Should I reduce my equity exposure as I approach retirement?

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  • This investor wants an income of £30,000 a year from his investments in retirement
  • It should consider reducing the risk level of its investments
  • It would make sense to diversify your investments by adding exposure to areas such as bonds, infrastructure, real estate and absolute return funds

Readers Portfolio

Louisa

52

The description

Sipp and Isa invested in funds and stocks, cash, residential real estate

Goals

Retiring at 60 with £30,000 a year, downsizing house, giving daughter money as a deposit to buy a house, adding £300,000 to £400,000 to investments, maximizing the value of investments

Wallet type

Invest for goals

Louise is 52 years old and has always been self-employed. She has a 16 year old daughter. Louise’s house is worth around £1.6million and she will have paid off the mortgage by then at the age of 60.

“I would like to retire at 60 with an income of £30,000 a year,” says Louise. “I hope to finance this with my investments and by selling my house when I am 60 years old. I will also use the proceeds from the sale. buy me an apartment and give my daughter a decent sized down payment to buy her first house when she’s in her early twenties. I would only like to take £300,000 so I can give my daughter more.

“I will also continue to save £30,000 a year for the next eight years in my self-invested personal pension (Sipp), which is currently worth around £110,000, and my individual savings account (Isa), which is worth around £92 £000.

“I am happy with a medium to high level of risk and want to maximize the value of my investments so that I can afford to give more to my daughter. However, I have read that I should reduce my equity exposure and buying bond investments as I approach retirement, but given that I will likely be earning income from my investments rather than cashing them in to buy an annuity, and will be keeping my investment, do I need to worry less about exiting actions ?

“I’ve been investing for 10 years, although I feel like I’m still a very newbie and don’t know what I’m doing. I would describe my way of investing as chaotic and I’m afraid I have way too much of funds and stocks that I have purchased after reading advice Examples of recent additions to my portfolio are BHP (BHP), iShares Core FTSE 100 UCITS ETF (ISF) and HSBC MSCI World UCITS (HMWO) ETF. I also tend to tinker too much.

“While my portfolio has largely performed well, I fear it was more luck than judgment. And in the first two months of the year its value fell 10% as markets seemed to have entered more volatile times. to simplify things and take a more methodical approach. Half the time, I wonder whether or not to sell everything and reinvest the proceeds in a Vanguard LifeStrategy fund.

Louise’s wallet
While carrying Value (£) % of portfolio
NS&I Premium Bonds 40,000 15.9
iShares Core FTSE 100 UCITS ETF (ISF) 34,625 13.76
Vanguard S&P 500 UCITS ETF (VUAG) 18,721 7.44
Rathbone Global Opportunities (GB00BH0P2M97) 17,616 7
HSBC MSCI World UCITS (HMWO) ETF 17,573 6.98
BHP (BHP) 15,576 6.19
Vanguard LifeStrategy 100% Equity (GB00B41XG308) 12,689 5.04
Species 10,000 3.97
Invesco EQQQ NASDAQ-100 UCITS ETF (EQQQ) 8,767 3.48
IFSL Marlborough UK Micro-Cap Growth (GB00B8F8YX59) 8,157 3.24
Lindsell Train Global Equity (IE00BJSPMJ28) 6,868 2.73
Scottish Mortgage Investment Trust (SMT) 6,750 2.68
iShares S&P 500 Health Care Sector UCITS ETF (IHCU) 6,502 2.58
Premier Miton European Opportunities (GB00BZ2K2M84) 6,062 2.41
Fundsmith Equity (GB00B41YBW71) 5,759 2.29
Baillie Gifford Positive Change (GB00BYVGKV59) 5,204 2.07
iShares Core MSCI EM IMI UCITS ETF (EMIM) 4,625 1.84
Special Situations IFSL Marlborough (GB00B907GH23) 4,002 1.59
Growth of Greater China FSSA (GB0033874107) 3,758 1.49
Sylvania Platinum (SLP) 3,650 1.45
Lloyds Bank (LLOY) 3,611 1.44
Anglo-American (AAL) 2,419 0.96
iShares Global Clean Energy UCITS ETF (INRG) 2,307 0.92
Finsbury Growth and Income Trust (FGT) 1,947 0.77
Aviva (AV.) 1,087 0.43
BlackRock Emerging Markets (GB00B4R9F681) 1,059 0.42
Delta Air Lines (US: DAL) 1,054 0.42
Vietnam Holding (VNH) 716 0.28
iShares Edge MSCI Europe Value Factor UCITS ETF (IEFV) 474 0.19
Thungela Resources (TGA) 38 0.02
Total 251,612

NONE OF THE COMMENTS BELOW SHOULD BE CONSIDERED ADVICE. THIS IS GENERAL INFORMATION BASED ON A OVERVIEW OF THIS INVESTOR’S SITUATION.

Chris Dillow, economist at Investors Chronicle, says:

You should be able to achieve your main goal. If you save £30,000 a year for the next three years, increased by inflation, and your portfolio achieves a real total return of 4% per annum, you will have around £550,000 in today’s money at the age of 60. With an extra £300,000 from the sale of your house you should have around £850,000. Speaking of today’s money, £30,000 is only about 3.5% of that a year, so you should be able to generate that income via a levy while leaving your capital intact, by mean.

Your portfolio is also fairly well-diversified as it not only includes UK-listed consumer stocks, but also has exposure to big tech via Invesco EQQQ NASDAQ-100 UCITS ETF (EQQQ), Scottish Mortgage Investment Trust (SMT) and Fundsmith Equity (GB00B41YBW71) (see table). And it’s exposed to more cyclical assets such as emerging market funds and mining stocks, although these are highly correlated, so think of them as the same asset.

You may, however, be able to achieve such diversification at a lower cost. Global Tracking Funds are basically funds of all equity funds that give you instant stock diversification at a low cost. And costs matter: over eight years, even an extra 0.5 percentage point in annual management fees could cost you more than £500 for every £10,000 you invest. If you own several actively managed funds, you risk diluting your returns because diversification reduces your chances of big gains as well as big losses, but not fees. So think very carefully about the actively managed funds you own. Only keep them if they add something to your portfolio that exchange-traded funds (ETFs) or similar cheaper active funds don’t.

In this context, you should not follow the advice. Instead, consider what a stock or fund adds to your portfolio. If you are already satisfied with, for example, your exposure to emerging markets, why would you need another fund for emerging markets?

The reason you go for bonds is that you are approaching the so-called “retirement risk zone”, ie the years just before and after retirement. In these years, a fall in stock prices is unpleasant because you don’t have enough years of work and savings to recoup the losses. So you need protection against them.

However, this protection need not be obligations. Cash could do just as well, depending on why stocks are falling. And you have other ways to adapt to a market drop. You could downsize your home to a greater extent or give your daughter a smaller share of the proceeds from the sale of your current home. But do not bet on a sharp rise in property prices in real terms in the coming years.

You can also plan to let your wealth run out in retirement. Even with zero real returns over the next eight years, you’ll have a retirement pot of over £700,000 in today’s money. Taking £30,000 a year from this would send you through the 80s – even if we still get two decades of zero real returns.

So don’t worry too much about switching to bonds. As long as you keep saving and investing, you’ll be fine.

Alex Brandreth, Chief Investment Officer, Luna Investment Management, says:

Based on certain market growth assumptions and your future contributions, your future income target of £30,000 a year from age 60 should be achievable with a well-diversified portfolio. My calculations suggest a portfolio return of around 3 percent, assuming these assumptions are correct.

You are only invested in stock markets, so we classify you as a high-risk investor. Your portfolio is also very concentrated and therefore requires greater diversification. For example, you have seven direct holdings, but we generally seek to diversify through about 30 different direct holdings. And some of them are in volatile sectors, for example Anglo-American (AAL)BHP, Sylvania Platinum (SLP) and Thungela Resources (TGA) are mining companies. So I would actually class you as a very high risk investor, which is not your medium to high risk level.

This point is closely related to your question of whether you should reduce your exposure to equities and add bond investments as you approach retirement.. If you want to reduce your income rather than buying an annuity, you can have a higher equity weighting. But there’s another reason you should reduce equity exposure and that’s to meet your stated risk target. This would help diversify your portfolio and you can reduce its risk in different ways.

You could buy bonds. At this point in the interest rate cycle, it might be appropriate to consider strategic bond funds, which can be allocated to different types of credit such as government, investment grade and high yield bonds – as and as they see opportunities. These funds can also manage interest rate exposure, a key attribute as it looks like interest rates will continue to rise over the next year.

You can also buy alternative assets. For a medium to high risk investor, we would buy infrastructure, absolute returns or hedges, properties, music royalties and perhaps private equity funds and structured products. The aim is to hold investments that are less correlated to the stock market over the long term, to improve the diversification of your portfolio and to reduce its risk.

Your portfolio currently has a high level of risk, which does not correspond to your objective. So diversify across different asset classes like bonds and alternatives, as well as looking at individual holdings.

If you really feel like you don’t know what you’re doing, consider talking to an independent financial adviser to find out how you might reach your investment goal of an income of £30,000 a year in retirement.

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