'Is £2.2mn enough for us to retire early and travel?'

When you're decades away from retiring, finding the right investment strategy is simple: invest for growth as you have enough time to withstand the ups and downs of the stock market. But managing money just before retiring invites all manner of complications. First, you need to decide if you have enough, and if not invest accordingly. All while making sure you don't risk being able to retire altogether.

Take Hugh as an example. On the face of it, he is in a good position. He's only 56, earns £165,000 a year and he and his wife, Sarah, 57, own a London home worth around £2.2mn, with no mortgage. Both will qualify for the full state pension at age 67. Sarah also has an old defined-benefit pension worth around £1,500 a year, and between them, the two have just shy of £2.2mn invested in nearly 40 funds and cash via pensions, individual savings accounts (Isas) and other accounts.

Substantial as that is, Hugh wants to call time on his career soon, so their assets will soon have to do some heavy lifting. “I am looking to retire within the next 12 to 18 months to allow my wife and myself to live abroad and travel while we are still fit and healthy,” he says. “We would like to be able to withdraw around £90,000, or 4 per cent of the portfolio, each year while achieving a total return of 5 per cent. Our aim is to ensure we have a long, happy and financially secure retirement.”

With that in mind, they wonder whether the asset allocation is fit for purpose and whether the 4 per cent withdrawal rate is sustainable. Hugh is also worried about inflation, his choice of funds and how any reinstatement of the pension lifetime allowance (LTA) might affect his sizeable self-invested personal pension (Sipp).

When it comes to investment strategy, Hugh says that he has “always had a high-risk attitude”, although the prospect of retirement has prompted him to become more conservative, and he has started adding bond funds. The couple also want cash worth around three years’ expenditure as a safety net. They currently have around just shy of £180,000 in cash and short-duration bond funds, or 8.5 per cent of their portfolio, some of which is in accounts that pay 6 per cent.

Changes in central bank interest rates have also prompted him to reduce the portfolio’s bias towards stocks. Hugh is currently thinking about investing in a longer-duration government bond fund. He is also considering the role of multi-asset funds in the portfolio, such as Personal Assets (PNL) and Baillie Gifford Managed (GB0006010168), to replace the former with “a mixture of gilts, US treasuries, gold and equities” and the latter with “a value-style equity fund and bonds”.

However, he adds: “The main part of the portfolio still needs to be invested in assets that will protect against inflation, as this is a danger over the long term. I am also considering whether on retirement to replace part of the gilt/cash allocation with an annuity to generate an income."

The couple still have time to add more to their savings as well. “We are each placing the full £20,000 allowance into our Isas each year. Due to the abolition of the LTA next year, I rejoined my workplace pension scheme, and my wife makes the maximum possible £2,880 contribution to her pension each year as well."

Hugh and Sarah have two children, both of whom are at university and should graduate in the next two years. The couple have already gifted around £200,000 to each of them with no current plans for further gifts. Hugh is not currently considering inheritance tax issues.

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

Jason Hollands, managing director at Evelyn Partners, says:

In reviewing the investment portfolio, made up of both active and index funds and investment trusts, one observation is that it is too diversified. There are nearly 40 different funds and trusts in the portfolio, which in my view is too many. You should rationalise this, for example by consolidating the global tracker funds into the lowest-cost option.

Despite the wide range of funds, the portfolio is not that diversified at the underlying asset class level. Excluding cash, nearly 80 per cent is invested in stocks (including listed real estate and infrastructure) and a further 10 per cent is invested in specialist and private equity funds. Only 9 per cent is in bonds and cash, although I do note that you have several multi-asset fund holdings. There is limited exposure to gold, via an exchange-traded commodity and Personal Assets.

For someone on the cusp of retirement, the high stocks allocation is too risky. The current approach will have undoubtedly served you well in the past, but once you are drawing down, a more stable approach is needed.

As a broad guideline, you should consider reducing equity exposure to around 66 per cent of the portfolio and increasing bonds to 25 per cent. The remainder – around 10 per cent – can be exposed to alternative assets such as property, operational infrastructure (rather than infrastructure equities) and gold.

Reshaping the portfolio to increase the exposure to bonds will also help meet your income objective, given the much more attractive yields now available on both government and corporate bonds. Your retained and still significant exposure to stocks will help grow your savings and fend off the impact of inflation. 

Funds to consider include the TwentyFour Absolute Return Credit Fund (LU1368730674), which invests in shorter-dated investment-grade corporate bond funds and the Janus Henderson Strategic Bond Fund (GB0007502080). For government exposure, add to the existing holding in the iShares UK Gilts 0-5 Year ETF (IGLS).

Around 54 per cent of the equity exposure is in US-listed stocks. Again, this will have served you well over the years given the strong returns from US equities – especially megacap technology stocks. However, the US is a low-yielding market and valuations are also currently quite rich.

With income set to become an important objective in a couple of years, I would suggest reducing US exposure to around 45 per cent of the stocks portfolio (28 per cent of the total portfolio) and buying more higher-yielding stock markets such as UK large-cap stocks. This can be achieved through funds such as Murray Income (MUT), Temple Bar (TMPL) and BlackRock UK Income (GB00B67DWR44).

Alice Guy, head of pensions and savings at Interactive Investor, says:

You’ve managed to save an amazing nest egg and have a potentially long retirement ahead, so it’s important to make the right decisions now to maximise your retirement income. The first step is to work out how much income you need and how much you want to set aside for travelling and living abroad. Bear in mind that because you’re retiring early you’ll have a 10-year gap to plug before the state pension kicks in.

With a long retirement ahead, you’ll need to keep an eye on your portfolio as small differences in expected performance can mount up. When it comes to the right withdrawal rate, there are no set rules. One option would be to start by withdrawing 4 per cent from your portfolio each year and adjust later on once you see how your investments are performing. You could also consider spreading your withdrawals across different investment wrappers – pensions attract income tax, and you could end up paying a higher-rate tax at 40 per cent, depending on how much you withdraw, especially when your state pensions kick in.

You are considering an annuity, but because you’re both young it could be an expensive option, especially if you want one that escalates in line with inflation and pays out a survivor benefit. This might be a decision to leave for a later date.

When it comes to your portfolio, the first thing that jumps out is the sheer quantity of funds. Having a complex portfolio, with nearly 40 funds, can make it very hard to monitor performance and make investment decisions. It’s usually easier to keep on top of a simpler portfolio, with 20, but of course the right 20, enough to be well diversified.

That said, there are some excellent funds in your portfolio. I like how the core of your holdings are in well-run but low-cost trackers from the likes of Vanguard and Legal & General, and you also have some more adventurous options, such as Pacific Assets Trust (PAC), Fundsmith Equity (GB00B41YBW71) and JPMorgan Emerging Markets (JMG).

If I were to change one thing, I would add a bond fund or two. With sterling investment-grade bonds now yielding about 6.5 per cent, I’d look at that sector to add some high-quality bonds that pay a very attractive yield and could deliver capital gains, when interest rates look like they may fall. Take a look at Rathbone Ethical Bond (GB00B7FQJT36).

You already have around £179,000 in cash and gilts, and it’s important to shop around for the best interest rates. As you have a lot more pension wealth, it makes sense to maximise both your allowances.

You’re also worried about the LTA rules changing and the impact that will have on any future tax bill, but it’s extremely difficult to predict the future when it comes to tax. What we do know is that other tax allowances and tax thresholds are likely to remain frozen for some time.

That means you may have to pay more tax on your income in future as more becomes taxable at 40 per cent and frozen capital gains (CGT) and dividend tax allowances could affect your assets held outside a tax wrapper.