Forget about buy-to-let before getting a home

"I would like my workplace pension and stocks and shares Isa to generate an income of at least £60,000 a year when I retire,” says Curtis. “I think this is achievable within the time frame I have.

"My workplace pension is a defined benefit scheme which will provide a guaranteed inflation linked payout when I retire. If I continue to receive my current level of salary and contribute to it for another 15 years it should pay out around £40,000 a year from when I’m 68, so could be higher than this.

"I regularly save £700 into a stocks and shares Isa and would like my investments to make an average annual total return of 6 per cent – 4 per cent from capital growth and 2 per cent from dividends. This is probably not achievable in current market conditions but I think it could be a realistic target over the next 40 years – especially if there is dividend growth.

"I have a degree in finance and have also learnt about investment from my parents. I have been investing for two years and am willing to take reasonably large risks, although I don’t think my investments, overall, are currently high risk. I would be willing to lose up to 50 per cent of the value of my investments in any given year as I have plenty of time to recover the value. I invest regularly on a monthly basis which should take advantage of any falls in markets via pound cost averaging.

"I am building up a core of exchange traded funds (ETFs) that give exposure to different geographies and asset classes. I aim to have 10 per cent of my assets in bonds and 90 per cent in equities, with the following geographical split: 30 per cent US, 20 per cent UK, 10 per cent Japan, 10 per cent Europe, and 30 per cent Asia and Emerging Markets. When this core has reached a sufficient size, I will add active funds and I'm aiming to eventually have around 20 holdings.

"But when would be the right time to start adding active funds? When my investment portfolio reaches a size of around £50,000? And what type of investments would complement the existing holdings, and increase the risk and reward potential? I am concerned that I do not have enough exposure to emerging markets and China. I would also like to add some renewable energy funds and funds focused on esoteric areas.

"I recently invested in CFP SDL UK Buffettology (GB00BF0LDZ31). And I replaced iShares Core FTSE 100 UCITS ETF (CUKX) with Vanguard FTSE 250 UCITS ETF (VMID) as I wanted wider exposure to the UK market. I also sold my holding in iShares Core MSCI World UCITS ETF (SWDA) and introduced HSBC MSCI World UCITS ETF (HMWO) because as I think that over the longer term its lower ongoing charge of 0.15 per cent and increasing dividends will be beneficial.

"I don’t plan to buy a home for at least 10 years, during which time I think there will be a recession and then hopefully cheaper house prices. I intend to make the maximum contribution to my Lisa, which is run by a discretionary wealth manager, for the next 10 years. So with my contributions of £40,000, government bonuses of £10,000 and 4 per cent capital growth a year I hope to build up £70,000 to £80,000 in this account. I would like to put down a relatively large deposit so that I have lower mortgage payments. 

"But before I buy a home I may use some of my cash savings to invest in a buy-to-let property. I have £5,000 in a cash Isa to which I aim to contribute £300 to £400 a month so that I have six months’ salary in cash to cover emergencies.

"Further down the line I would like to have a family so I'm investing a lot now to benefit from compounding and time in the market. When I start a family I will put some of the money I invest into Junior Isas to cover my children’s university tuition fees.

"I hold nearly all of my investments and most of my cash in Isas, but wondered if I should also start investing in a self-invested personal pension (Sipp)? I do not plan to stop working in the public sector so have plenty of time to build up a good pension pot. But if I don’t start a Sipp, will I miss out on tax efficiencies when it comes to passing on wealth to the next generation?

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You are making good use of tax wrappers and are keeping fund costs down by investing in ETFs. Most important of all, you’ve started early so should benefit from the power of compounding which can be enormous. If you invest £1,000 a year for 30 years and get an average total return of 5 per cent a year, you will make over £65,400. If you do this for 25 years you would get less than £47,000 – so even a few years extra investing can make a difference. By just investing £5,000 more you could get over £18,000 more – a massive return.

But longer-term investors face the danger that the future will not resemble the past. History tells us that equities offer great long-term returns so all you need to do is buy and hold. However, we have no assurance that history will repeat itself. I fear that several of the things that helped equities to do well after the 1970s won’t recur, such as the conquest of inflation, defeat of working class militancy and triumph of investor friendly policies. The latter has already started to go into reverse so it’s possible that standard advice – to load up with equities – is wrong.

The future may also not resemble the past with other assets, so I would be very cautious about investing in buy-to-let property. Valuations suggest that house prices are unusually high relative to equities and the political climate is turning against landlords.

I’m also not sure why you want to hold bonds. These offer insurance against recession or increases in risk aversion. But this insurance is hugely expensive because it comes at the price of losses in real terms, on average, over the life of bonds. Cash and time diversification – buying more equities when their prices are low – are better forms of insurance.

Another form of insurance is your public sector job which provides a defined benefit pension –another means of diversifying risk.

James Norrington, specialist writer at Investors Chronicle, says:

Your objective of a 6 per cent annualised rate of return over 40 years is realistic in nominal terms. After adjusting for inflation, the annualised rate of total return for global equities between 1900 and 2018 was 5 per cent, according to the Credit Suisse Global Investment Returns Yearbook. So your estimate shouldn’t be too wide of the mark.

However, near-term returns could disappoint. You have a long-term investment horizon so are able to ride out stock market falls. But also be prepared for this psychologically because it gets very uncomfortable when a serious bear market starts clawing at your holdings. You were still in school when the financial crisis wiped 54 per cent off the value of MSCI World index so be careful not to anchor expectations of equity market risk to the period since 2009.

Forget about getting a buy-to-let property before you have purchased your home. If you think property prices are expensive why would you buy into bricks and mortar as an investment? You’d need to take on a mortgage, you only earn income when the property is occupied and the effective yield on what you paid could fluctuate. The band of UK property you could afford is arguably in a bubble thanks to the government’s help-to-buy scheme. And if the market crashes you’d be trapped with a highly illiquid asset – one you’d be unable to sell – at the time you want money to pay for a home. The tax treatment of buy to let is no longer favourable and, even if you could buy a home without selling your investment property, you’d have to pay 3 per cent supplementary stamp duty land tax.

You have started investing early so will benefit from compound returns, and are taking advantage of the benefits available to you such as your generous public sector pension and tax-efficient Isas. It is worth paying into your pension the amount necessary to get the maximum contribution possible from your employer as this is, in effect, free money. The primary purpose of a pension is to support you in old age, so maximising your accumulation is more important than inheritance tax (IHT) planning. You will not retire for a long time so bag as many of those generous public sector contributions as you can. If you are worried about IHT closer to your retirement, at that point speak to an independent financial adviser about transferring your pension into a Sipp – if uncrystallised portions of a Sipp still fall outside of your estate for IHT purposes in 30 or 40 years’ time.

Jason Witcombe, chartered financial planner at Progeny Wealth, says:

Joining an employer’s pension scheme is a great way to start saving for retirement. Pensions become even more attractive once you start paying higher-rate tax as you get better tax breaks. This tax band starts at £50,000 a year and your salary is just over that. The problem with pensions for a 23 year old, though, is that the money is tied up for a very long time and can’t be used for your shorter-term goal of buying a house. So building up extra savings in Isas and Lisas seems prudent. 

If you put more money into pensions be careful about how much you commit to them. Maybe just focus on making sure that any contributions are on earnings over the higher-rate tax threshold so that any extra pension contributions become more attractive with future pay rises.

Your public sector employer offers a very low cost additional voluntary contribution (AVC) scheme. It has a standard annual management charge of 0.17 per cent a year and the default fund, a multi-asset fund run by Legal & General, has an annual management charge of 0.13 per cent a year. This results in a total cost of just 0.3 per cent a year, which is very attractive and likely to be much more cost effective than a Sipp. Also, as your contributions would be deducted directly through payroll, as a higher-rate taxpayer you would receive the full 40 per cent tax relief straight away.

With a Sipp you would only get 20 per cent tax relief up front and have to reclaim the other 20 per cent from HM Revenue & Customs. Your  employer's AVC is likely to be lower cost and easier for you to administer than a Sipp.

Don't ignore the state pension when making your retirement income projections, even though you will not receive it for a very long time and plenty could change. You need 35 qualifying years to get the full state pension which is currently £168.60 per week, and you are building up an entitlement to this each year. You are due to receive it from age 68.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your key consideration is whether this portfolio can cope with the danger that long-term equity returns might be low. In one respect it can – by investing a lot you are taking a precaution against the risk that your wealth won’t grow from investment returns alone.

Another thing you could do is follow the 10-month or 200-day moving average rule when investing – buying assets when they are above this average and selling them when they are below it. Japan’s experience after 1990 shows that even long bear markets can be punctuated by nice rises. Buying when prices go above their moving averages can get you into these rises and selling when prices go below them can get you out of nasty long-term bear markets. This means that you may not buy during market dips but history suggests that this is a price worth paying.

In this context, your robotics ETF could be a good choice – not because it taps into a future source of growth – but rather because it offers early exposure to a potential bubble.

You do not have any private equity investments but it is possible that the best future growth will come from firms that are not listed. A quoted company with many external shareholders is not necessarily the best way of exploiting rare growth opportunities. So consider adding some private equity investment trusts to mitigate the risk that future investment growth will come from unquoted rather than quoted investments.

James Norrington says:

It makes sense to use low-cost ETFs to track the UK and, in particular, US markets. Just as compounding dividends are your friend, compounding fees are a drag on returns, but ETFs keep fees to a minimum. Passive funds such as these are best for tracking mainstream equity market indices such as the FTSE 100 and S&P 500, or liquid bond indices. I’d steer clear of smart beta ETFs which I think are just a way for passive managers to have higher fee products, and be wary of ones that track less liquid benchmarks.

The S&P 500 and FTSE 100 ETFs your Lisa is invested in are good core holdings. But the portfolio you self manage has too many small holdings which could make it unwieldy. Just a few ETFs tracking the S&P 500, FTSE 100, a Japanese index and a broad emerging markets index would enable you to put together a less US-focused exposure than a global market-cap weighted tracker – see the IC Top 50 ETFs for some suggestions.

Your proposed geographic equity allocation seems quite sensible. Together with this, an active bond fund and some cash would give you a diverse portfolio.

But, even though you are investing for the long term, a 90 per cent allocation to equities is very adventurous at this stage of the cycle. I’d be tempted to reduce that to 60 per cent equities, 30 per cent bonds and 10 per cent cash. Or even a 60:20:20 split to equities, bonds and cash given the uncertainty in markets right now.

Jason Witcombe says:

The wealth manager that runs your Lisa offers well diversified portfolios at a sensible cost so although some of your underlying holdings are very small you are not suffering any extra costs. But be careful of any fixed costs with your self managed Isa, such as dealing charges. Some of the holdings in this are small so any fixed transaction costs would translate into high percentages and eat away at returns. It would be a shame if your sensible focus on low-cost index funds such as ETFs was undermined by expensive dealing costs.

It has been said that investing is like a bar of soap because the more you handle it, the smaller it gets. It's great that you are interested in investing, but consider setting up a monthly direct debit into your stocks and shares Isa and investing it in a low-cost global tracker fund or adventurous multi-asset fund and just leaving it. Doing this would take up less of your time, which is valuable, and would minimise costs, too.