Is high risk, high equity the way to go?

Daniel is 49 and earns about £500,000 a year from his advertising and marketing business. His wife earns about £25,000 a year. They have two children aged 12 and 14.

Their home is worth about £1.5m and has a mortgage of £900,000. They also have six buy-to-let properties worth £6m, with £3m of outstanding mortgages. These generate £4,000 a month before tax and are held in a family trust. 

“I hope to step back from full-time work at age 55, but remain active and engaged in business life with non-executive directorships,” says Daniel. “I already hold one non-executive directorship and anticipate having a salaried income of £100,000 a year between the ages of 55 and 65. When both the kids have finished school we plan to consolidate our property holdings, and have one family home in London and one in the countryside where we have family.

“When I turn 65 in 2036, my wife and I would love to retire on a joint income of £250,000 a year in current terms, with no mortgages. We also want to be in a position to be able help the kids and other family members financially, and increase our charitable donations.

“So how can I maximise our investments’ growth over the next 16 years? Am I invested in the right places or, for example, overexposed to equities? I am a totally self-taught investor. I grew up on the bread line and at age 39 still had no pension or investments, but rather £50,000 of credit card debt. However, my business has taken off during the past 10 years – a transformative decade – during which (among other things) that debt has been cleared. 

“I have recently stopped paying into a pension worth £270,000 because the growth has been disappointing over the past three years. It is invested in an equity fund provided by my bank. My wife also has a pension run by this bank worth £75,000, and she too is not contributing to it. So what should I do about my pension – where would it be best to hold it and what should it be invested in? And more generally, how can I best achieve reasonable taxation on income?

“I would say that I have a high risk appetite, but at times I think that we should take our gains of the past two years of around £200,000 and reinvest them in cash or lower-risk investments. But, so far, we have stayed invested through this year’s market turbulence. And, despite our investments experiencing very large falls in March, I have continued to invest and overall had very good investment growth over the past year.”

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

TAX AND FINANCIAL PLANNING

James Norrington, specialist writer at Investors Chronicle, says:

First off, well done for staying invested throughout the March turmoil. There may be more downside to come in the short term unfortunately but, as you have plenty of cash already in reserve and can meet your immediate commitments comfortably out of earned income, there is no need to panic and crystallise losses.

With a 16-year timeframe and a reasonable risk appetite, you have time to make good on some periodic falls in the value of your investments, so you should be of the mindset that risk is all part of making your money work harder for you. That said, you’ll still need to position yourself carefully in what is an incredibly challenging new era for portfolio managers.

Before looking at the portfolio, however, you need to address some financial planning issues. These are suggestions but worth ticking off: ensure you and your wife have made wills and settled power-of-attorney issues; take the current opportunity to fix your capital-repayment mortgages at low rates for a long time; take Isa allowances for the whole family each year; have adequate life insurance provisions.

You mention pensions specifically. Given your lifestyle plans; the amount you already have saved in pensions isn’t huge; and the fact that your annual tax-free pension saving allowance will be severely tapered on account of your high income could make it worth discussing solutions with a financial planner/tax adviser.

You already have a good starting amount, and as you’re going to be working and contributing to your investment pot for another 16 years, there is time to build up more for when you retire. You may also have spare money after consolidating your property portfolio and you could also sell your business when you retire. Again, planning for disposals will require tax advice.

Let’s now move onto the portfolio (when I say investment portfolio, I mean the shares and funds and I’m excluding the properties and cash which you should keep as a diversifier). Inflation is super-low right now, but it could easily tick up. So, you need to stay invested and rely on time and the power of compound returns to help your wealth grow faster. In terms of expectations, you shouldn’t anchor yourself to the past five years for equity markets. We’ve had some extraordinary conditions that may never be repeated, so don’t take huge risks chasing eight, nine, 10 per cent a year.

If you can control risk and make 2 per cent a year more than inflation, you’re doing well; inflation plus 4 per cent is fantastic and with sizeable regular contributions to your investment pot compounding away, that should get you close to what you need.

Michael Martin, private client manager at 7IM, says:

The questions you have asked suggest that you need a financial plan, in the same way that you probably have a business plan. Where do you want to get to and what do you need to do to achieve that goal?

Consider reducing your mortgages, as interest rates may not be low forever. Repay while you can as it is always a good feeling to be debt-free. 

You already have a trust in which you hold your buy-to-let properties. Pensions are in fact one of the most efficient and cheapest types of trust you can get. The goal for your pensions should be to increase their value to close to thelifetime allowance via investment growth rather than contributions. You couldpass those funds to your children in atax-efficient manner, as pensions do not form part of your estate for inheritance tax (IHT) purposes.

I assume that you are concerned about IHT as you already have a trust and this might be your biggest issue going forward. Rather than focusing too heavily on whether you will have enough money to retire, a key consideration may be how to mitigate a potentially large IHT bill without spoiling your children by giving them too much money at a young age. To really get to the bottom of this you will need to have a deeper conversation about it.

Retiring on a net income of £250,000 seems like an attainable goal for you. And, with a detailed plan, I think you could even bring your retirement forward by a few years.

HOW TO IMPROVE THE PORTFOLIO

Ben Gilmore, investment manager at Charles Stanley, says:

Your investments are well-positioned, and diversified both globally and across key growth sectors. Your holdings in Fundsmith Equity (GB00B4Q5X527) and Smithson Investment Trust (SSON) underscore this, as these funds have sizeable exposures to technology, healthcare and consumer staples companies.

You are also making good use of active and passive funds, and benefiting from a lighter exposure to UK equities.

But your investments are high risk with a very high equity weighting. Although Ninety One Global Gold (GB00B1XFGM25) offers some diversification, this fund is invested in gold equities which have a higher correlation to global equities than a physical gold exchange traded commodity (ETC). It should also be noted that there is concentration risk in your portfolio, with large allocations to relatively few funds.

The higher risk approach you have taken has served you well, so we would suggest that you take your foot off the accelerator somewhat rather than hit the brakes completely. This would be best achieved with some defensive additions to provide insulation.

We like the flexibility of the Janus Henderson Strategic Bond (GB0007533820) and Vanguard Global Credit Bond (IE00BYV1RG46) funds for fixed income exposure so would include an allocation to them. We would also introduce some alternative assets for further diversification such as Personal Assets Trust (PNL), a mixed-asset fund which held up well in the volatile first quarter of this year. We would also add Warehouse REIT (WHR) which stands to benefit from the online-shopping revolution.

Sixteen years is a good time frame in which to put in place the foundations of a portfolio which will generate a healthy income in retirement, though you still need good growth to get closer to your target income. So I suggest looking for investments that are growing dividends consistently, even if from a low base, and avoiding the traditional above average yield approach. Funds we like that do this and would complement your portfolio include TB Evenlode Income (GB00BD0B7C49) and Troy Trojan Global Income (GB00BD82KP33), which invest in the UK and global markets respectively. 

James Norrington says:

I like that your investment portfolio doesn’t have too many holdings. I also think that you’re wise to use funds to get diversified exposure to important themes such as healthcare and global technology. Smithson Investment Trust is an excellent managed fund and I also think it’s a decent idea to include a global tracker fund as they are a cheap way to smooth out periods of relative underperformance by managed funds.

To your equity holdings, I’d add a strategic Asia fund. China’s recovery from Covid-19 is gathering pace and as it liberalises its capital markets and its currency becomes more significant, so should its weight in your portfolio. There are some good managed investment trusts available that have great exposure to some of China’s most exciting companies. One of the advantages of the UK stock market being quite volatile is that investment trusts can often be pulled to a discount to the assets they hold. Watch for dips as you could get a good deal on investment trusts that trade at a discount, to get exposure to great businesses abroad.

In terms of diversification, you already have the buy-to-let portfolio, but in the fund portfolio I’d alsothink about a holding in a managed strategic bond fund. As you have a16-year time frame, I’d also think about an index-linked bond fund. A slither of the portfolio (no more than 3 to 5 per cent) could also be used to buy a gold ETF, to diversify when your other assets sell off, although slightly more in a gold mining shares fund would also pay dividends.

Overall, if you can handle periodic sell-offs such as in March, then keeping 60 to 70 per cent of your fund portfolio in equities isn’t unreasonable.  Although you’ll want to reassess this as you get closer to retiring.

The holding of Eleco (ELCO) is slightly incongruous with the portfolio strategy. I don’t have an opinion on the prospects of a construction software company and if it does rocket in value, I’ll have egg on my face, but in general, this sort of single stock play isn’t needed to achieve your goals. It’s only one stock, but if you were to buy loads of speculative small-caps the portfolio could take some serious managing and distract you from your goals and worse still cause you to make some bad choices and lose money.

Michael Martin says:

I like your thinking: just because you have a high risk appetite does not mean that you should take high risk. You have already taken risk by building up a successful company. Your idea of banking the profits from the investments is right.

Consider how much risk you need to take to achieve your goals. Given your capital base and current investments, and earning potential, that risk may be quite low.

You are obviously a fan of Terry Smith [manager of Fundsmith Equity] but diversification is always a good idea. You also have a high equity allocation, but I don’t think you require this.