Do we have the right mix of holdings and risk?

Seamus is age 35, and he and his wife work full-time for a joint annual income of about £140,000 per year. They have a young child and have recently moved to the Netherlands, where they expect to stay for the foreseeable future.

“My wife and I intend to buy a home in 2021 worth up to £500,000 and have set aside £60,000 in cash to help fund the purchase," says Seamus. "In the Netherlands you can get a 10-year fixed rate mortgage at 100 per cent loan-to-value (LTV) with an interest rate of 1.6 per cent. But as mortgage interest payments on your primary home are tax deductible the effective interest rate would be around 1.2 per cent. 

"We plan to hold cash equivalent to six months of our normal expenditure of around £25,000 to cover any unforeseen expenses or emergencies. We expect to grow our family so our income is likely to fluctuate in the coming years, although we expect to earn a gross income of at least £85,000 per year.

"We would like to retire by 2050, when I am 65, on an annual income of at least £40,000 per year in today’s money and to have paid off our mortgage.

"My employer offers an average salary defined benefit (DB) pension scheme. My future expected benefit is currently equivalent to annuity income of approximately £1,700 gross per year of service. I am not including any state pension in my retirement income calculations because we are expats and there may be further relocations. 

"So I estimate that our target retirement income should be achievable if we make additional annual contributions of £12,000 per year to our investments, and they (excluding cash) make a 3 per cent average annual real return. This should generate a pot of over £1m by 2050. To help achieve this growth rate I will invest the cash savings we have not set aside for shorter-term objectives, and we reinvest dividends.

"I am prepared for the value of our investments to fall by up to 35 per cent in any given year as time is on our side. During the market falls in March the value of our investments fell about 30 per cent, but I did not trade. And their overall value has since regained much of that fall, largely due to our holdings in gold and exposure to tech stocks in our global equities exchange traded funds (ETFs).

"However, I would say that our tolerance to risk is medium so I have an allocation to assets that are not correlated with equities such as gold.

"I think that we need to reduce our exposure to sterling and make sure that our investments are not overly biased to the UK. About £47,000 worth of our cash is already held in euros.

"I also wish to reduce our holdings in higher cost active funds that have underperformed in recent years such as Jupiter India (GB00B4TZHH95). I will reallocate this small portion of our investments into higher risk stocks and funds that have the potential to deliver above-average growth. I am considering private equity investment trusts such as Princess Private Equity (PEY). I will also add some infrastructure investment trusts.  

"I like the valuations of property trusts such as Tritax EuroBox (EBOX), but find their high charges off-putting. I feel most comfortable with the concept of value investing and wouldn't buy into large parts of the equity markets at current valuations as there is no safety margin. That said, monetary policy should continue to prop up high valuations for the foreseeable future. So to help achieve my target returns, in the coming months I will gradually add to our existing holdings in low cost global equities ETFs.

"I have been investing for seven years and have enjoyed the challenge of stock picking. But more recently I have had less time to spend on this and do not expect to have enough time to manage direct share holdings for the foreseeable future."

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

Ketan Patel, wealth planner at Kingswood, says:

It is good that you have prioritised your short and longer term goals, and have specific investment objectives. It is also important to assess your goals and objectives, and understand how realistic and achievable these are now and in the future.

Managing currency risk is important, particularly as you wish to reduce exposure to sterling. Consider your sterling versus euro requirements, bearing in mind which currency your income will be paid in. If the majority of your expenditure is in euros, your emergency fund and other cash savings should also be in this currency.

As you are are able to get a mortgage with a low interest rate, compare the opportunity cost of a 100 per cent LTV mortgage with a lower LTV mortgage at a lower interest rat, combined with a cash deposit. Having an emergency fund is vital and, with a young family, consider whether there might be any other lump sum capital expenses that may not be covered by your income in the short term. It is very important that you do this before embarking on a long-term investment strategy, especially if you add private equity exposure.

As you have a young family, are about to take out a mortgage and will rely on earnings going forward, ensure that you have sufficient protection. Undertake a full review of any workplace protection benefits such as death in service before deciding on a protection strategy. This could include income and mortgage protection, and life cover. Protection is often underused and undervalued, but should be one of the key components of a wealth planning strategy. The effects of Covid-19 have shown why it is more important than ever to consider different forms of protection.

Draft wills with an appropriate local legal adviser, especially if you buy property in the Netherlands. With a young and growing family it is important to address issues such as guardianship. Wills and a supporting letter of wishes should ensure that estate planning is appropriately structured with your wishes for your children over the longer term.

Your retirement objectives are specific and measurable, but your income, assets, and expenditure are subject to significant currency risk. We suggest cash-flow modelling to illustrate how realistically you could achieve your targets in 2050 and thereafter. Cash-flow modelling should stress test the assumptions made, and help you address what could derail your short- and long-term plans.

Cash-flow modelling also enables informative debates over ‘what ifs’. For example, is the £40,000 income target net or gross, and is this achievable based on your assumptions? What if there is a sustained period of market downturn? What if the income projections are lower or higher for a period of time, and there is an unanticipated expense? If you model the DB pension with future accrual, what will this income stream look like in retirement? What if your planned annual contributions to your investments cannot be made in some years, and or the annual 3 per cent rate of return is not achieved?

Planning around these scenarios will help you make decisions, and plan for best- and worst-case scenarios.

As you are residents in the Netherlands, think about how your UK tax wrappers, such as individual savings accounts (Isas) and pensions, will fit into your longer-term planning. You may need to take action if you return to the UK or are more likely to be internationally mobile. It is also important to get local advice on how you can achieve tax efficiency annually and understand how this will interact with your investment objectives.

Before allocating your surplus capital and income into a new portfolio, select the right tax wrappers based on your current and expected future circumstances. Investing across these wrappers will also help you to attain the 4 per cent withdrawal rate you will require in retirement to generate income of £40,000 per year. Holding your investments across different tax wrappers can also enhance portfolio returns over the long term.

An action plan encompassing specific financial, legal and tax aspects would help to achieve the best strategy for you, which also needs to work in conjunction with a planned investment strategy.

HOW TO IMPROVE THE PORTFOLIO

Jason Porter, business development director at Blevins Franks Financial Management, says:

Your goal of retiring in 30 years and achieving 3 per cent annualised real growth seems reasonable. Over several decades, global equity markets have easily achieved this growth rate in US dollar and sterling terms.

You have a 30-year time horizon so do not need to take excessive risks to attain your financial goals. Small-cap Aim-traded stocks are notoriously hard to analyse and stock picking at this end of the market frequently proves hazardous. So consider as to whether the small part of your portfolio that you wish to invest in high-risk stocks would be better invested in a fund with a similar remit.

Your portfolio, excluding the cash, is largely composed of equity ETFs, gold, Aim shares and real estate investment trusts, with around a quarter in balanced, mixed asset funds. And as a significant proportion of the mixed asset funds are in equities, well over 80 per cent of your investments are relatively high-risk assets. Being comfortable with losing up to 35 per cent of your portfolio’s value in any given year and your experience in the recent market crash also suggest that you are in a high-risk category. 

Your desired allocation to cash seems sensible, and reflects a well-reasoned financial planning process rather than a lower risk attitude. 

The low-cost ETFs and active balanced funds provide a well-diversified, cost-effective core for the portfolio. Alternative assets such as property, gold and private equity should also provide several different sources of growth and stability.

However, when combining global and regional equity ETFs, and mixed asset funds, it is important to ensure that the overall portfolio is aligned with your investment thesis and goals. For example, the investments have a 9 per cent exposure to the UK via a FTSE 100 tracker and UK equity tracker, as well as UK exposure through global equity ETFs and mixed asset funds. So your investments' total UK exposure is well over 10 per cent, but the UK stock market only makes up roughly 5 per cent of the total global market. Your investments are overweight in the UK at the expense of other regions, notably the US, and overweight sterling exposure.

Asset allocation is one of the most important determinants of portfolio growth, so have a clear idea of how and where you are invested.

Paul Surguy, head of investment management at Kingswood, says:

Your Isas and pensions are invested in a diverse range of tracker and active funds, direct equity holdings and private equity. The overall exposure is high risk and your investments could fall further than your stated tolerance of up to 35 per cent during a significant setback. This is because of the level of exposure to equities which include emerging and Asian markets. That said, you understand risk and have a long-term time horizon.

Invesco Physical Gold ETC (SGLD) should have been supportive this year and provide an element of security in future market downturns. Technology exposure should also have been supportive, although we do not see a bias to this in your portfolio.

However, we would be nervous of any commercial property holdings at the moment because the impact of Covid-19 has probably accelerated the demise of the traditional office. 

You do not appear to have a bias to value equities and this will have been beneficial over the past few years. Ongoing monetary stimulus across the world is likely to continue to support growth style investments over value style ones, so we wouldn't advocate excessively altering the style exposure. And with low interest rates likely to persist in the US for some time, your emerging and Asian investments should also continue to perform well.

Before adding any investment trusts check what their level of gearing – debt – is. We like infrastructure investment trusts because it is highly likely that there will be further expenditure in this area in the coming years.