Aiming for safety and simplicity

"I expect to fully retire at the end of next year when my wife starts to receive her state pension, which she has delayed taking for six years,” says Aiden. “We want an income of around £35,000 a year, and when my wife is receiving her state and private pensions, between us, £48,000 a year. 

"I will also soon start to receive a private pension of £24,000 a year from defined-benefit schemes. I also have some defined-contribution pensions which I will start to draw after age 70, although the charges on these are high and I find them hard to understand.

"We want to supplement our retirement income with our investments, and have about £348,000 of these in three individual savings accounts (Isas) and £85,000 in a self-invested personal pension (Sipp). My wife has savings accounts and bonds – I take the greater investment risks. We want to make a return greater than we would get on cash held in building society accounts and have some fun investing.

"I have been investing since 1983 and think I could tolerate a fall in the value of my investments of 15 to 20 per cent in any given year. I mitigate risk by spreading my money thinly over many investments, and don’t entrust a high proportion of them to any single organisation, if possible. I have been burnt by over-the-counter share purchases, an Equitable Life pension and shares in a bank.

"I mainly invest in collective funds, in particular investment trusts and exchange traded funds (ETFs), and have recently bought Target Healthcare REIT (THRL). I invest less in direct shareholdings as I am trying to keep life simple as I go into my autumn years, but still buy a few such as recent purchase BT (BT.A).

"I have recently sold Merian Gold and Silver Fund (IE00BYVJRH94) and AstraZeneca (AZN), and am thinking of replacing the latter with GlaxoSmithKline (GSK).

"I made quite a number of transactions over the summer, which is unusual for me. These were mainly purchases because I think UK equities offer good value, and are much more attractive than Europe or US equities. I invest according to my hunches depending on how the market is at the time and if any opportunities appear.

"When choosing funds, I look at favourite fund lists. I have done some book-keeping, so when choosing direct shareholdings I check financial reports. I understand some ratios, although am not an expert on financials. I like direct shareholdings on low price/earnings ratios (PEs) and to see some kind of return for holding a share. I also monitor director dealings mainly looking at when they sell.”

Aiden and his wife's portfolio

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

With average luck over time, this portfolio could give you an income of around £20,000 a year while preserving the value of its capital. You can create your own dividends by selling a few shares and [if you don't hold them within tax-efficient wrappers such as Isas or Sipps still] mitigate any tax incurred by offsetting profits against your capital gains tax allowance.

If this isn’t enough, you would have to run down your capital and leave a smaller bequest to your children and grandchildren.

You like to buy equities on low PE ratios. But there’s a danger that such stocks might be cheap for a reason. You say that the UK looks more attractive than the US and, on valuation grounds, it is. But this could be because UK companies have less scope for earnings growth than their US counterparts, in part because Brexit uncertainty might continue to depress their growth prospects. 

You might have been tempted into utilities stocks for similar reasons. Their valuations also look good but reflect the risk that a future Labour government might nationalise them on unfavourable terms.

This isn’t to say you should ignore valuations. UK equities' cheapness relative to their history is a strong reason for optimism about the general market. But in other respects carefully assess and be wary of what appear to be attractive valuations.

Rosie Bullard, partner and portfolio manager at James Hambro & Partners, says:

You would like an income of £35,000 a year from. With a portfolio (excluding your primary home) of just under £475,000 this represents a withdrawal of 7.5 per cent a year on a gross basis [if you rely solely on your investments for this]. This is a relatively high return target after fees, so we assume that you are expecting to erode your capital and are comfortable with that. Although returns of 7.5 per cent are not unattainable, you should be prepared to continue having a bias to equities and be comfortable tolerating volatility. A portfolio that only holds equities, for instance, can go down more than 20 per cent in a year. As markets do not rise in a straight line you may have to make significant withdrawals when your assets have fallen in value, which weakens the opportunity for your portfolio to recover.

You like to invest in direct shareholdings on low PE valuations. Although the price paid for a security is the key determinant of future returns, stocks are often cheap for a reason. In the current environment, in which investors are willing to pay for higher-quality companies, if you focus too much on stocks with a low PE ratio you may end up holding more cyclical or weaker companies, exposing your assets to more risk.

Paul Derrien, investment director at Canaccord Genuity Wealth Management, says:

You have built a sizeable portfolio within tax-efficient wrappers. The investments are extremely diversified and you are not taking excessive risk with any one of your holdings. It looks as though you could meet your income requirements with your pensions, so your portfolio could provide surplus income as you move into retirement. It could also provide long-term growth and achieve your aim of beating the returns you get from building society cash accounts. 

However, you should review your risk. You say you are willing to accept a drawdown of up to 15 to 20 per cent, but have about 78 per cent of your portfolio in risk assets and 22 per cent in cash. A similar portfolio over the past 20 years would have seen a drop on two occasions of between 30 per cent and 35 per cent. Although these were extreme circumstances you need to consider whether you are comfortable with this because, if market movements during 2018 are anything to go by, future falls could be swift and severe. 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your portfolio is not as overdiversified as first appears. You’ve avoided the worst costs of overdiversification by not holding too many active funds with high charges. Many of your holdings are tracker funds, so you are spreading risk across different fund providers. That said, I suspect that the risks associated with these individual fund providers are small.

Your main holdings are trackers, alongside some property funds and some big defensive equities such as Royal Dutch Shell (RDSB), Reckitt Benckiser (RB.) and major telecoms companies. History suggests this is wise. Stocks such as Reckitt Benckiser and Royal Dutch Shell have been underpriced, in part because investors did not realise how important their monopoly power was – the sort that comes from big capital requirements or strong brands. However, they should by now have corrected their error. If this is the case their future returns should not be as good.

This isn’t to say they’ll be poor: there are still reasons to expect defensives to do well – not least because some fund managers avoid them for fear of underperforming a bull market. It’s just that we shouldn’t expect the future to be as good as recent years.

A second risk concerns property funds. In downturns, property becomes even harder than usual to sell. Open-ended property funds might respond to this by stopping investors withdrawing money from them and closed-end property funds' discounts to net asset value might widen, reflecting the risks to their assets. In theory, the counterpart of this liquidity risk should be higher average returns. So think of such funds as very long-term investments – they’re not right if you have to sell in a downturn.

Rosie Bullard says:

Your plan to simplify your portfolio makes sense as it may be difficult to monitor more than 50 individual assets. When you simplify your list and focus on funds rather than direct shareholdings, try to avoid duplicating underlying exposures as a result of holding too many funds. For example, over a third of your portfolio is invested in 16 funds focused on UK equities and 11 of these are tracker funds. So there is certainly scope for simplification and a reduction in duplication. You should make sure you understand what structure the passive funds you hold have – for example, do they invest in the assets they track or get the exposure through derivatives?

You have a number of direct shareholdings, all of which are listed in the UK and have a bias to the domestic economy. We stress the importance of not having a home bias within a portfolio because although you might be familiar with the holdings you could miss out on opportunities overseas. Over the three years to the end of September 2019, the S&P 500 index returned 54 per cent whereas the FTSE All-Share index returned 22 per cent for a sterling-based investor, according to Bloomberg data. Although we agree that there may be value emerging in certain areas of UK equities there are also many opportunities overseas.

Paul Derrien says:

You have too many holdings and duplicate investments. For example, you have UK equities funds from iShares, Vanguard, BMO and Legal & General Investment Management. Many of your holdings are too small to make any material difference to the performance of your overall portfolio and you don't seem to have a clear strategy. Some of the holdings have significant overlaps with each other in terms of their underlying assets. And you have some poor performers.

So this portfolio could do with some reconstructive surgery. Start by reviewing each fund, and noting its performance and ongoing charge. Then list your holdings according to their geographic and thematic focus, for example property and resources, so you can see what your asset allocation is. Consider if it reflects your world view – your strategy – and make adjustments accordingly. 

Reduce your number of holdings by consolidating them into the cheapest trackers and funds with the best returns. For example, you are massively exposed to the UK through a large variety of investments, but you would probably be better off having this exposure via one FTSE All-Share index tracker fund as it would cost less and potentially provide better returns. 

Decide how much of your portfolio you want in the UK, and how much of this should be in globally exposed companies listed on the FTSE 100 index, and how much should be in UK domestic-facing small and mid-cap companies. You should get exposure to these two areas via three funds at most rather than the 16 you currently have.

Do the same with your holdings in other geographical regions and themes because, for example, having 0.45 per cent of your portfolio in an emerging markets fund is neither here nor there. If you like a holding have a meaningful allocation to it, and if you are not prepared to commit more, sell it. 

By doing this, you should be able to reduce your number of holdings by half or more and improve performance – even if it is just by reducing costs. But don’t forget to get rid of the poorly performing investments and maybe use this opportunity to switch your direct shareholdings into collective investments to achieve that simpler life.