Think before you purchase an additional property

“I would like to retire at age 60 on an income of £50,000 a year,” says Stephen. “I also want to give my three children about £30,000 each as deposits to buy homes. And I am considering buying a holiday home abroad for my wife and I to use for three months a year, and to let for the rest of the year.

"I hope to draw my retirement income tax-efficiently by taking it from various sources, including pensions, individual savings accounts (Isas) and property income, and have flexibility on when I draw from them.

“My workplace pension is a money-purchase scheme and worth about £470,000. My employer contributes £15,000 a year to it and I will contribute another £15,000 annually. My self-invested personal pension (Sipp) is worth about £140,000.

"I will also put £10,000 a year into my Isa, which is currently worth about £74,000, although could probably increase this to £20,000 a year. I intend to contribute £40,000-£50,000 a year to my retirement assets in total via monthly contributions and occasional one-off payments.

“I would like my investments to make a total return of 7 per cent a year. I have a moderate to high risk appetite, and would be prepared for my investments' value to fall by up to 20 per cent in any given year, in return for the possibility of higher returns.

"I aim for growth and try to diversify my investments by investing globally in funds that do something different to each other. Most of my investments are equity-based, including my workplace pension, which is 100 per cent in equities. But I think I get some diversification from my rental properties.

"I try to invest in funds with annual management charges of less than 0.5 per cent. But I have made very good returns with active funds such as Fidelity Global Special Situations (GB00B8HT7153) and Allianz Technology Trust (ATT), so want to continue investing in them. Recent trades include putting £5,000 into the latter, as well as the same amount into each of TR Property Investment Trust (TRY) and Impax Environmental Markets (IEM).

"I am happy with the funds I hold so will add money to some of them, though plan to consolidate some of my smaller holdings. And I am thinking of adding First State Global Listed Infrastructure (GB00B24HJL45).

I also hold some Aim companies as I find investing directly in equities educational, and enjoy it. However, in the 12 years that I have been investing actively I have never been able to outperform good fund managers, so I limit this allocation to £20,000."

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:

To get an income of £50,000 a year, you need wealth of over £1.2m, and much more if you want a holiday home and to give money to your children. But if you can save £40,000 to £50,000 a year for the next five years you should achieve this objective, assuming average luck with equity returns.

You are right to consider your Aim holdings as an indulgence. Since Aim was launched in 1995 it has hugely underperformed the FTSE All-Share index. This is because investors have usually paid too much for the small chance of great returns, causing speculative stocks to be overpriced on average. But speculative sentiment comes and goes in waves, which means that Aim shares, in general, are driven by momentum even more than other stocks. So I would apply a 200-day moving average rule to these holdings: hold them while their prices are above their 200-day average and dump them when they fall below it. This approach helps you ride out waves of sentiment.

Dale Scorer, financial planner at EQ Investors, says:

You are working well towards meeting your financial objectives, but giving some consideration to the following may further improve your position.

You might be able to increase your pension contributions. Many additional-rate taxpayers had reduced their pension contributions as they were affected by the tapered annual allowance threshold income. However, on 6 April 2020 the threshold income increased to £200,000, meaning anyone who earns under this amount is not affected by the tapered annual allowance. Many individuals have not reviewed their pension contributions since the change, so may be losing out on additional tax relief and savings for their retirement.

Also check your state pension entitlement as this will assist with your retirement income planning. [You can do this at https://www.gov.uk/check-state-pension]

You hope to be tax-efficient in retirement by drawing income from a combination of sources. This is a good strategy because taking income from various tax wrappers allows you to create a tax-efficient income in retirement. So consider using as much of your annual £20,000 Isa allowance as possible each tax year. Isa allowances cannot be carried forward, so it’s a case of use it or lose it. Although Isas are not considered to be as tax-efficient as pensions, they are an additional tax wrapper with which to create a tax-efficient income strategy in retirement.

You are thinking of purchasing a holiday home abroad, which would result in more of your overall portfolio being invested in illiquid assets. Although property can be a good way to generate additional income and capital growth, it is illiquid so can be difficult to sell – especially during periods of market stress. Before purchasing an additional property, consider how you will pay off the interest-only mortgage on your buy-to-let property.

Review your will to ensure it is up to date and still relevant. And as wills do not cover pensions, ensure that the beneficiary nominations on all your pensions are up to date and in line with your wishes.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your portfolio is equity-heavy and I would question how much your rental properties diversify it. To a certain extent they don't because another recession would result in both making losses. But your investments are well diversified globally, which is a very good thing if you also hold a lot of UK property. In the past, a weak property market has come at the same time as falls for sterling, which results in decent returns for foreign currency assets.

A better diversifier for your equity risk is your job. If you are willing to postpone retirement for a year or two you have a great protection against a bear market, as you would offset potential losses with another £50,000 to £100,000 of savings.

You hold a lot of property, which carries liquidity risk. In hard times it can be difficult to sell, so you might be unable to sell holdings in open-ended property funds and property investment trusts could swing out to big discounts to net asset value (NAV). And if working from home really does become permanent there will eventually be a big fall in demand for office space as current leases are not renewed.

In theory, these two dangers should already be embedded into prices, which means the sector should offer good returns for those brave enough to buy it. But that does not seem to be the case. TR Property Investment Trust’s discount to NAV at time of writing was just over 10 per cent. Though this is wider than its 10-year average, it is not as great as it was in 2012 or 2016. It is slightly cheap, but not screamingly so.

Your biggest holding in a security, Allianz Technology Trust, is not so much a play on technology as monopoly because its biggest holdings are Apple (US:AAPL) and Microsoft (US:MSFT). This strategy has worked wonderfully in recent years. But most strategies stop working at some point as investors pile in and push prices up too far. There’s a danger that this will happen and hit Allianz Technology Trust if it still has such large holdings in them. At time of writing the trust was trading at a premium to NAV, a sign that sentiment is unusually favourable. This isn’t a cue to rush and sell it, but something to watch out for.

And you have diversifiers against this risk in the form of exposure to smaller companies.

Dale Scorer says:

Your investment allocation reflects your moderate to high attitude to risk. Although this may be appropriate for now, you may want to review your risk profile as you head into retirement and need to start drawing from your investments. Your portfolio is made up of a range of equity funds, direct shareholdings and smaller companies, which are likely to experience greater volatility. Although those saving for retirement can often afford to ride out the ups and downs of the stock market, certain events can have a much bigger effect on investors taking income. A diversified portfolio can help to smooth out the ups and downs of the market, and reduce the effect of falls, so this is an important thing to consider in your retirement.

Consider splitting your savings into short, medium and long-term pots. Your short-term savings should be your emergency funds and easy to access in case of unexpected expenses. We usually recommend having six months' expenditure available. This could include the money that you plan to gift to your children, depending on the time frame over which you will give it. Splitting out the long-term investments and drawing from the medium-term pot will enable you to better ride out market fluctuations with the long-term pot.

One of your most recent buys was Impax Environmental Markets, but you still don't have much exposure to socially responsible/sustainable/positive impact investments so consider adding more of these to your portfolio for further diversification.