Increase your overseas exposure

“I hope to stop work at age 60, the normal pensionable age for my former workplace defined benefit pension (DB),” says Ashley. “It is due to pay out about £25,000 a year from that time, although I could draw it at a discounted rate from age 55. 

"I expect I will [start to] take income from the Isa when I take my occupational pension. But I may need to make capital withdrawals from it in 18 months' time if I do not have a job by then. I could also change the Isa's asset allocation to produce more income – the yield is only about 1.4 per cent. And when I am age 60, I may reduce the risk profile of my investments by investing in blue-chip stocks with a more secure dividend. 

"My growth strategy has also led me to invest in smaller company and Aim stocks. But I tend to avoid sectors that are volatile or about which I have limited knowledge, such as airlines, oil & gas, natural resources and commercial property.

"I invest £400 per month into five of my former employer’s Save As You Earn (Saye) share schemes, which mature between December 2020 and 2024, and are worth less than I invested in them. I need to make a decision on what to do about them by mid-December, when I am thinking of withdrawing them. They would generate cash worth around £12,000."

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:

You are right to reinvest dividends as it's quite likely that, over the long term, the majority of the total returns from equities will come from doing this rather than capital growth. And it is good that your portfolio has a decent weighting to defensive stocks such as Hill & Smith (HILS) and Diageo (DGE), and momentum stocks such as Team17 (TM17) and Frontier Developments (FDEV). Defensives and momentum outperform over the longer run, and are the only strategies for which we have strong evidence of sustained success.

You want to increase your income return which, in one sense, is sensible. It is risky to seek capital growth from smaller Aim-listed stocks as these are often overpriced because investors pay too much for the small chance of big quick gains. But there are risks to trying to increase your income return. A high yield can indicate dividend cuts, as was the case with BP (BP.), or exposure to recessions such as is the case with miners and housebuilders. If you want to add dividend payers go for more defensive ones such as utilities or tobacco stocks.

Tom Claridge, senior portfolio manager, and Glenn Branney, regional head of wealth planning (Belfast), at Julius Baer, say:

Make sure that you have sufficient cash available to cover any period of unemployment before your retirement, maybe one to two years’ worth of essential and non-essential expenditure. NS&I Premium Bonds can be considered as part of this cash holding. And use as much of your annual Isa allowance as you can afford to as this will help to bring greater security in times of crisis or uncertainty.

At this stage, look to optimise the value of your pensions. Get a state pension forecast by completing a request online at https://www.gov.uk/check-state-pension or filling in the BR19 application form and submitting it by post. This will tell you the value of the guaranteed income you will get from your state pension. This and your DB pension, which is also index-linked, will be likely to provide the bulk of your annual retirement income requirement.

You have a sizeable Isa portfolio and cash reserves from which you could draw, if required, to supplement your income until you are age 60. Doing this would mean that you do not suffer any early retirement penalties for taking your DB pension early. If you can continue to work until age 55 consider making additional pension contributions, as a long as doing this doesn't incur an annual allowance tax charge.

Delay making a decision on whether to transfer out of your DB pension until as close to age 60 as possible, so you have more time to consider the best option from an income versus risk perspective. Transferring your DB pension benefits could potentially create a lifetime allowance charge down the line.

A partial transfer may be possible, but get guidance from an adviser who could compare the benefits of remaining in the DB scheme with those of a full or partial transfer out. An in-depth cash flow analysis would help to determine what scope you have to meet income requirements until age 55 to 60, and beyond. This should also help to identify the returns you need to make to achieve your objective, and the necessary strategy and risk profile.

Have you considered what tax is due on your redundancy payment? Make sure you have the money to cover this unless it is collected under Pay As You Earn (PAYE).

Consider investing in venture capital trusts (VCTs) to mitigate your income tax liability this year and as a possible further source of tax-free income via dividend payments.

Leaving employment means losing benefits such as life and private medical insurance. Review which of these are important to you and consider replacing them yourself if you are not able to get a new job.

As your SAYE scheme is worth less than you invested in it, look into whether the savings contracts can be cancelled and a refund of your contributions made.

Ensure that you have an up-to-date will. You could leave part or all of your estate to charity, or make gifts during your lifetime so you can see their benefit while you are alive.

Kay Ingram, director of public policy at LEBC Group, says:

Retain your redundancy payment in cash and draw it for income until you find another job. When you have a new job and regular income consider investing some of your surplus cash in the Isa. 

You need income of £30,000 a year net of tax to maintain your standard of living. From age 60, the bulk of this will come from your former workplace pension, which should pay you £22,500 after tax. This leaves a shortfall of £7,500 a year. The extent to which you can take a risk with this part of your income depends on how much of it you need for essential bills or for discretionary spending, and your willingness to vary discretionary spending if your investments' value falls.

You should be able to cover the gap between your guaranteed former workplace pension from age 60 and income target with your Isa, which only needs to produce 1.5 per cent over inflation to meet this.

You will be entitled to a state pension from age 67. If your former workplace pension was contracted out of the earnings-related pension scheme, your pre-2016 state pension may be less than you expect. With four years or less of the post-2016 state pension, you may have a shortfall in NI contributions to get the full state pension, which would pay £6,832 per year after basic-rate tax. So get a forecast from the Pensions Service to find out. Each year you work and pay NI from now on will produce £260 of annual state pension.

Whether you can afford to retire at age 55 depends on the level of pension you will be paid at that age. A reduction of 6 to 8 per cent a year is not uncommon. It is not usually possible to know the early retirement figure on offer until a few weeks before the pension starts, so you may need to reconsider retiring before age 60.

However, if you are in poor health your ability to work for longer may be in question and the value of the guaranteed pension over the longer term may be less. If you also have no dependents this could be a reason to transfer out of your former workplace pension. However, this is an irreversible course of action which could leave you worse off. Unless you are terminally ill this is something to consider closer to age 55 or later. 

There is a danger that without the distraction of work you will deal more often or take big positions on individual stocks, increasing the risk of losses. But as you only need to cover a modest income shortfall you do not need to take this risk.

If you continue to manage your investments yourself consider arranging a power of attorney to deal with your financial affairs, in case you lose the capacity to do this. This is not just a problem in old age but can arise as a result of an accident or a long stay in hospital. 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your investments are underweight overseas stocks and in recent years the UK has underperformed overseas markets. The UK is now relatively cheap, so this might not be the case in future. But as this is not certain consider increasing overseas exposure, which you could do via a global tracker fund.

You might have too many holdings. Diversification reduces the chance of outperformance – as well as underperformance. It leaves you with something like a tracker fund, but acquired at greater expense and effort.

This problem is mitigated by your bias to defensives and momentum, which tend to do well. I’d be happy with a portfolio that diversified individual equity risk, and only left me exposed to defensive and momentum as factors.

In portfolio construction there are diminishing returns. Even if the efficient markets hypothesis is wrong, some stocks are underpriced and you have the ability to spot these mispricings – would you be able to spot more than 30? Asset managers employ teams of analysts because they know that one person can’t find many bargains.

We can mitigate this problem by screening for defensives and momentum stocks. Limiting your search to these raises your chance of finding something.

So consider cutting your number of holdings, while retaining the defensive and momentum orientation.

Glenn Branney and Tom Claridge say:

You have a significant exposure to UK smaller companies and large positions in individual stocks. Although these types of exposures can generate outsized returns they also tend to create more volatility. And smaller companies tend to be less liquid. Consider increasing your investments' diversification, and exposure to larger global and UK companies. We suggest doing this via an active or exchange traded fund (ETF), where the fee is justified by benefits of diversification.

Although fixed-income investments are low-yielding relative to history, diversifying across asset classes will help to reduce volatility, in particular investment-grade corporate bonds. We also suggest an allocation to riskier, higher-yielding parts of the fixed-income market, such as non-investment-grade high-yield bonds and emerging market hard currency bonds. We suggest investing in them via active funds where the manager is not necessarily seeking the highest yield, but rather focuses on companies with sustainable business models. And go for a fund share class that is hedged back to Sterling.

Kay Ingram says:

Having a cash buffer will give you more time to reallocate your Isa investments. The current allocation may have been suitable while the Isa was surplus savings invested for growth. But it is not positioned to produce a steady stream of income in the short term or to supplement your retirement income.

You have done well to avoid oil & gas, airlines and commercial property, which have suffered badly as a result of Covid-19 restrictions. However, your investments are very concentrated in a handful of shares, with 30 per cent of [the Isa's] value in only three stocks and 50 per cent in only seven. As you do not have a regular income this concentration represents too high a risk as a sharp fall in one of these holdings would have a significant effect on the overall value of the Isa, and potential income and growth.

You are invested almost exclusively in UK-listed shares, so are missing out on the potential of global markets. The growth opportunities from these may be greater and foreign currency exposure may bring gains if the UK economy suffers Brexit disruption and Sterling is weaker. Diversify into a broader range of investments to reduce risk.