Do we have enough to retire at 55?

Matthew is age 51. He earns about £95,000 a year plus bonuses and his wife, who works part-time, earns £10,000 a year. Their home is worth about £700,000 and mortgage-free.

"We would like to be able to retire as soon as possible after we are age 55 in about three-and-a-half years," says Matt.

"I have a group personal workplace pension worth about £36,000 to which my employer and I contribute £8,500 a year. My wife has a stakeholder pension worth about £20,000 to which she contributes £1,000 a year. Most of our other assets are held in three self-invested personal pensions (Sipps), into which we have consolidated several personal pensions, and two individual savings accounts (Isas). When we retire we will further consolidate our pensions. I already manage our investments as a single retirement savings portfolio, and several of the core holdings are held across different accounts.

"When we retire we plan to relocate, so will have some money from the sale of our home. But we plan to use this as a cash reserve. We currently have cash worth £45,000 – about six months' worth of our take-home salaries – but this is also for emergencies and short-term needs.

"So I would like the investments to reach a value of £1.8m by the time we retire so that we could initially withdraw about 3.5 per cent a year from them, to meet our income requirements. The amount we draw would increase with inflation, but when our state pensions start to pay out we could decrease this.

"We plan to take our tax-free cash entitlement of 25 per cent, and from next year increase the cash allocation in our Sipps by no longer reinvesting dividends. We will reinvest this money in Isas over a five-year period and in retirement continue to manage the investments for a total rather than income return.

"However, the value of our investments has fallen from its January high, so I am worried that we will not be able to retire as soon as we want and have to work for longer. I calculate that with our current contribution levels, building up the investments to a value of £1.8m would require them to make a return of 7 per cent a year. And while I could accept a significant fall in the value of our investments, I am concerned about how long it would take to recover and how another significant market drop would affect our plans to retire in a few years. But I’m hoping to minimise how long after age 55 we have to work.

"I am also concerned that our income in retirement will not be able to keep pace with inflation and that we will run out of money. And I wondered what impact low growth at the start of our retirement would have on our ability to successfully maintain the income we require?

"I started investing 20 years ago by choosing workplace pension rather than just accepting the default option. I opened an Isa in 2011, and became more interested in managing our portfolio about five years ago.

"About a quarter of our investments, excluding the £45,000 cash reserve, are defensive and include with-profits and UK fixed-income investments. About a fifth are in income-paying alternative assets such as property, infrastructure, renewables, private equity and mining funds. And the remaining 55 per cent are in equity funds with a bias to the UK and emerging markets.

"I have diversified our investments across geographies and asset classes. I try to maintain our target allocations with new contributions, and rebalance the investments on a quarterly basis if an asset category has diverged 25 per cent or more from its target allocation. Most recently, I reduced our holdings in Lindsell Train Global Equity (IE00BJSPMJ28) and Fundsmith Equity (GB00B41YBW71) because the allocation to active global equity funds was greater than I wanted.

I reinvested the proceeds in our worst performing investment – BMO Commercial Property Trust (BCPT). I hope that it will recover and bring the property allocation back to the proportion I want it to be. But my property investments are very exposed to retail premises and offices, so I am considering replacing them with more thematic real estate investment trusts (Reits) focused on areas such as logistics and healthcare.

"I am considering reducing the number of holdings in some areas. I have tended to select multiple funds within each area in the hope that their investment styles or underlying holdings are different to each other. But I think I’ve ended up with too many holdings."

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

FINANCIAL PLANNING

Simon Bonnett, senior consultant – private clients at Beckett Financial Services, says:

With investments worth £1.8m, a joint gross income of £63,000 a year, or 3.5 per cent annual withdrawal rate, should be achievable over a 30-year-plus time horizon. Read about Bengen’s Safe Withdrawal Rate for more on this.

I suggest using an active cash flow model to track your income objectives every six months to enable you to finesse your expectations and portfolio management. You could withdraw more in the first 12 years of retirement, after which the state pension could provide you with a joint annual gross income of up to £18,220. You can get a state pension forecast via the Department for Work and Pensions BR19 form at https://www.gov.uk/government/publications/application-for-a-state-pension-statement.

I suggest having just one Sipp and your Isas on one investment platform as doing this often reduces charges, and simplifies the administration and investment management. When consolidating the investments onto one platform, if you do it in-specie (transfer the assets in their current form rather than as cash) you will not be out of the market while you do it.

When you withdraw pension income, make sure you have a valid financial Lasting Power of Attorney and ensure that your Sipp Expression of Wish is current.

I would hold your cash in NS&I Premium Bonds as these can be accessed quickly and are fully backed by HM Treasury.

I am not a fan of building up cash several years prior to taking your pensions tax-free entitlement because doing this dilutes investment growth. Also, what is your rational for using tax-free cash to build up Isa reserves? Moving assets out of a Sipp into an Isa increases the amount of your estate that is eligible for inheritance tax. The choice of investments and the growth characteristics within Sipps and Isas are almost identical.

Instead, consider phasing tax-free cash and income between you so that you both use your full tax allowances.

ASSET ALLOCATION

Chris Dillow, Investors Chronicle's economist, says:

Your investments are generally well diversified. But the most fundamental question in asset allocation is the split between safe and risky assets. Your bonds and cash account for only just over 16 per cent of this portfolio [minus the £45,000 cash savings]. As most equities tend to fall at the same time as each other in bear markets – however well you diversify –  your investments are risky.

So what matters is how long it takes for equities to recover from bear markets, and this depends on why they fall in the first place. If equities fall because investors believe that they have become riskier, they could bounce back swiftly once the risk passes. This gives us hope for next year: if a vaccine against Covid-19 is rolled out and economic activity returns to normal, equities might stage a massive relief rally.

But if equities fall because investors expect permanently lower cash flows in future they won’t bounce back at all – if those expectations are correct. It’s possible that Covid-19 will have this effect if, for example, it results in companies' cash balances being run down, impairing their ability to grow or pay dividends.

So it’s important to spread your equity investments around the world – as you are doing. Doing this doesn’t provide much protection against short-term bear markets because equities tend to fall together at such times. But it does protect portfolios against the likelihood that some markets will deliver much better long-term growth than others as we cannot say in advance which these markets will be.

You seem underweight US equities. Their resilience this year owes a lot to big gains for a handful of huge stocks such as Apple (US:AAPL) and Amazon (US:AMZN). If these have become overpriced they might eventually drag down the S&P 500 index. But there is no way of telling when this will happen and [if you do not have exposure to them] you risk underperforming until it does. 

You shouldn’t just diversify across countries but also across corporate forms. It’s quite possible that a lot of future growth will come not from listed companies, many of which are mature, but rather unlisted ones. So you are right to invest in private equity funds.

That said, these carry fund manager risk. Private equity managers who back just one or two more stellar performers than their rivals will have very different performance. So hold more than one private equity fund.

Your portfolio is overdiversified in so far as you have 47 holdings, which individually make little difference to its overall performance. So there's a case for slimming it down, meaning that you can diversify fund manager risk [with more funds in areas] where this tends to be greater, such as unquoted companies. 

However, overdiversification is most detrimental when you hold many active funds with high fees and incur unnecessary expenses. And you are mostly avoiding this problem so in your case cutting the number of holdings is less urgent.

Elliot Basford, assistant portfolio manager at Beckett Asset Management, says:

Your asset allocation framework appears logical. But with zero or even negative interest rates, the extent to which your fixed income exposure is a portfolio defence is questionable. The addition of some more defensive alternatives could be useful. These could include low-risk market neutral or multi-asset funds such as SVS Church House Tenax Absolute Return Strategies Fund (GB00BNBNRF27).

The allocation split between UK and overseas equities seems justified, although the exposure to the US dollar and emerging market currencies is an added risk.

It is very important that you establish what retail and office property exposure you have. That said, office space is still likely to be required, especially while there is a need for social distancing. And much of the pain in the property sector has probably been taken.

You could then try to determine which parts of the property market will benefit from structural growth, such as distribution warehouses. 

You have too many holdings. If your asset allocation and country split were more granular you could justify this number of holdings. But as you hold global equity funds it might be better to have larger allocations to some of your holdings. There may not be much benefit in having as many global equity holdings as you do, because the correlation coefficient between certain ones over three and five years is greater than 0.9. This means that they move in a very similar way to each other as time goes on, limiting the diversification benefits.

Also, where you have more than one holding invested in the same sub asset class, such as UK smaller companies, you could consolidate them into one holding. 

Consider whether it is appropriate for you to get exposure to a market such as the UK via passive tracker funds. The UK indices your funds track have fairly significant exposure to fossil fuels, but you also hold renewable energy infrastructure funds, so is this a contradiction?