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In the US I trust

This investor doesn't need to double the value of his investments to meet his goals
May 21, 2020, Sarah Coles and Adrian Lowcock

Edward is age 60, self-employed and earns about £15,000 a year. His home is worth about £1m and has no mortgage. He also owns a flat worth about £650,000 with a mortgage of £200,000, which he lets and makes £24,000 a year in rental income.   

Reader Portfolio
Edward 60
Description

Pension, Isa and trading account invested in funds and direct share holdings, residential property, cash.

Objectives

Draw £20,000 a year from investments in retirement, take occasional lump sums, preserve investments' capital value, pay off mortgage, downsize home, double value of investments, switch pension to more flexible account.

Portfolio type
Investing for goals

“My outgoings currently come to about £14,000 a year, so I could live off the income from my work and rental income, and savings if necessary for the next five years," says Edward. "I may also move to a smaller, cheaper home in around five years, releasing equity to help fund my retirement.

"But my state pension will not start to pay out for another seven years, and only pay out about £7,000 to £8,000 a year. So I will also need to draw from my savings and investments.

"When I retire I want to draw an annual income of £20,000 a year from my investments and take some lump sums when required. But I do not want to eat into the capital value. So I want to double the value of my investments in the next five years, pay off a mortgage and have enough to live off in retirement without having to sell my home in a rush for a bad price.

My personal pension only allows you to take a lump sum, so I need to switch it into a newer account with more fund choices and lower charges.

"I am willing to be quite adventurous with my investment individual savings account (Isa) – I could tolerate falls in its value of up to 20 per cent a year. But I could not tolerate such falls in the value of my pension.   

"I have tried to balance my Isa across funds run by several different managers, but many of them seem to have a similar geographic allocation to each other and have not performed well. Some of the ones that were making the best returns changed managers and their performance has fallen considerably relative to their peers. Some of my direct shareholdings have also not performed well over the time that I have held them.

"So I would like to weed out the poorly performing investments and rebalance the Isa for more aggressive growth until I retire in five years. At that point I will move my Isa to a more defensive asset allocation.

"In the meantime, I would like to beat the S&P 500 index. I think this is a better benchmark than UK equity markets for my timescale in view of Brexit and UK sovereign debt, and that UK and European equities are going to perform poorly over the next five years. I can’t understand why people waste time with poor UK growth companies or bonds, many of which are making worse returns than cash. I also don’t trust Asian markets.

"But when the US has come through the coronavirus pandemic it will be the only developed market worth investing in. US tech, healthcare and retail companies such as Google owner Alphabet (US:GOOGL), Microsoft (US:MSFT) and Amazon (US:AMZN) will continue to dominate. I am thinking of buying a cheap S&P 500 tracker, although I am wary of buying into those companies at stretched valuations."  

 

Edward's portfolio
HoldingValue (£)% of the portfolio
Artemis UK Special Situations (GB00B2PLJQ03)15,457.581.82
AXA Framlington Health (GB00B6WZJX05)28,332.843.34
Barclays (BARC)69,4.770.08
Fidelity Global Special Situations (GB00B8HT7153)2,434.470.29
Fidelity Special Situations (GB00B88V3X40)1,815.480.21
Informa (INF)1,542.120.18
ITV (ITV)1,151.050.14
JPM Emerging Europe Equity (GB00B8DLLD51)1,365.70.16
JPM Natural Resources (GB00B88MP089)4,907.090.58
Jupiter Emerging European Opportunities (GB00B45MWP75)2,147.50.25
Jupiter Financial Opportunities (GB00B8JYV946)42,828.65.05
Merian UK Smaller Companies (GB00B1XG9599)29,492.723.47
United Utilities (UU.)1,0920.13
Vodafone (VOD)213.610.03
Invesco High Income (GB00B1W7HH10)17,818.802.1
Legal & General UK Index Trust (GB0001036531)12,0801.42
OMW Fidelity Multi Asset Open Adventurous (GB00BF95R878)27,920.433.29
OMW Invesco Managed (GB0006967227)46,334.615.46
OMW Janus Henderson Selected Opportunities (GB0008165861)21,694.482.56
OMW Quilter Investors Cirilium Moderate Portfolio (GB00B3B9WP50)51,873.936.11
OMW Janus Henderson UK Property (GB0008058074)2,586.160.3
Buy-to-let property minus mortgage450,000.0053.02
Cash85,00010.01
Total848,783.94 

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:

If you want an annual income of £20,000 a year while preserving capital you will need investments worth around £500,000, plus average luck in retirement. This implies that your investments need to grow around 10 per cent a year for the next five years. Even if we assume some post-lockdown recovery in prices – something far from assured – markets are unlikely to deliver such returns. So your desire to beat the S&P 500 is understandable.

But according to FE Trustnet data, only around a third of US equity funds have beaten Vanguard U.S. 500 Stock Index Fund (IE0002639668), which tracks the S&P 500 index, over the past five or 10 years. This is because that index’s rise has been boosted by just five stocks, which now account for over one-fifth of the S&P 500 index – a record concentration. So funds that are underweight Apple (US:AAPL), Amazon, Facebook (US:FB), Alphabet and Microsoft have underperformed, while the minority of funds that are not underweight in them have done well.

If the future resembles the past, an S&P 500 tracker and exposure to big US tech companies would be the right move. But the future might not resemble the past – especially in the long run. There is not just a danger of creative destruction – why assume that Google and Facebook will be more permanent than, for example, Netscape and MySpace were?

There’s also the risk of a political backlash against big monopolies. Economists are increasingly unhappy at the domination of monopolies, which they believe are sapping the US economy of its dynamism. In the 19th century, monopolies were broken up by anti-trust laws. Although there are big obstacles to a repeat of this, can we be wholly confident that they will be strong enough? And even without these risks these companies could be fully valued. So you would be brave to take a long-term overweight position in big tech.

But an S&P 500 tracker fund should be a key part of many portfolios.

 

Sarah Coles, personal finance analyst at Hargreaves Lansdown, says:

It’s good to have a specific investment objective. But you may need to rethink your aim of doubling the value of your investments in five years as there’s a good chance that it won't be possible. So revisit what you’re trying to achieve.

You want income of £20,000 a year in retirement in addition to your rental income. You think your state pension will pay out around £8,000 a year, but get a pension illustration to be certain.

[You can check this at www.gov.uk/check-state-pension]

This means you need to make £12,000 a year from your investments and pensions. If you take 3 per cent a year as income that would require you to grow your investments to a value of £400,000. We’d also recommend having one to three years’ worth of expenses in cash when you’re retired so you may need to keep around £40,000 in this.

You have £85,000 in cash and just under £314,000 in investments and pensions, so you don’t need the pots to double to hit your goals.

If you want to pay off your £200,000 mortgage you will need more cash. However, you are considering downsizing your home and releasing equity, which could cover the mortgage. But consider carefully whether this is something you really want to do. We often find that people get to the point of downsizing, and then realise they don’t want the change in lifestyle or upheaval. So think through exactly what you want in retirement.

Likewise, if you’re factoring rental income into your retirement plans consider the reality of letting your investment property as you get older. Will you be happy to continue managing it, or will you need to pay someone to do this? Will you be comfortable with the risks and could you cover any unexpected costs?

And if you keep two properties and live off the income from a large investment portfolio, you will die rich. Many people want to leave a legacy, but as you do not have a family do you want to factor this into your planning?

When you have established your goals, you need to tailor your investments to your objectives. You say you are happy taking risk, but you have a very large holding in cash. It’s generally important to have an emergency cash safety net, and you need cash to cover expected expenses in the next five years.

But if you want your portfolio to grow it makes more sense to invest the excess. You aren’t contributing to your pension, so are missing out on the potential tax advantages. You could get an immediate uplift in your money by paying some of this cash into your pension.

If you want to draw from your pension you will need to transfer it, but as you are over age 55 doing this shouldn’t cost more than 1 per cent of the fund. Before you switch, it’s worth shopping around for the best possible provider. As the pension will largely be used for drawdown, focus on the services potential providers offer and what support they will give you. It’s much more difficult to manage money in the withdrawal phase than during accumulation, so find a provider that suits your needs.

 

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

You have an ambitious growth target of doubling your investments in five years, which would require returns of around 15 per cent a year. You’d need to get a lot of things right to achieve that, so would probably need to add more money to your investments to hit that target.

Wanting to focus on the US is understandable. But remember that this market did very well after the financial crisis, helped by tech stocks, and that past performance is no guarantee of future returns. 

Having no exposure to bonds and being entirely focused on a couple of areas of the market increases your investments' risks. If you are exposed to the wrong areas of the market you could miss out on growth and your investments could experience a big sell-off. Think about what a further 30 per cent drop in share prices would mean to you – especially as you may struggle to replace that money without having to sell your home. Is it worth taking that risk?

The events of 2020 put a lot of things in doubt and make it hard to forecast what could happen in the next six months. Investors are nervous, so there are concerns that stock markets haven’t yet fully experienced the impact of the Coronavirus pandemic. So it would be prudent to consider what the impact of the lockdown, central bank actions and government stimuli might be. Usually, there are some surprises after events.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

There is a huge mismatch between your beliefs and investments. You think that active funds are lousy and the US is the only developed market worth investing in. But I’d never have guessed this from looking at your holdings. Adding a US equities tracker fund would help you align your holdings with your beliefs. But I’d warn against investing in recovery plays just now because history suggests caution.

Momentum works both ways: fallers tend to fall further, in part because holders of bad stocks cling onto them as they hate admitting they were wrong. And John Campbell, professor of economics at Harvard University, has shown that, on average, financially distressed stocks underperform. Although some financially distressed stocks make huge returns a greater number of them fail. This is an especially big danger at the moment: indebted companies that have seen their cash flows slump because of the lockdown will go one of two ways – out of business or an into an enormous relief rally. And I’m not sure any investor could confidently tell which is which. Trying to do this would be a great risk.

 

Sarah Coles says:

Your investments are diversified geographically, but you could broaden this further. If you want growth emerging economies offer good opportunities. Look to get exposure to these via a fund run by a manager with great experience in this field who has invested through several downturns.

ASI Asia Pacific Equity Fund (GB00B0XWNG99) benefits from the skills of Hugh Young, one of the best Asian equity investors. Or if you prefer a fund with a broader geographic allocation, as well as investing in Asia, JPMorgan Emerging Markets (GB00B1YX4S73) also invests in south America and Africa. It is run by two very good managers – Leon Eidelman and Austin Forey.

Fidelity Global Special Situations (GB00B8HT7153) is a solid choice. But your portfolio could benefit from another global equity fund such as Rathbone Global Opportunities (GB00BH0P2M97), which would add diversification. Its manager, James Thomson, has a growth investment style and tries to identify industry leaders. The fund has a large allocation to tech stocks, which you’re keen on, and is geographically biased to the US. 

You don’t like debt and want “aggressive growth”, but there is some merit in adding ballast to a portfolio. And in recent months it has been bond funds that have suffered the least, with a few even making gains since the beginning of the year. The less you lose, the lower the hurdle to get back on track.

Adding some steadier funds now would also mean that you would not have to completely overhaul your investment portfolio when you move into more defensive assets in five years' time. So a multi-asset fund that focuses on preserving capital while delivering some growth, such as Troy Trojan (GB00BZ6CNS31), would be good to add now and hold for the long term.

Your direct shareholdings are also worth revisiting, so you know exactly what you want from them. These are a mixture of risky recovery plays and income stalwarts.

 

Adrian Lowcock says:

Although holding a cheap US equities tracker fund would keep costs down it would also mean owning the bad and the ugly companies in the US market – as well as the good ones. And you would get exposure to the less appealing areas of the market, as well as growth areas.

To have any impact on the overall returns of your investment portfolio, the holdings need to be of decent size. Given the value of your investments, I would suggest minimum holding sizes of around 10 per cent. For example, even if your holding in Vodafone (VOD) rose 10-fold it wouldn’t have much impact on the overall value of your portfolio. 

You say you haven't had much success with your direct shareholdings, which could be a timing issue. But as it is a problem, I suggest disposing of them and reinvesting the proceeds in a fund.

Taking into account your views while maintaining some diversification, possible asset allocations include the following:

 

Fund% of investments
T. Rowe Price US Large Cap Growth Equity (GB00BD5FHX29)10
Merian UK Smaller Companies (GB00B1XG9599)10
ASI Global Smaller Companies (GB00BBX46522)10
Polar Capital Global Technology ( IE00B42W4J83)5
LF Lindsell Train UK Equity (GB00BJFLM156)10
Fundmsith Equity (GB00B41YBW71)10
AXA Framlington Health (GB00B6WZJX05)5
TM CRUX European Special Situations (GB00BTJRQ064)10
Fidelity Asia Focus (LU1033664456)10
Legal & General US Index Trust (GB00BG0QPL51)10
MI Somerset Global Emerging Markets (GB00B3KL3W60)10