Spread your investments more broadly

“I draw £300 a month tax-free from my late husband’s self-invested personal pension (Sipp), and receive dividends worth about £370 a month, on average, from one of my individual savings accounts (Isa),” says Catriona. “I want to continue to take about £7,000 to £8,000 a year from the investments. So I would like my investments to make a total return of about 5 per cent a year, on average, over the long term. I need to draw on them to supplement my pension income, and fund my and other family members' trips to Australia to see our relatives there.

"I have no major costs coming up, but if I need any money beyond this I will sell holdings outside tax-efficient wrappers and offset any profits against my annual capital gains tax allowance [which is £12,300 for the 2020-21 tax year]. 

"I have recently moved to a smaller, cheaper home and after making renovations to it should have £20,000 left to invest. Also, my father died last year and I will inherit about £120,000 when his house is sold. I intend to give £40,000 from the proceeds to my children, and put some of the rest into safe investments such as cash – possibly Premium Bonds and other NS&I products.

"I would be prepared for the value of my investments to fall up to 15 per cent in any given year. I have tried to spread them globally, and across different assets including equities, infrastructure, property and bonds."

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:

I question your plan to hold more safe assets such as NS&I savings products. If past relationships between the dividend yield on the FTSE All-Share index and subsequent medium-term returns continue to hold, equities will do very well. And returns on safe assets are negative in real terms. So switching to safer assets might be expensive in that you forego returns. Is your motive for doing this because the coronavirus crisis has increased the salience of risk by reminding us that shares can fall a lot – rather than risk itself? You cannot drive a car only looking out of the rear-view mirror, and you can't invest on this basis, either.

But it is possible that the historic link between yields and subsequent returns will break down, and as you seem to have more equities than many investors, de-risking isn’t unreasonable. Just don't panic and sell near the bottom of the market.

I’d also warn you of a danger with portfolios that appear to be diversified, such as yours is. As well as limiting downside, diversification also limits upside. And it results in a portfolio that moves like a global tracker fund, albeit with a more defensive bias. Although this is not necessarily a bad thing [in terms of performance] holding many actively managed funds can raise the overall level of fees you pay without adding to overall performance. So keep a keen eye on charges and, if necessary, switch into active funds with lower charges.

But I’m offering you things to think about, rather than recommending any instant action, and there’s a lot you are doing right. You’re using tax allowances such as pensions and Isas. And you have decent allocations to [cheaper] tracker funds and regard individual shares as a peripheral part of your portfolio.

Rory McPherson, head of Investment Strategy at Punter Southall Wealth, says:

You have a good mix of investments and, given recent market falls, you are hopefully pleased that you have balanced your equity allocation with cash. But consider spreading your investments across a broader range of assets as they are quite heavily skewed to equities, in particular growth stocks, to diversify away some of this risk.

However, due to the current state of the market, it may not make sense to shift away from these investments immediately as they are trading at attractive prices. Rather, spread your risk across a broader range of assets going forward and, if necessary, to help you do this engage the services of a financial planner – even if only on a one-off basis.

Tim Stubbs, investment consultant at Tim Stubbs Investment Strategies, says:

You might be taking on more risk than you realise. Roughly 80 per cent of your investments, minus the cash and residential property, are in equity investments. And the bond funds you hold are focused on credit or high yield, which have recently sold down with equities – there is no such thing as a free lunch in the hunt for yield. So the defensive padding of your investments appears very thin.

You say that you could tolerate the value of your investments falling by up to 15 per cent in any given year [and in the recent turbulence] your investments had declined by such an amount. Since then, I estimate that you might have been holding reasonably steady. Although at the time I wrote this you had probably not exceeded your preferred maximum loss objective, the jury is still out on whether the market has bottomed. If it hasn’t, your investments are vulnerable to further falls because of the80 per cent-plus allocation to equities.

When investors unwittingly take on too much risk it often only becomes apparent to them when the eye of the storm hits, and many [investment] lessons are learned the hard way. When the realisation hits, normally at moments of maximum financial panic, the logical implication from a risk-management perspective is to take immediate action and get rid of all the excess risk. But this is typically what causes many investors to crystallise large losses immediately after sharp market falls.

However, when stock markets fall by around a third it creates a great opportunity for long-term investors. For example, if the FTSE 100 index were to reach 15000 by the early to mid-2030s, the chance to buy in today at around 5500 might present a long-term opportunity to broadly triple-up. This would be a 7 per cent to 10 per cent annual return range, ignoring dividends. But investors often forget that such a time frame is appropriate [for equity investments] and rarely look so far ahead.

By contrast, buying only a few months earlier at 7500 implied a chance to double [rather than triple] your money over the same estimated future period so, in this respect, the situation has vastly improved since then. Long-term investors should seek to buy investments at a cheaper entry point, if possible.

Investors who have experienced a fall in the value of their investments need to decide whether to sell for reasons of risk management, or buy with a long-term perspective on the assumption that markets rise over time. While it is very hard to decide what the right course of action is when in a hole, buying is most appropriate for investors who aspire to make strong long-term returns. You often make money when you buy – not when you sell.

Also plan to make sure that you never have to sell investments when markets are down. Just like insurance, planning is only of any use when it is in place ahead of time. 

Stock markets have halved and doubled, and racier individual investments often fall further. This means that risks are often lower at the bottom of the market – even if they seem much higher.

The good attributes of your investment allocation should have resulted in your portfolio falling less than many others so far, but its risk exposure seems on the high side in view of your objectives. You have little defensive padding with the exception of your cash.

However, [if you do not need to cash in investments for now] you can hopefully sit tight and ride this episode out. 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Compared with most equity-heavy portfolios, yours has a bias towards defensives. You are light in emerging markets and you also have many defensive funds. Your infrastructure funds hold listed utilities companies, while funds such as Lindsell Train Global Equity (IE00BJSPMJ28) own large monopoly-type defensives such as Unilever (ULVR), and others such as EdenTree Higher Income (GB0009449710) hold GlaxoSmithKline (GSK) and oil majors.

This bias has served you well during the downturn. But there are two drawbacks: when equities recover, your portfolio might not do as well as others, although the coronavirus crisis has reminded us that almost all shares and funds rise and fall to some extent with the global market. And there might come a time when big monopoly-type stocks are overpriced. A few years ago investors neglected them because they underestimated how companies’ entrenched market power benefits earnings growth. They have since corrected that error, but they might have overcorrected it.

And a fund’s good past performance can mean more than one thing. It might be an indication that its manager has good stockpicking ability. But it could also indicate that the shares the fund holds have become overpriced.

This isn’t to say that you should rush into riskier stocks, as over time there are good reasons to believe that many safer stocks will do better than they should. Just be prepared for a period when you will lag behind the market.

Rory McPherson says:

Your total return target of 5 per cent is doable, and could be achieved if your investment portfolio has a 50 per cent allocation to equities, with the rest in different asset classes. At present, your asset allocation is more skewed to equities, which isn’t consistent with only being able to tolerate a fall in the value of your investments in any given year of up to 15 per cent.

I’d suggest trimming some of the concentrated exposure to growth stocks and increasing your exposure to lower-risk bond funds with decent yields. You already hold MI TwentyFour Dynamic Bond (GB00B5VRV677), which is an excellent example of such a fund. This is also the case with some of the other funds run by TwentyFour Asset Management such as TwentyFour Corporate Bond (IE00BSMTGG87) and Vontobel TwentyFour Absolute Return Credit (LU1273680238), which are lower-risk ways of diversifying your portfolio without giving up too much return. And AXA Global Short Duration Bond (GB00BDFZQV30), run by Nicolas Trindade, is another way to balance out some of the equity risk. 

Given your return target, also consider upping your allocation to Legg Mason IF RARE Global Infrastructure Income (GB00BD3FVT86) via the sterling hedged share class. This offers a high income, is fairly defensive and will also benefit from high government expenditure on infrastructure.

Tim Stubbs says:

Your portfolio has a diversified blend of asset classes, including infrastructure, property and emerging markets equities, alongside more mainstream assets. EdenTree Higher Income, Investec Diversified Income (GB00B2Q1J923) and Invesco European High Income (GB00BJ04G628) are diversified multi-asset funds in their own right. Your investment allocation spans many geographies. And your preference for funds, trackers and investment trusts, rather than individual stocks, is a further plus. It is very important to resist the temptation of casino-like outcomes – diversification is a superior alternative. Many of your equity funds are also relatively defensive.

Your investments' relatively low allocation to UK equities will have served you well in recent years. But although there are many merits in having a global portfolio, UK equities are now keenly priced and sterling is at a 35-year low versus the US dollar. These suggest relatively brighter prospects for UK equities, so consider modestly raising your exposure to them.