Having buffers allows you to take risk

“Our house is worth about £1m and we have no mortgage,” says Graham. “In five years we will probably move to a smaller house in a lower-cost area nearer to our children, and I expect to raise £300,000 to £500,000 from this move.

“I would also like to achieve a real annual return of 4 to 5 per cent from my investments so that I can take £10,000 a year from them when I fully retire in approximately five years’ time. As we have a reasonably secure income and no immediate need to draw on the investments, I am reasonably relaxed about risk, but would get worried if their value fell by 30 per cent or more.

"I am also concerned about putting large amounts into individual funds following the Woodford debacle. I still have some money in the [former] Woodford funds, although luckily I sold the majority of my holding in LF Woodford Equity Income (GB00BLRZQC88) before it was suspended from trading.

"The vast majority of my investments are, I hope, reasonably well balanced and I intend to hold them for the long term.

"I consider the remaining small portion of my investments as 'fun money'. These are mainly direct share holdings in smaller companies which I hope will grow rapidly. I have chosen these based on information in the financial press, and analysis using online tools. But to date the performance of these holdings has been mixed: some have done very well and some have been disasters. So I am waiting for a favourable moment to sell the majority of my smaller direct share holdings and, for example, recently sold a holding in Avingtrans (AVG) worth £2,426.

“I have been investing since the 1980s when BT (BT.A), British Gas and other utility companies were privatised. These investments did very well and I have been hooked ever since. In recent years, as my financial situation has improved, I have invested more seriously and regularly added to my self-invested personal pension (Sipp) and individual savings account (Isa). I invest £500 a month into each of the Lindsell Train Global Equity (IE00B644PG05) and Rathbone Global Opportunities (GB00BH0P2M97) funds, which are held in my Sipp.

"But three years ago I significantly reduced my number of investments and am not going to add new funds as I would prefer to top up those I already hold. However, I have recently invested £5,000 in Rio Tinto (RIO) and £3,000 in Mercia Asset Management (MERC)."

Graham and his wife's portfolio

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You say you are reasonably relaxed about risk. Your portfolio reflects this, with less than 10 per cent in cash and little bond exposure.

A justification for this is that you have two great diversifiers – your income from work and pensions, and the plan to release a lot of home equity by trading down.

At some point, though, you’ll lose these diversifiers. When you do, you might want to consider reducing the risk in your portfolio by shifting towards cash or bonds. The advice that older people should own more safe assets than younger ones is true to the extent that older people have fewer ways of spreading risk than youngsters. When you’ve stopped working and have moved to a smaller home you’ll be in this position. But it’s possible that by then interest rates and returns on safe assets will be higher.

I say this because the risk that worries you – a 30 per cent-plus fall in the value of your investments – is a genuine one. If future returns on global equities are like past ones, they will average 5 per cent in real terms with a standard deviation of 20 percentage points, which means that there’s roughly a one-in-12 chance of a 30 per cent loss over a two-year period. That seems low. But if you live into your late 80s, you’ll see 10 two-year periods. And there’s a greater than 50:50 chance that during one of these there will be a 30 per cent drop.

In the short term, you could cope with this by working for longer or moving to an even cheaper property than what you have in mind. It is true that the circumstances in which shares fall a lot could be ones in which the price of your house also falls, but some people might become forced sellers of houses, so you might be able to snap up a bargain. The question is, what will happen when you lose these diversifiers?

The dull economist in me questions whether you should invest the 'fun money' in smaller growth stocks. Economists think that what matters is your portfolio as a whole. And a big win on a speculative holding wouldn’t make much difference: even if a £1,000 holding were to double in value it would only add about 0.2 per cent to the value of your investments, which is less than the day-to-day variation caused by global markets' ups and downs.

As you’ve discovered, it is unlikely that such stocks, in aggregate, will do well. One reason for this is because corporate growth is largely unpredictable – as economists Alex Coad and Josef Lakonishok have shown. Another reason is that many investors value the small chance of a big win more highly than they should, causing speculative stocks to be overpriced on average: this is just the flipside of the tendency for defensive stocks to be underpriced.

You are right to regard such stocks as a bit of fun. But remember – nobody pays you for having fun.

Rob Morgan, pensions & investments analyst at Charles Stanley, says:

The future target level of income you require should be easily achievable with a portfolio of this size. You could take a lower-risk approach and still meet this target, for example, by incorporating some further asset class diversification and increasing weightings to lower-risk areas. However, your buffer of potential additional capital, secure income from pensions in payment and ability to tolerate losses allows you to take greater risk. So I see nothing wrong with your main broad investment strategy at present.

It could be worth considering how you are going to take your income when you fully retire. From the point of view of inheritance tax (IHT), it could be a good idea to take a high income from your Isa and/or other assets such as the cash sum you get when you downsize your home, and leave as much of your Sipp intact as possible. Pensions are generally outside a person’s estate for IHT purposes.

Doing this could have implications for your future investment strategy. Prioritising the withdrawal of income from Isas may mean rejigging the nature and asset allocation of the different pots. For example, holding income-producing investments in the Isa and taking their natural yield as the lion’s share of your regular withdrawals, and holding more of the growth orientated part of the portfolio in your Sipp. There are various options here, and much will depend on how your situation evolves. If you have not already considered some financial planning on this issue it could be worthwhile.

Victoria Rutland, chartered financial planner at EQ Investors, says:

You and your wife appear well placed to meet your financial goals, and have a few options available to do this.

I would suggest that you make additional pension contributions to your Sipp each tax year, if you can afford to. This is particularly worthwhile while you continue to work. You are a higher-rate taxpayer so would get 40 per cent tax relief and the extra pension contributions would allow you to make additional savings for retirement.

I would consider using as much of your annual £20,000 Isa allowance as possible each tax year. Isa allowances cannot be carried forward so you use it or lose it. Although an Isa is not considered to be as tax-efficient as a Sipp, an Isa will provide you with a tax-efficient income in retirement. Tax-efficient withdrawals are key to not drawing too quickly on your assets in retirement.

You should also bear in mind the implications of downsizing your home. Assuming that you are planning to invest some or all of the proceeds, an Isa would offer you the flexibility of a more tax-efficient portfolio. For example, if you have a fund or share that pays a high dividend, if you hold it in an Isa you don’t pay tax on the dividends.

HOW TO IMPROVE THE PORTFOLIO

Rob Morgan says:

This is a diverse portfolio with a core of sensible funds. It also provides a balance of UK and overseas exposure.

I’m pleased that you are not planning to add to your number of holdings as you already have a large quantity. A bit of consolidation would be sensible so that your portfolio is not too unwieldy, and having fewer direct shareholdings will reduce its risk – as well as the time you need to spend on research.

You have quite a bit in cash in your Sipp – £32,254 out of a total value of £223,758. I assume this is tactical, for example, because you are waiting for market opportunities, and will invest it at some point so that it isn’t a drag on returns.

Victoria Rutland says:

After one of the longest bull markets in history we know that at some point the next market downturn will come, but in what shape and size is anyone’s guess. So I would suggest that your investments are positioned with enough risk to capture late-cycle gains. However, have an eye on the crest of the wave – hold enough defensive and uncorrelated assets to weather the next storm.