In our Money Pit Stop series, we ask an investing expert to give This is Money readers a free portfolio makeover.
A young Kent couple are planning for a comfortable retirement, which will include a six-month dream holiday travelling around South America.
Andy and Emma meant to take the trip far sooner, but put it on hold due to the recent birth of their son.
He is a 32-year-old marketing manager at a manufacturing firm, and she is a teacher. He is a high risk investor who wants to retire at 60.
Long haul trip: Andy and Emma want to take a six-month dream holiday travelling around South America in retirement
Currently, he has a passive portfolio with Nutmeg, and has put money into peer-to-peer lender Funding Circle and several cryptocurrencies.
He doesn’t own individual shares but is open to the idea, saying: ‘I would like to get some, but I don’t know where to start. I have about £500 to invest each month.’
We asked Ray Black, a chartered financial planner and managing director of Money Minder Financial Services, to explain how the couple can reach their financial targets for retirement.
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Andy’s savings and investments
Risk appetite: High
Time horizon: 28 years
Funds, investment trusts and ETFs:
£20,000 in a passive portfolio with Nutmeg, highest risk level available (portfolio 10), paying a 0.45 per cent management fee
£7,000 with peer-to-peer lender Funding Circle, conservative loan category
£3,500 in cryptocurrencies, held with Coinbase – 70 per cent Bitcoin, 20 per cent Ethereum and 10 per cent Litecoin
Greater Manchester Pension Fund, final salary, current yearly value £800 from age 65
Current employer, defined contribution pot worth £32,000, paying in £500 a month
Cash: £3,000 in a cash Isa
Properties: Home worth £315,000, outstanding mortgage £150,000 on a new five-year fixed deal at 2 per cent
Other: A 10 per cent shareholding in a small family property letting business, holding 10 houses worth an average £100,000 each
Names have been changed.
Ray Black writes: Andy and Emma have 28 years to get ready for an early retirement and appear to be taking full responsibility for achieving their goal which is highly commendable, especially as their attention will undoubtedly be focused on their young son right now.
What is Andy and Emma’s current financial position?
Cash: I am concerned that they have only £3,000 in cash funds. It’s important to have a reasonable size emergency fund, particularly now that Emma has recently given birth.
I’m concerned they only have £3,000 in cash… it’s important to have a reasonable size emergency fund
The majority of their investments are high risk/highly volatile assets. In the first instance, I would suggest there is at least six to 12 months of net income easily accessible.
Alternatively, if their joint income is high enough for this amount to seem excessive, a £10,000 emergency fund coupled with a holiday fund and a short-term expenditure fund may be sufficient.
Nutmeg investment: Andy says he is a high-risk investor, which, bearing in mind that deposit savings are unable to keep up with the pace of inflation at present, may explain the lack of cash funds.
Ray Black: ‘Even though Andy describes himself as a high-risk investor, I have yet to meet anyone who actually enjoys their investments going down in value’
However, a loss in value in his Nutmeg savings due to a significant market downturn could leave this young family feeling vulnerable.
For example, whilst Nutmeg’s high risk portfolio number 10 has enjoyed some reasonably good performance when markets have risen, it has also seen some significant losses in a short space of time.
For example, between autumn 2018 and December 2018 it fell in value by around 20 per cent.
If Andy and Emma had needed to withdraw money at that time, it would have consolidated those losses.
In addition, it’s important to remember that cheapest isn’t always the best.
Nutmeg uses passive exchange-traded funds (ETFs) that track markets, and it manages asset allocation to get the best out of them.
This is an inexpensive approach, but you can end up with tracker-like performance.
Fund manager investment expertise can be worth paying for and whilst past performance is no guide to the future, the long-term results of the best performing ‘active’ fund managers often prove this.
Cryptocurrencies: Similarly, the money Andy has invested in cryptocurrencies is very volatile and prices can change in a very short space of time.
What is the FSCS?
FSCS protects customers of financial services firms that go bust, writes This is Money.
On investments, it pays up to £85,000 per eligible person, per firm. Read more details about the compensation it provides here.
For example, the value of a bitcoin peaked in mid-December 2017 at $19,650, only to fall in value to $3,183 by mid December 2018, an eye watering loss of over 83 per cent in one year.
In fairness, the price rose to $11,865 six months later but has since fallen back to $6,946 at the start of 2020.
That’s a highly volatile investment with no Financial Services Compensation Scheme protection.
Peer to peer: Apart from the £3,000 they have in the cash Isa, the peer to peer lending investment might potentially be considered as low to medium risk, due to them investing in the ‘conservative loan category’ where Funding Circle aims to lend money only to a range of ‘creditworthy’ companies.
However, instant access to this money is not guaranteed as a new investor is required to buy the loan stock and, presuming a new investor can be found, withdrawals also incur a 1.25 per cent fee.
Unlike some other peer to peer lending platforms, Funding Circle does not have a contingency fund and most importantly, just like cryptocurrencies, innovative finance investments like these are not covered by the FSCS.
What can Andy and Emma do to their investment strategy?
Even though Andy describes himself as a high-risk investor, I have yet to meet anyone who actually enjoys their investments going down in value, and there is a high possibility of that with this portfolio.
As such, I think it is really important for Andy and Emma to re-evaluate both their short and long-term investment strategy and consider reducing the exposure to highly volatile and FSCS-unprotected investments.
How does pension tax relief work?
Pension tax relief allows everyone to save for retirement out of untaxed income, writes This is Money.
You receive rebates, effectively free cash from the Government paid into your pension, based on your income tax rate of 20 per cent, 40 per cent or 45 per cent.
Currently, investors can access their pension fund from the age of 55 but this is due to rise to 57 from 2028. Those considering early retirement should be aware that it could rise further in the future.
Insurance: In light of the birth of their son and before they put any more money into savings, a full review of their protection plans, to ensure the family’s long-term financial security, is essential.
If they haven’t got them already, I suggest getting life assurance, critical illness cover and an income protection policy.
Pensions: Once that’s done, and a sufficient emergency and short-term spending fund is in place, I would suggest looking at a combination of pension investments for Andy – for the advantageous tax relief from the Government, and free contributions from his employer – and more mainstream, FSCS-protected investment Isas for them both.
Andy has a good foundation for his retirement planning due to his deferred benefits in the local government-based Greater Manchester Pension Fund and his defined contribution scheme with his current employer.
To help him to achieve his early retirement goal, then if he hasn’t already he should first find out the maximum level he can pay in contributions which his employer will match with free cash from its side.
If its affordable, he should ensure that there is at least that much going in to his pension to get the full benefit of this.
How do you research investments
Andy doesn’t say how his pension is invested, but if he is in the ‘default’ fund it may well be a cheap tracker.
It is worth taking a look at the other funds available within the scheme, and considering if it is worth paying more for active management and potentially better performance in the long term.
Emma has the security of a teachers’ pension, which means she is in a public sector defined benefit scheme which will make guaranteed payouts from her retirement age until she dies, and will continue making reduced payments to Andy if he survives her.
This scheme is backed by the taxpayer and should put her in a good position for retirement.
South America: Machu Picchu is a tourist highlight in southern Peru
Investment Isas: As his state pension age is 68 – but could yet turn out to be later if rules change – Andy also needs to be focused on building a sizeable amount of savings outside his pension if he wishes to finish work eight years early.
In order to use their personal tax allowances in retirement efficiently and to provide them with access to savings before retirement, once Andy’s pension contributions are secured – 10-15 per cent of his gross salary would be a good target for now – any spare cash that he and Emma can save could be invested into investment Isas for tax-free growth and income over the long term.
It is worth them both having investment Isas, in which they can each save up to £20,000 per year (minus anything they are also putting into cash Isas), to take full advantage of the tax benefits.
Even if they are not making maximum use of their annual Isa allowances at first, this might change as Andy and Emma’s salaries increase over the course of their careers, or one or both of them receive an inheritance.
Andy may already be making use of his investment Isa allowance via Nutmeg. If he wishes to invest elsewhere in future, here is an example of a high risk investment portfolio. If Emma has a different stance on risk, a medium risk portfolio is also below.
Mortgage: Once their very attractive five-year, 2 per cent fixed rate mortgage is coming close to the point where some or all of the outstanding debt can be paid off without penalty, they should review their financial affairs.
At that time, it will be worth considering the option of paying off some or all of their mortgage debt.
The decision will depend on the prevailing mortgage rates payable at that time and their level of motivation to become debt free as soon as possible.
The information provided by our expert is for the purposes of this article and is not personal advice.
If you are at all unsure of the suitability of an investment for your circumstances please seek advice.
Nothing in this response constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
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