You need to consolidate

“I hope to retire by March 2021,” says Ebrahim. “At this point we would like to start receiving an inflation-proof income of £38,000 a year from the investments in our self-invested personal pensions (Sipps) and individual savings accounts (Isas). Together with our other income, this should will allow us to maintain our current lifestyle.

“My income over this year is likely to be less as I am winding down my work. Any pension contribution I make will go towards building up a tax-free lump sum entitlement of at least £50,000 to take when I retire for personal spending, when I will also start to draw on my pension.

"We would like to largely preserve the capital value of our investments, and retain our properties as an inheritance for our two children and two grandchildren – unless we incur major care costs in the years to come. We would also like to reduce the amount of inheritance tax (IHT) they will have to pay as far as is possible.

"I invest in funds, and hold the different types across two platforms where it is most cost efficient to invest in them. Using two platforms also means I have a wide choice of investments and should provide flexibility in terms of how I draw down income in retirement.

"I have you been investing for 10 years and have been particularly proactive for the past seven. I would say that my risk tolerance is moderate as I would be prepared to lose up to 10 per cent of the value of our investments in any given year. I intend to hold at least two years worth of our annual income requirement in cash to allow the investments to recover after any downturns, and to manage risk within this volatility range.

“I have tried to run a diversified balanced portfolio with an asset allocation that reflects my macroeconomic views, influenced by model allocations including the FTSE UK Private Investor Balanced Index. Due to the uncertain outlook for and risks relating to bonds I do not have much in this area, and am uncertain as to whether to increase it. I have more substantial allocations to alternative investments, sector-specific and property funds, and cash.

"I have also tried to build in a natural sterling hedge via domestic and overseas investments, based on the outlook for sterling. I revise and rebalance the investments every four to six months.

"About 85 per cent of the investments are core holdings that I plan to hold for the long term. But I frequently switch the remaining 15 per cent via momentum trades. However, I intend to stop trading frequently in the near future as I want to switch this segment of my portfolio into income-focused investments that I will not trade often as I approach the time when I start to draw on my pension. I also suspect that I may have too many holdings and selling the investments that I trade frequently will reduce them by 12. 

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:

Your target of a £38,000 annual income is feasible. It’s reasonable to expect a real return of around 4 per cent a year from this portfolio, which means that on average you could take around £40,000 a year in real terms from it while leaving the capital intact. I stress that this is a total return as you could create your own income by selling some holdings. I’m pleased to see that you are not making the mistake of thinking you need to own income funds to generate income.

But there is a risk in doing this. These same reasonable expectations suggest that there is around a one-in-12 chance that your equity holdings will fall 20 per cent or more over a three-year period. That might seem low. But, I hope, you should live for at least eight more three-year periods, which means that there’s a roughly 50:50 chance of you experiencing such a bear market during your retirement.

Your portfolio's low weighting to bonds suggests that it would not be resilient to this. But I think this position is reasonable because, although bonds insure against recession and increases in risk aversion, this insurance is expensive – it comes at the price of a guaranteed loss in real terms in normal times.

A protection you could have is to leave a smaller bequest to your family, effectively pooling risk with your children and grandchildren.

Another insurance is cash to which it’s sensible to have a decent sized weighting. It doesn’t just protect against falling share prices, but also the type of liquidity risk that comes with property and infrastructure funds. But you do need a way of diversifying risk.

Peter Savage, chartered financial planner at Fairstone, says:

You have a small inheritance tax (IHT) liability due to the value of your main home, two Isas and buy-to-let property. The assets held within your Sipps aren’t subject to IHT and could be passed down to future generations, which can make these wrappers efficient tools for IHT planning.

To reduce your heirs' IHT liability, consider drawing on the assets within your Isas first for income, as this will lower the value of your estate for IHT purposes. If you do this you may want to reconsider the asset allocation of the Isas and Sipps. If you withdraw what you need for income from the Isas first, maybe hold lower-risk assets within these tax wrappers. Also look to have yield-bearing assets within the Isas as much as possible.

You could then keep more equity-based growth investments within the Sipps and allow the capital value of these assets to appreciate more as they will not be drawn on for the first five years.

If you die before age of 75 the assets in your Sipps could be paid out as a tax-free lump sum or a tax-free drawdown pension. If you die after age 75, the benefits could be drawn down or paid as a lump sum taxed at the beneficiary’s marginal rate. If you die before age 75 and leave the benefits to a spouse who draws from the pension tax-free and dies after they are over age 75, the benefits would revert to being taxable income for whoever next receives them.

The disadvantage of your beneficiaries or spouse taking the benefits as a tax-free lump sum is that they would take an asset that didn't previously fall within their estate for IHT purposes into it.

An alternative option would be to use a bypass trust for your Sipp benefits in case you die before age 75. This is a discretionary trust that is set up to receive the pension death benefits. So, instead of nominating your beneficiaries directly, you nominate the trust. This would ensure that the death benefits remain outside the estate of the beneficiary and are not subject to IHT. The beneficiaries can withdraw capital or income, and keep the assets within an IHT-efficient wrapper. For older clients, this also reduces potential social impacts and third-party claims. If the beneficiary passes away after age 75 this would not affect the tax position of the assets within the trust.

If you die after age 75 you may not wish to nominate a trust, because if the benefits are paid out as a lump sum to the trust this would incur a tax charge of 45 per cent. However, I would seek advice on this option after you reach age 75.

You have too many holdings and need to reduce the number to make them easier to monitor.

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

Your income target from the investment portfolio means you need to aim for a yield of around 3.7 per cent, which should be achievable as your equity-focused investments offsets the lower yields from the bond funds. But you face two major challenges in meeting your income objectives.

Aiming for an inflation-proof income income requires investing in lower-yielding inflation-linked bonds. But if you want to take a flexible approach, equity investments offer the potential to generate income and growth ahead of inflation, albeit with some risks.

Your desire to hold two years' required income in cash – around £76,000 – means that the rest of your portfolio needs to work harder to generate the required yield of 4 per cent. In the current environment, it is difficult to generate a yield of 4 per cent and it would require your portfolio to be focused almost entirely on income-generating investments.

But you should still be able to generate the income you need without drawing on the capital, allowing you to pass it onto your family.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You have too many actively managed funds. Diversification works both ways, reducing the chance of big gains as well as big losses. So you are incurring a lot of fees without the chance of great returns. Fees also compound horribly, for example over 10 years an extra percentage point of fees could cost you £15,000 for each £100,000 you hold.

And holding many funds doesn’t mean that you are perfectly diversified. Many of your funds have similar holdings – large defensive stocks with some monopoly power. So you are not just duplicating holdings, but also taking on a hidden risk. Many such stocks have had a fantastic run in recent years as investors have wised up to the virtues of big monopoly-type stocks. This, however, might mean that they have run too far and are now overpriced – or soon will be.

A fund with a good track record, meanwhile, may have a manager who is a good stockpicker, but it also might be holding a lot of stocks that have become too expensive.

So, consider reducing your number of holdings and reinvesting the sale proceeds in the passive funds you hold.

Adrian Lowcock says:

There are a number of things that you need to address, such as the number of funds you hold. Although your investments are held across a number of pensions and Isas it still makes sense to consolidate the number, as each investment will have a more meaningful impact on the overall portfolio return, helping you to achieve your objectives. Small investments of £3,000 or less will do little to the performance of a portfolio worth £1m or more. A more concentrated portfolio would be easier to manage and would help you to achieve your goals, so I would suggest 15 to 20 funds. 

To reduce the risk of the portfolio it makes sense to have investments with a broader focus. Although sector-specific funds can make strong returns they are also quite volatile and high risk – as are single-country emerging markets funds that can add a lot of risk to a portfolio.

To ensure that your portfolio will generate the income you require, you need to give it a complete overhaul. You have many growth funds that don't generate much income. And I suggest increasing your exposure to bonds. Although I share your concerns on this area, it would be risky to try to get the majority of your income from equities because they can be volatile and subject to cuts, particularly in a downturn.

I have put together an example of a portfolio to illustrate the type of asset allocation that could generate the income you require.