Can my three-funds and short-term trading strategy deliver?

“I hope to retire in 15 to 20 years,” says Sylvie. "At that point we will sell our main home, and spend half of the proceeds on a home for our children and add the other half to our retirement savings. We will live in our holiday home.

"My husband contributes to a self-invested personal pension (Sipp), which is worth about £600,000, and an individual savings account (Isa). He also holds about £100,000 in cash.

"I am trying to invest around £20,000 a year and would like this money to make an average annual return of 10 per cent, although this is quite an optimistic goal. When I retire I will stay invested, and aim for a mixture of growth and income.

"I have been investing for three years and am quite comfortable with risk as I have a long-term investment horizon. I think that I would be prepared for the value of my investments to fall by up to 20 per cent in any given year.

"I look to hold funds for the long term, but I take a short to medium-term view on some of my direct shareholdings if I think they are undervalued. I realise that this is trading rather than investing, but it is fun – I enjoy picking shares - and my direct shareholdings have done reasonably well. 

"But sometimes I think I should leave it to the professionals – I am concerned that I am overexposed to technology and that my investments are not very diversified. I also don’t hold any passive funds, so maybe I should add some."

Sylvie's investments

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:

Your aim of 10 per cent annual returns over the next 15 to 20 years is optimistic. To achieve this you would need to systematically beat the market, and there are only two well-attested ways of doing this if you stay invested.

One is to use momentum – buy stocks that have recently risen a lot. But this requires a lot of trading. The other is to invest in defensive stocks, which some investors avoid because they think they might underperform rising markets. Roche (ROG:VTX) and AstraZeneca (AZN), which you already hold, are examples of such stocks.

You would also need a way to time the market. You could apply the '10-month rule' – hold equities when their prices are above their 10-month average and get out of them when they are below it. This strategy doesn’t work for dips in the market, and doesn’t get you out at the top or in at the bottom. But it does mitigate the effects of the sort of longer-term bear markets we saw in the early 2000s. And in the next 15 to 20 years, at least one of these bear markets is very likely.

The strategy also works especially well with sentiment-driven assets such as emerging markets to which you will need to have exposure if you are to have any hope of making a return of 10 per cent, on average, a year.

Alternatively, you could lower your expectations and make regular investments into a global equities tracker fund. This is dull, but in a world of low returns with few ways of beating the market, it is the only option.

Ian Futcher, financial planning consultant at Quilter, says:

Your aims are realistic, but there are some potential bumps further down the road. However, these can be avoided with some careful tax-efficient planning.

Because of your family's amount of wealth, it's crucial to look beyond just maximising your portfolio's potential for return. You need to look at how to protect your wealth. I would start by making sure that you are using the correct tax-efficient wrappers and all your yearly allowances. 

To illustrate your options, I will make some assumptions. Your husband appears to have used up about half of his pension lifetime allowance, which is currently £1,073,100. So consider getting him to pay into a pension for you.

If you’re both using your full annual Isa allowances, which are currently £20,000 each, consider opening Junior Isas into which you can contribute £9,000 per child per year. However, your children will get full access to this money when they reach age 18. Also consider paying into pensions for your children, into which you can pay £2,880 per child each year. 

When you sell your home it will take several years to put the proceeds into pensions for you and your husband tax-efficiently, unless you have any unused allowances left that year.  As this is quite a complex area and you would be adding a large value to an already large estate, I would suggest getting professional advice to help you find a tax-efficient solution.

You and your family also have potentially huge inheritance, capital gains and income tax bills further down the line. Look into using a combination of products and strategies such as Enterprise Investment Schemes, Venture Capital Trusts (VCT), gifting, Lifestyle and other types of trusts, and onshore and offshore bonds.

These are complex products that have drawbacks as well as advantages, so it is important to get professional advice before using them.

By holding a mix of managed funds you run the risk of being overexposed to one sector, so you could end up with a lack of diversification.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You hold actively managed funds for the long term, but you pay a price for this. Annual management charges compound horribly over time: a charge one percentage point higher than what you’d pay for a passive tracker fund could easily cost you over £4,000 for a £10,000 investment, over 20 years. And I'm not sure that you would get greater returns to compensate for this.

Many of your active funds have performed well in recent years, but this is as much a warning as a recommendation. Lindsell Train Global Equity (IE00BJSPMJ28), Fundsmith Equity (GB00B41YBW71) and Scottish Mortgage Investment Trust (SMT) have done well because their managers realised a few years ago that investors were underpricing companies with the sort of monopoly power you get with powerful brands or a dominant market position. The danger is that investors have now wised up to this, so such stocks are more fully priced. If this is the case your returns will be lower in future.

And some of your funds have similar holdings to each other. Paypal (US:PYPL) is one of Fundsmith Equity's, Lindsell Train Global Equity's and Rathbone Global Opportunities' (GB00BH0P2M97) 10 largest holdings. And Amazon (US:AMZN) is one of Rathbone Global Opportunities' and Scottish Mortgage Investment Trust's 10 largest holdings.

This highlights a problem that big funds can have – a more limited number of investment possibilities. A £2bn portfolio of 40 stocks means that the average holding size is £50m. It’s very difficult to take a position of that size in a mid-cap stock. So funds of this size may have to focus on bigger companies.

This works well if large monopolies do well, so might not be a problem in the short term. But it could be a risk for a longer-term investor.

So consider ways to diversify, such as smaller companies funds. One advantage of these is that they are exposed to cyclical risk, so should do well during economic expansions.

Alex Brandreth, chief investment officer at Luna Investment Management, says:

I agree that your Sipp and Isa are too focused on technology-related companies and that you need to review your direct shareholdings.

Your biggest holding, Fundsmith Equity, accounts for 21 per cent of your Isa and Sipp. That is a high weighting to have to one investment. The maximum exposure our clients' portfolios can have to one fund is 20 per cent, and in practice it is usually more like 10 per cent.

Lindsell Train Global Equity and Scottish Mortgage Investment Trust account for 20 per cent and 19 per cent, respectively, of your Isa and Sipp. So three funds account for nearly two-thirds of your investments, highlighting a lack of diversification.

These three funds also have similarities to each other in terms of their investment style, and sector and regional allocations. They are large-cap growth-orientated funds, and although Lindsell Train Global Equity is slightly more core it has growth holdings. This investment style has been in favour for the past 10 years, but if value-style investing starts to do better, your investments overall may underperform because they are too focused on growth-orientated managers.

Fundsmith Equity, Lindsell Train Global Equity and Scottish Mortgage Investment Trust have 67, 31 and 55 per cent of their assets, respectively, invested in the US. And they have a bias to the technology and consumer sectors.

Although these funds have been excellent performers over the long term and we also invest in them, I would reconsider your weightings to them. Add other equity funds focused on different regions, such as Europe, the UK and emerging markets, and funds that invest via different styles such as value. Diversification is key.

Reduce your return expectations. The long-term annual return from investing in equities is around 8 per cent a year, so a return of 10 per cent would require significant alpha each year from the funds you invest in.

I have always been an advocate of investing portfolios with a value of less than £500,000 in funds. When you invest in an active fund you entrust your money to an experienced investment professional. They will invest it where they see opportunities and aim to do this in your best interests. So at the moment I would avoid holding direct equities in your portfolio. But direct shareholdings can play a part as the size of your portfolio increases. 

When investing directly in equities, we typically hold 30 large-caps. So with only six companies, your Sipp and Isa are overly concentrated, exposing them to significant risk. Your exposure to Sylvania Platinum (SLP) in particular, which accounts for 13 per cent of your Sipp and Isa, is too high. Our portfolios have a maximum exposure to any one direct equity holding of 5 per cent and, in practice, 3 to 4 per cent is a more typical level of exposure.

Holding Aim companies with market capitalisations of about £113m in the case of Sylvania Platinum and £127m in the case of Bango (BGO) is going to add significant volatility to your portfolio. Instead, consider investing in a UK Smaller Companies fund which is diversified across different companies and sectors. Smaller companies are a less efficient part of the equity market because brokers do less research on them. This means that smaller company fund managers can outperform, and such a fund would be a better way of investing in UK smaller and Aim companies.