Simon is age 47 and earns around £250,000 a year as a chief executive. His wife is 40 and does not work, but each year makes the maximum pension contribution possible for those with no income. He also uses his full pensions annual allowance, and they both put the maximum amount possible into individual savings accounts (Isas) each year, which for the 2020/2021 tax year is £20,000.
Pensions and Isas invested in cash, residential property, wine and art
Retire early, generate £50,000 per year by drawing 4 per cent from investments, sell buy-to-let properties and invest proceeds in funds
Simon and his wife's home is valued at £1,650,000. They also have buy-to-let properties worth £750,000 and £550,000, which generate annual net incomes of £17,250 and £18,750, respectively. All the properties are mortgage free.
“I may want to retire early on an income of around £50,000 a year," says Simon. "So I would like to build up a fund large enough to provide this amount if I draw about 4 per cent a year from it. I plan to dispose of our rental properties and reinvest the proceeds in investments that would generate enough annual growth to meet this amount.
"As the Coronavirus outbreak escalated in February we sold our equity-based investments. However, we are now thinking about re-investing this money, worth about £576,436, according to the following asset allocation in these funds.
|Simon's proposed investment allocation|
|Type of fund||% of investments|
|Simon's proposed fund allocation|
|Holding||% of investments|
|City Merchants High Yield Trust (CMHY)||3.50|
|Royal London Sterling Extra Yield Bond ( IE00BD0NCB41)||3.00|
|M&G Emerging Markets Bond (GB00B7GNKY53)||3.50|
|MI Chelverton UK Equity Income (GB00B1Y9J570)||1.50|
|Montanaro UK Income (IE00BFFK9L34)||1.50|
|Royal London Sustainable Leaders (GB00B7V23Z99)||5.00|
|Finsbury Growth & Income Trust (FGT)||5.00|
|Mercantile Investment Trust (MRC)||5.00|
|BlackRock Smaller Companies Trust (BRSC)||2.00|
|Standard Life UK Smaller Companies Trust (SLS)||2.00|
|Bankers Investment Trust (BNKR)||3.00|
|Scottish American Investment Company (SAIN)||3.00|
|Mid Wynd International Investment Trust (MWY)||4.50|
|Rathbone Global Opportunities (GB00BH0P2M97)||4.50|
|Edinburgh Worldwide Investment Trust (EWI)||5.00|
|Monks Investment Trust (MNKS)||5.00|
|European Opportunities Trust (JEO)||5.00|
|Fidelity European Values (FEV)||5.00|
|Montanaro European Smaller Companies Trust (MTE)||2.00|
|Baillie Gifford Shin Nippon (BGS)||2.00|
|Fidelity Japan Trust (FJV)||4.00|
|Schroder Asian Total Return Investment Company (ATR)||2.50|
|Allianz Technology Trust (ATT)||3.00|
|BlackRock World Mining Trust (BRWM)||0.50|
|Impax Environmental Markets (IEM)||0.50|
|Jupiter International Financials (GB00B58D9P37)||0.50|
|Legg Mason IF RARE Global Infrastructure Income (GB00BZ01WV25)||0.50|
|Pantheon International (PIN)||0.50|
|Polar Capital Biotechnology (IE00B42P0H75)||0.50|
|Standard Life Private Equity Trust (SLPE)||0.50|
|VT Gravis Clean Energy Income (GB00BFN4H792)||1.50|
|Worldwide Healthcare Trust (WWH)||4.00|
|TR Property Investment Trust (TRY)||5.00|
|Tritax Big Box REIT (BBOX)||5.00|
"We have tried to avoid funds with many of the same holdings as each other.
"We have experienced losses in many markets and have an investment time horizon of five to 10 years, so I would say that we are adventurous investors.
"But we are concerned about the economic environment. So how and when do we go back into the market? Pound cost averaging [investing a set amount of money at regular intervals] is a way to hedge against market fluctuations. But at what rate would we drip feed our cash into investments?
"I am also thinking of investing in venture capital trusts (VCTs) for their tax benefits."
|Simon and his wife's investment portfolio|
|Holding||Value (£)||% of the 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:
There are lots of uncertainties about drawing 4 per cent a year from your investments in retirement. This rule was devised at a time when returns on safe assets were reasonably high. But to get 4 per cent returns a year now requires you to take considerable investment risk, and run the danger of your wealth's value falling over time. But this shouldn’t be a big problem if you aren’t worried about leaving a bequest because you can respond to disappointing returns by running down your wealth.
It's great that you’re making full use of your tax allowances, avoiding high management fees, are aware of liquidity risk [how easily you can buy and sell assets] and are looking to diversify sensibly.
But don't buy VCTs just because of their tax breaks. If you had two assets with the same expected returns and tax treatments, and the government gave one of them a tax break, its price would rise as people bought it for the tax advantages. And at the same time its expected returns would fall. So post-tax expected returns on the two assets would probably be similar – just as before the tax break was given to one of them.
There’s a different argument for VCTs. Future growth won’t only come from today’s quoted companies, but also from firms that aren’t yet listed. VCTs and private equity funds offer exposure to such growth. However, some of these companies are highly geared, having borrowed in anticipation of future profits, so are especially vulnerable to bankruptcy. I like private equity and venture capital in principle, but would be very wary of buying them just now.
Paul Bowater, wealth planner and Eilidh Anderson, investment manager at Kingswood, say:
Spend more time considering your priorities and needs.
You would like £50,000 a year in retirement but what is the minimum level of income you will need? Does the £50,000 a year include state pension and will you ever need to take lump sums in addition to your annual income? It's important to establish this, to ensure that you have the necessary access to your investments, and the right tax arrangements and asset allocation. These can be determined by how much money you will need and over what timescale.
If you want an income of £50,000 a year it is likely that you could retire now. But another five to 10 years could make a big difference in terms of what level of risk you should take, what types of tax wrappers you hold your investments in, and what geographic allocation they have.
You want to reduce the amount of tax you pay. But is this more important than the level of risk you are taking and achieving your target retirement income? For example, if your goals could be met without investing in VCTs, why take that risk – especially as you are concerned about the economic environment?
Is mitigating tax on your assets after you die important? We think you would be likely to incur a tax bill of around £1.2m.
If you sell your buy-to-let properties the proceeds will be subject to capital gains tax (CGT) at 28 per cent? Or are the properties and the income they generate in your wife’s name? Also, rent worth £36,000 a year would meet the majority of your target retirement income.
On the whole, it looks like your plan will deliver and meet your goals. But we recommend employing a financial planner to help direct and construct a financial plan that is tax, cost and income efficient.
If your main goal is to generate £50,000 a year indefinitely do you need to have an adventurous investment profile? It would be beneficial to define your priorities because if a cautious or balanced approach could meet your goals this would make more sense.
Although some consider pound cost averaging to be a cautious investment strategy, studies suggest that lump sum investment methods generate better returns over the long term. Your decision to sell in February spared you falls in the value of your investments of around 20 per cent – something that many investors fail to achieve. But markets are often unpredictable and illogical. So, for example, if you had been invested along the lines of the allocation you are thinking of, since the lows of 23 March your portfolio would have returned around 40 per cent. This reinforces the old adage that time in the market is better than trying to time the market.
However, we believe that the recent rally got ahead of itself, buoyed by economic stimulus and positive sentiment. Prices appear to be detached from fundamentals and two-thirds of global fund managers believed that it was a bear market rally. We can expect further clarity once second-quarter results and economic statistics filter through. But our concern is the scale of any new waves of infection in the winter.
So if there is a second correction this could be a good time to begin a pound cost averaging strategy. We would generally suggest drip feeding in tranches the size of a third of your money, but this will depend on the amount of the money, which may be determined by the timing of your property sales.
Rob Harrison, investment manager at Progeny Asset Management, says:
It is very hard to identify the ‘right’ point at which to invest money in a market downturn. Mmarkets can move very quickly and it is almost impossible to identify the market lows. So our policy is to phase investments into markets over the medium term to average out the cost of purchase. If you are buying lots of positions that incur dealing costs, these can stack up.
Due to the complexity of your financial situation we would recommend speaking to a financial adviser and investment manager to avoid any potential pitfalls.
The key to asset allocation is making sure that it fits your risk tolerance. If you are a higher risk investor, having little exposure to defensive assets such as fixed interest is not a problem. However this means that your portfolio is higher in volatility and offers little protection in times of market stress.
An allocation to property acts as a diversifier. But in times of deep market stress, such as in February and March, closed-ended property funds tend to be correlated with equities and experience similar draw downs to the broader market. Having a global, diversified equity exposure is desirable due to the differences of regions and the make up of the markets.
The US equity market is very tech heavy, while the UK has a much larger exposure to more cyclical sectors such as banking, oil and mining. And allocating to global equity funds can be tricky, because their holdings will overlap with your regional funds' holdings as managers are able to move their asset allocation around. So your exposure to one region could change overtime without you realising.
HOW TO IMPROVE THE PORTFOLIO
Chris Dillow says:
By holding investment trusts you are not wholly avoiding liquidity risk. It’s just that this risk manifests itself in a different way. Investment trusts that invest in property or private equity can experience a substantial widening of their discounts to net asset value (NAV) if their underlying assets become difficult to sell. This shouldn’t be a problem for long-term investors, in fact, you could benefit from a risk premium caused by others avoiding liquidity risk. But many investors who think they will take a long-term view on investments don't when disaster strikes, so make sure you are not one of these.
International diversification across equity markets does not protect you from crashes or many bear markets. National stock markets can fall together for several months. Rather, diversification protects you from long-term underperformance. For example, during the past 10 years UK stocks have risen less than 2 per cent a year, but the US market has risen over 13 per cent per year in sterling terms. Spreading your investments across countries would have protected you from that underperformance.
To get protection from short-term bear markets, you need assets other than equities. I’m not sure that high-yielding bonds are the answer as their high yield is compensation for credit risk. If this rises, as it does in recessions, these bonds – as well as equities – might make losses.
Rather your substantial cash savings are very wise.
Paul Bowater and Eilidh Anderson say:
The investments you plan to buy are mainly investment trusts, of which the closed-ended structure mitigates liquidity and large redemption issues. These types of funds also benefit from the oversight of a board of directors.
However, if you buy an investment trust at a premium to NAV it is at risk of both a fall in its asset value, and swings from premiums to discounts. And the use of gearing – debt – can exacerbate poor performance in a falling market.
The funds you propose investing in offer a good level of diversification and are run by a variety of asset managers. But if you are an adventurous investor, your allocation to equities is on the low side. This collection of funds is also heavily weighted to the UK and Europe, but underweight the US, Asia and emerging markets.
Your thematic allocation increases the overall defensiveness of your investments via exposure to areas such as healthcare, technology and metals. It also gives exposure to key long-term trends, such as companies not listing on public markets for longer, clean energy and infrastructure.
Other themes we like include artificial intelligence and environmental opportunities.
And in volatile periods such as these there is no harm in holding cash and gold.
Rob Harrison says:
It is important to diversify your investments across sectors and company sizes. It can be tricky to achieve in practice and many funds, especially in the UK, are mainly invested in mid- and small-cap companies. The funds you propose investing in have a bias to small- and mid-cap companies, even though in some cases their names do not indicate this.
The fixed interest funds that you buy will be key to your portfolio's diversification. Investing in long-dated government bonds is likely to provide the most protection in a market downturn. An allocation to high-yield bonds could produce a greater yield. However, in a market downturn they tend to behave more like equities than bonds and fall with equity markets as they have the greatest economic sensitivity.
It is important to look at the investment style of managers of international equity funds as this can have a greater effect on correlations than a few holdings in common. For example, if a manager buys heavily into the technology sector they are likely to move in the same direction as other managers investing in the same area. The stocks they pick are key but, as we have seen from the past few years, high-quality growth stocks have driven the market and managers invested this area are likely to perform in a similar manner to each other. It can be easy for a portfolio's holdings to all go in the same direction.