- These investors should use their full annual Isa allowances
- They could invest some of their cash
- Bonds offer a more attractive yield than they have for years
Reader Portfolio
Mike and Penny
69
Description
Sipps and Isas invested in funds, VCTs, EIS, cash, residential property.
Objectives
Cover living expenses of £100,000 and go on three luxury holidays a year, have enough money to cover care costs in later life, help children pay mortgages, help grandchildren pay unversity fees and buy homes, average annual return of at least 4 per cent, pass on assets tax-efficiently
Portfolio type
Investing for income
Mike and Penny are 69. They both receive the full state pension, and Mike receives three defined-benefit (DB) pensions which in total pay him £45,000 a year. He also still works in a self-employed capacity and earns about £4,000 a year. Mike and Penny supplement this by drawing about £3,000 from their cash accounts every month.
They have children and two grandchildren, aged seven and 11. Their home is worth about £950,000 and mortgage-free.
“We need to cover living expenses of £100,000 a year and want a comfortable retirement,” says Mike. “We want to go on three luxury holidays a year and sometimes pay for our family to come with us. We also want to ensure that we have enough money to cover the costs of care at home and or care homes in later life, if necessary.
“We assist our children with paying their mortgages and we would like to help our grandchildren to pay their university fees and buy homes.
“We would like our investments to make an average annual return of at least 4 per cent. I would say that I have a medium risk appetite and would be prepared for the value of our investments to fall by up to £200,000 in any given year if there was potential for them to recover. Penny, however, has a low risk appetite – she would only be prepared for the value of our investments to fall by up to £100,000 in any given year if there was potential for them to recover.
“We have been investing for 25 years, and have taken advice from an independent financial adviser (IFA) on tax, pensions and individual savings accounts (Isas) for over 20 years. Our decisions have also been driven by estate planning considerations, for example I and Penny have self-invested personal pensions (Sipps) worth £750,000 and £527,000, respectively, but we have not yet drawn from them. However, we have just ended our relationship with our IFA as we believe that we can manage our affairs ourselves.
“In terms of our investments, we have recently purchased Legal & General International Index (GB00B2Q6HX78), Legal & General UK Index (GB00B0CNGM05) and Vanguard Emerging Markets Stock Index (IE00B51KVT96). And we are thinking of increasing our exposure to bond investments.”
| Mike and Penny’s total portfolio | ||
|---|---|---|
| Holding | Value (£) | % of the portfolio |
| Cash | 1,300,000 | 41.4 |
| Legal & General International Index (GB00B2Q6HX78) | 520,000 | 16.5 |
| Vanguard FTSE Developed World ex-UK Equity Index (GB00B5B74F71) | 515,000 | 16.4 |
| Vanguard FTSE Global All Cap Index (GB00BD3RZ475) | 188,000 | 6 |
| NS&I Premium Bonds | 100,000 | 3.2 |
| Vanguard FTSE UK All Share Index (GB00BPN5P782) | 98,000 | 3.1 |
| Legal & General UK Index (GB00B0CNGM05) | 97,000 | 3.1 |
| Vanguard Emerging Markets Stock Index (IE00B51KVT96) | 97,000 | 3.1 |
| Vanguard Global Bond Index (IE00B2RHVP93) | 75,000 | 2.4 |
| Fused4 EIS | 40,000 | 1.3 |
| Vanguard Global Short-Term Bond Index (IE00BH65QH62) | 38,000 | 1.2 |
| VCTs | 31,000 | 1 |
| Vanguard UK Investment Grade Bond Index (IE00B1S74W91) | 26,000 | 0.8 |
| Vanguard UK Government Bond Index (IE00B1S75820) | 18,000 | 0.6 |
| Total | 3,143,000 | |
NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS’ CIRCUMSTANCES.
James Norrington, associate editor at Investors’ Chronicle, says:
Although you have ended your relationship with your IFA, due to your future income requirements you should still seek some professional tax advice. You’re likely to fall into a bad spot when it comes to income tax, and need to be smart about how you draw from Sipps and Isas to mitigate this. For non-tax-sheltered investment gains, you can use capital gains tax allowances, and you’re already using tax-efficient vehicles such as venture capital trusts (VCTs) and enterprise investment schemes (EIS) for a portion of your money, although these early-stage investments are risky.
One option to discuss with someone properly qualified is insurance products such as offshore bonds. These allow you to defer income tax, enabling you to plan your finances so that the tax bill is due in a year when you take less income.
When it comes to portfolio management, imagine a worst-case scenario and whether you have the capacity and personality to shrug it off. You wish to fund an expensive lifestyle and for the portfolio to achieve a compound annual growth rate of over 4 per cent. But you are both relatively conservative in terms of the level of peak-to-trough fall in portfolio value that you could stomach.
In the medium term, think about investing some of that large cash allocation, although in the short term there is a good argument for you to remain cautious. Some equity markets, notably in Europe, started 2023 brightly on the back of a milder than feared winter and some encouraging economic data for the eurozone. Expecting equities across the board to do well throughout this year is still a leap of faith, however.
Bonds now offer a much more attractive yield than they have for years, but be careful about how you build an allocation. When inflation has been as high as it is currently, getting it under control has required interest rates to be much higher than they are now. This means that yields could still go up and force bond prices down, and that translates into capital losses for bond funds.
For now, particularly given Penny’s low risk tolerance, you should probably retain the cash allocation. Inflation is eating away at its value, but if you buy bond funds and rates rise more than the market expects you will suffer a nominal loss.
Your focus for now should be rebalancing the invested portion of your wealth, which is heavily weighted towards equities, although this will be a challenge. China reopening and good data out of the eurozone gave impetus to something of a rally in January, but it would be wholly premature to call this the beginnings of a new bull market.
Taking advantage of the early-year rally, you could sell a portion of the equity weighting and reinvest the proceeds in some bond funds. Interest rate risk may have another sting in the tail, so check that the bond funds you choose have a low average duration meaning their values are less sensitive to interest rates. Short-duration sovereign bonds are attractively priced if interest rate rises moderate and, if they don’t, your capital risk is still less than it is now with so much invested in equities.
With an optimists’ hat on, investment-grade credit – corporate bonds – should be a good investment, too. But be wary of inflation-linked index bond funds: these may sound perfect but typically they hold many long-duration bonds that can sell off badly if rates surprise upwards.
Melissa Thorogood, wealth manager at Investment Quorum, says:
You require £100,000 a year to cover living expenses and additional cash for three holidays a year, which I will assume cost £30,000 a year.
Your state and DB pensions provide a degree of inflation protection as they are annually adjusted for inflation, based on current legislation and subject to their relevant caps. So you have secure pension income of £66,200 a year, leaving you with an annual shortfall of £63,800 net in retirement. A high-level calculation would indicate that, based on a 30-year investment time horizon, you require approximately £1.4mn invested to generate an income of £63,800 a year in today’s money. This assumes a 4 per cent investment growth rate net of fees and that withdrawals increase by 2 per cent a year in line with the Bank of England’s inflation target. It does not take into account your personal tax positions.
We suggest that you continue to make full use of your annual Isa allowances to take advantage of the tax-sheltered investment environment, underpinned by an appropriate investment strategy that gives you the required return of 4 per cent a year net of fees.
Penny currently has a significant amount of cash with which to fund this shortfall, but consider your plans for this cash. We typically advise clients to retain an emergency cash fund, and NS&I Premium Bonds are a great place to park such cash. They currently have an annual prize fund rate of 3.15 per cent and are 100 per cent government-backed. In addition to this, it would be prudent to hold cash worth a year’s income. Cash in excess of these amounts is being unnecessarily eroded by inflation, particularly with UK inflation at 10.5 per cent. You could invest the excess cash as a lump sum, or gift some to your children to help them pay their mortgages, and your grandchildren to cover their university fees and help them buy homes.
The investment composition of your Isas and SIpps is identical, which does not reflect that you each have different attitudes to investment risk. The mirrored investment strategy also means that your overall portfolio lacks diversification.
All of the investments are passive and track various market indices so are likely to be competitively priced. Trackers follow a particular market but tend to slightly underperform it net of fees. This should mean that the tracker does not significantly underperform the market in a downturn but also that it is not going to outperform in a rising market, when an active manager should add value in excess of its higher charges.
Your investments are geographically diversified but you are underweight US equities. US equities represent nearly 68 per cent of the MSCI World Index and are an area you could consider increasing exposure to.
If you are considering adding fixed-income investments, consider Artemis Corporate Bond Fund (GB00BKPWGV34). After a 40-year bull market, in 2022 Sterling corporate bonds endured an unprecedented sell-off. Rapidly escalating bond yields amid inflationary pressures not experienced in decades caused performances across the sector to register record lows over a 12-month period. But even in this difficult environment, Stephen Snowden, manager of Artemis Corporate Bond, beat the Investment Association Sterling Corporate Bond sector average over most timeframes since the launch of this fund.
This sell-off has created one of the best opportunities in decades to invest in Sterling corporate bonds. And even though Artemis Corporate Bond invests in high-quality investment-grade holdings it generated an attractive yield of around 4.5, as of 9 February. This should more than compensate investors looking for income without taking equity risk in a low-growth or even recessionary environment.
