Am I on track to achieve my financial goals?

“I am a new investor, and would like to know if I am on the right track to achieve my long-term aims and, if not, how to do this,” says Graham. “My wife and I plan to retire in about 18 years when we would like an annual income of £50,000 a year in today’s money. Our dream is to buy a narrowboat to live and cruise on for six months of the year, and maybe live abroad or rent a small home in this country for the other six months.

"Our fixed outgoings are currently around £7,000 a month, and we have been contributing to personal pensions over the past couple of years after consolidating some previous pensions. My pension pot is worth around £38,000 and my limited company contributes £750 each month into it. My wife’s pension is worth about £16,000 and her limited company contributes £1,000 a month into it. These pensions are invested in LV= Vanguard LifeStrategy 60% Equity Fund (GB00B70DDK80).

"I have recently opened an individual savings account (Isa) into which I contribute £350 a month. The only holding in this at the moment is Montanaro UK Income Fund (IE00BFFK9L34).

"The rental income from our three buy-to-let properties comes to £1,700 net per month. Buy-to-lets 1 and 2 have 14 years remaining on repayment mortgages, and our home and buy-to-let 3 have 18 years remaining on their mortgages.

"My hairdressing business is worth between about £50,000 and £70,000. Or if I don't sell it when I retire and employ someone to continue running it, I could take a dividend from it.

"We would also be willing to let our family home when we are retired, which would give us extra income of around £1,800 net in today’s money.

"We would also like to help our children to buy homes, so pay £200 a month into each of their help-to-buy Isas to fund deposits."

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 THESE INVESTORS' CIRCUMSTANCES.

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

The good news is that with average luck you might achieve your objective of a £50,000-a-year income in 18 years’ time.

The rent from the buy-to-let properties is now just over £20,000 a year. If this rises in real terms – after inflation – by 1.5 per cent per year, this would be in line with what real income growth is likely to be. And this would give you just under £27,000 a year. So you need £23,000 a year from your investments on top of this.

In terms of how big a pension pot you would need to achieve this level of income, people generally used to calculate this via the rule of 4 per cent. This stipulated that you could withdraw 4 per cent of your investments each year while leaving capital intact, so this implies that you need a pot of £575,000.

You save £25,200 into your pensions and Isa each year. Let’s assume you continue to do so in real terms, that is raising your payments in line with inflation each year. And let’s assume real returns of 2.2 per cent a year on these savings.This would give you just over £550,000 in today's money.

You might wonder where that 2.2 per cent comes from. If we assume a real annual return on equities of 5 per cent, and a real return on bonds of minus 2 per cent, which are current long-term real yields, it is what you can expect from a 60 per cent equities/40 per cent bonds lifestyle fund.

However, there are massive uncertainties here with regard to the macroeconomic environment, so it is not clear whether we will we get such returns. We also don't know what the tax regime will be in future. 

A particular uncertainty is whether the rule of 4 per cent will hold. To have any chance of it applying, you need to have an equity-heavy portfolio and average luck. If you do not get these, you may have to sell assets in retirement to meet your desired income. If you do not plan to leave assets to your children this should be less of a concern and give you that much-needed optionality.

There is also uncertainty regarding your personal circumstances – will you be able or willing to continue saving so much for so long? And what income will you need in retirement? Will £50,000 be enough? If it isn't now, it might not be in future.

If you are going to spend a lot of time abroad when you are retired you will need to think about currency risk. If sterling falls, your money won’t stretch so far in foreign currency. I’m not sure that you need to worry about this now. But as you approach retirement, try to hold some assets in the currency of the country you plan to move to, in order to reduce sterling risk.

Shelley McCarthy, managing director at Informed Choice, says:

Experience tells me that a couple who arrive at retirement with a diverse portfolio of assets and income streams tend to be able to have the lifestyle that they want. The rental income from your buy-to-let portfolio may well provide a significant part of your retirement income, particularly as the outstanding mortgages you have on these properties are on a repayment basis. So as long as you pay them off in the next 18 years the rental income should rise from the current net level.

The size of your pensions is currently modest, but the contributions that your limited companies are paying into them will help to build more robust pots of retirement funds. And because you are paying into these on a monthly basis you do not need to worry too much about market volatility.

Also, because you have invested the pensions in a fund with a 60 per cent equities, 40 per cent bonds allocation, you don’t have to worry too much about reviewing the investments, although a yearly review to make sure you remain on track makes sense.  

You have introduced a degree of flexibility into your longer-term income sources by paying regular contributions into an Isa. Although you do not get tax relief on Isa contributions under current rules, you can draw from Isas tax-free.

Pension plans, Isas and a buy-to-let portfolio each have their own specific risk profiles, and it wouldn’t surprise me if future governments played around with the way such things are taxed. But you can only plan for the long term based on the rules today.

You mention that your income varies from year to year, so you should have a budget plan in order to know what the cost of all of your essential spending is.

Although state pensions won’t be payable when you are age 60, when you plan to retire, they will form an important part of your guaranteed retirement income from the time of your and your wife's state pension ages. You should check what your state pension entitlement is going to be – you can find this out on the government website www.gov.uk/check-state-pension.

Letting your home and living the dream – a narrowboat life in your case – has certainly worked for some of our clients, so hopefully it can work for you. But I would recommend that you do some prudent financial planning, including some cash-flow forecasting, as it might even give you the confidence to start living your dream sooner than in 18 years’ time.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

A 60 per cent equities/40 per cent bonds fund might be overly cautious, especially as bonds are now very expensive and equities cheap by historic standards. Think about shifting to an 80 per cent equities, 20 per cent bonds allocation.

There will also come a time when you’ll have to think about diversifying out of Montanaro UK Income Fund. Although its cyclical risk might pay off in the longer run, you’ll need a greater spread of exposure at a later stage.