Can this mix deliver 6% growth a year?

“I want to retire early at age 60 – or at least have the choice of doing this – and plan to fund it and supplement my pensions income by drawing on my investments,” says Richard. “My pensions should cover my day-to-day living costs in retirement. At present, I and my employer put £825 a month, in total, into a pension on a salary sacrifice basis.

"My mortgage has a 33-year term, but I hope to start making overpayments when my five-year fix comes to an end and I do not have nursery fees to pay.

"So I estimate that I will need a minimum of £25,000 a year in today’s money from my investments for leisure, travel, and helping children with deposits for first homes, university costs, starting a business and weddings.

"I expect that my investments will need to help fund my retirement for 20 years as the current average UK life expectancy for men is around 80. I would also like my investments to cover any care costs or home improvements my partner and I will need to make as we get older, so that my children don’t have to pay for this.

"I aim for my investments to grow 6 per cent a year before any dividend reinvestments over the next 26 years. This assumes I fully stop work at age 60 rather than working part-time thereafter. It also assumes that I will not add to my investments after I have retired, although this is unlikely because I see investing as a hobby and may have more time and disposable income for it then. And I have not factored in any inheritance or income from the state pension.

"I consider dividends important as I can reinvest them now and take them when I am retired to supplement my pension income. If my investments were to pay me dividends worth £10,000 a year in retirement I would only need to take capital worth £15,000 each year. But my dividend income would decrease as I sold holdings to pay for big-ticket items.

"I have been investing for five years, and have a medium to high risk appetite because of my long-term investment horizon, so would be prepared to see the value of my investments fall by up to 50 per cent in any given year. I try to see falls as an opportunity to buy in at a lower price and may top up some of my existing holdings. The value of my investments fell by 13 per cent over just the first two weeks of March. But the only sales I made were as a result of stop-losses [orders placed with brokers to buy or sell securities when they reach a certain price] on stocks I had made a healthy profit on. 

"My reasons for adding new investments include being a takeover target or paying a good dividend, or if I am interested in what the company does. I like technology companies and ones that produce things that could fundamentally change the way we live, such as electric vehicles or green technology.

"I have tried to diversify my portfolio geographically by, for example, reducing my pensions' allocation to the UK. I also try not to hold companies that do similar things to each other."

Richard's portfolio

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:

By starting to invest early you are able to take advantage of the power of compounding – over a 26-year time horizon even modest annual returns compound nicely. A return of 4 per cent a year after inflation would turn £100 today into £277, in today’s prices, by the time you turn 60.

However, your aim of 6 per cent capital growth per year seems excessive. Over time, dividends should grow at around the same rate as the general economy. If valuations don’t change share prices will also rise in line with economic growth. But we’ll be lucky to get growth in real terms of as much as 2 per cent a  year.

That said, valuations might change: as I write, the dividend yield is well above its long-run average so should fall. But some of this fall will come from dividend cuts. So I would instead budget on price rises of half of what you expect, say, 3 per cent a year – much of which could come soon.

This means that you are unlikely to achieve your aim of dividends worth £10,000 a year. This amount would require a portfolio of around £250,000, which would require your current portfolio to grow over 8 per cent a year. You’ll not achieve this by growth alone, so you need to put in extra money.

You need to be sceptical about growth potential. Green technology may well be the future, but can you tap into it via quoted companies? The problem with expanding markets is that they attract new entrants and competition. So, before you buy any stock consider what market power it has to make profits in the face of greater competition. Although investors might be overpricing established big monopolies just now, you should still pay heed to how growth stocks can fend off competitors, so it is good that you hold some tracker funds to diversify stock-specific risk.

You need stop-losses because over a 26-year time period some of your holdings are bound to fail. You’ll make some mistakes and economic growth is driven by creative destruction so that, over time, even apparently strong companies end up on the wrong side of this. And if you don’t have rules for selling you’ll end up with so many holdings that your portfolio will become unwieldy and expensive.

But you only seem to be applying stop-losses to holdings on which you have made a profit. So you take profits as winners slip back, but don't sell losers. This results in you betting against momentum – selling winners and holding losers. This is disadvantageous because momentum is one of the more powerful forces when investing. Past winners, on average, tend to rise for a few months and past losers continue to fall. So put in place a stop-loss rule for all of your stocks.

And be prepared for mistakes and disappointments along the way because every investor sometimes makes them.

Keith Bowman, analyst at interactive investor, says:

Saving into a pension from a young age and reinvesting dividends over the long term are very important when building up a pot for retirement. Physicist Albert Einstein said that “compound interest is the eighth wonder of the world”. And investors should frequently remind themselves that it’s not about timing the market, but about time in the market.

Also consider setting up a monthly saving scheme, something that many investment platforms offer. These allow you to drip feed money into global stock markets over time and mean that you do not have to try to time the markets. 

In addition to long-term savings, it is also important to have a cash reserve to help deal with emergencies such as being made redundant. It means that in such circumstances you do not have to draw on and deplete investments intended for retirement income or helping children in later life, and the investments can continue to grow.

You have built up investments worth over £28,000 outside pensions, but not said what kind of account you hold them in. If you do not already, you should hold these within an individual savings account (Isa), a good tax-efficient wrapper in which to build up medium- to longer-term investments. You could withdraw money from this when you need to fund something such as helping your children meet university costs.

Also, as the main aim for the investments is to eventually supplement your pension income, consider at some point selling investments and buying them back within a pension. But consider the capital gains tax implications and get professional advice before doing this. Although this would mean that you cannot draw on the monies before age 55, or 57 from 2028, the government tax relief applied to the contributions would give the pot an extra lift.

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

There are many good things about your approach so far, and you have a sensible and realistic attitude to risk in that you are willing to expose your savings to the vagaries of the stock market. As we have recently seen, markets can be susceptible to huge falls, but if you have a long investment horizon you can materially benefit from them – especially if you are able to invest money at these points. You are already doing this with your current workplace pension and, ideally, should also do this with your non-pension investments.

Your intended growth expectations are conservative, so you should be able to comfortably achieve and maybe exceed these. If you exceed your growth expectations it will mean that you can reduce your risk levels as you approach the time when you need to draw from your investments. 

The level of pension contributions you are making is commendable, as is the fact that you review your pension investments and non-pension investments as one entity. Your current contributions, which should rise over time, should provide an attractive amount of assets for retirement. At some point, it will probably make sense to consolidate them into one self-invested personal pension (Sipp). 

But you are generally pursuing the right strategy to achieve your investment aims.

HOW TO IMPROVE THE PORTFOLIO

Keith Bowman says:

You have a broad collection of investments that include potential takeover targets and companies that pay good dividends. And global equities funds such as Scottish Mortgage Investment Trust (SMT) provide diversified exposure to companies such as Amazon (US:AMZN) and Netflix (US:NFLX). This would be a good investment to add to during market falls.

However, never forget to diversify. Three banks account for over 10 per cent of your investments' value, and added to your holdings in life assurers mean that financials account for nearly 20 per cent of your investments. But Covid-19 and regulatory pressures have resulted in a suspension of dividends by banks and many insurers. Such events can rarely be predicted, underscoring the importance of being diversified both in terms of the individual investments you hold and your sector exposures.

Paul Derrien says:

You have a good spread of investments that are roughly the same size as each other. It is good that you do not have many direct shareholdings because having a large number of these is time-consuming to monitor. And your investments are well diversified because you hold a number of funds that, importantly, don’t have many of the same holdings as each other, so give your portfolio a decent balance. 

But there are times such as the present when it pays to watch currency markets. You can make material gains from weakness in sterling only to lose them in a recovery. However, exchange traded funds (ETFs) often provide ways of playing stock markets while removing currency risk.

Some modest tweaks may help you preserve a little more in the downturns and maximise your returns when investment opportunities are available. So consider what proportion of your investments are defensive and could take advantage of market weakness. You don't have many such holdings, so maybe add some that you could sell and reinvest in equities during market falls. Options include bond funds, or defensive funds such as Ruffer Investment Company (RICA), BH Global (BHGG) and BH Macro (BHMG). These can maintain or add value during periods such as the present, or could be sold and reinvested in equity investments to materially increase your exposure to these.

There is evidence to suggest that environmental, social and governance investment themes have outperformed in recent years and during the decline. So consider adding some additional exposure to investments that fall into this category, especially as you are already interested in them. Options include Impax Environmental Markets (IEM).