.