This is the third and final part of our mini-series on portfolio construction where we discuss some key life milestones and how they can impact investment plans and portfolios.

Managing a portfolio of investments should be a dynamic process which evolves with changing life circumstances, goals, age, and risk appetite.

Your early 20s are often associated with significant changes to financial and personal circumstances. Whether it is completing qualifications and apprenticeships, graduating from university, or starting a new career and moving out from the parents.

The cost-of-living crisis and rampant inflation have made it tough for most people to get by, let alone put money aside for the future. Balancing short-term budgets with longer-term financial goals is never easy.

But it is worth remembering that starting as young as possible provides a longer runway for investment returns to grow and for compounding to take effect.

STARTING OUT

Benjamin Franklin probably described compounding the best: ‘Money makes money. And the money that money makes, makes money’.

Studies have shown that starting early with small amounts is superior to waiting and investing larger amounts later. Also, depending on your life goals, starting earlier may allow you to retire sooner.

Part one of this series looked at the importance of diversification and provided some tips on how best to go about creating a well-balanced portfolio by purchasing just a few products.

When starting out always consider the benefits of tax efficient vehicles like ISAs (individual savings accounts) and pensions first before should ordinary dealing accounts.

Twentysomethings do not need to worry about whether the stock market is about to tank. In fact, if they do, it would be a boon since this cohort of investors are likely to be net buyers of stocks for many decades to come.

Stock markets anticipate economic recoveries ahead of them happening as the next cycle of wealth is created. This has been the pattern for several decades.

This means younger investors can embrace more risk by allocating a bigger proportion of their portfolio to stocks and shares.

Once in a job, it usually entails working up the career ladder which means promotions and job hops. This is not only good for career progression and confidence, but it can also bring in extra cash each month.

Rather than spending all the extra cash, consider using some of it to feed long-term savings and investments. You may look back and not remember that nice treat many years later but you will probably see the difference it makes to the size of your pension pot if you forgo it.

PREPARING FOR A RAINY DAY

Career paths do not always run smoothly and losing a job can be a devastating experience and a knock to confidence. Under these circumstances it makes sense to focus on getting back to work.

Inevitably it also means there is no money to put towards an investment pot. It highlights the advantage of building up cash savings for a rainy day. Taking a break is not a disaster in the long run, particularly if you continue to reinvest dividend income.

The principle that investing is a long-term endeavour and should not be done with money which might be needed within five and ideally 10 years remains a strong principle, but unforeseen circumstances do happen.

Pensions are off limits until 55 years of age, but ISAs have some flexibility (not all providers provide flexible ISAs) which allow a short-term withdrawal during the tax year without reducing your current year’s allowance as long as you put it back in the same tax year.

FAMILY MATTERS

Settling down and starting a family is often a challenging time and can put a strain on family finances.

In such circumstances, consider reducing contributions rather than stopping altogether, if practicable. Taking a break from regular investing does not mean your portfolio will be starved of new money. Remember those dividends which can be reinvested.

Families that can afford it might consider opening a stocks and shares Junior ISA. Annual contributions are capped at £9,000.

Money cannot be withdrawn from a Junior ISA until the child turns 18 which means this is a genuinely long-term investment. But the rewards from compounding can be worth it.

For example, contributing £250 a month or £3,000 a year over 25 years (£75,000 invested) into a global diversified equity portfolio can turn into roughly £150,000 after reinvesting dividends, assuming the portfolio achieves 5% compound annual growth.

APPROACHING RETIREMENT 

Talking with a financial advisor is always a good option for investors approaching retirement to help navigate the pension rules and available options.

From a portfolio perspective, as retirement comes into view it is natural to start thinking about dialling down risk.

Falling markets may be a boon for younger investors but they are a nightmare for retiring investors.  A market sell-off just before retirement can significantly reduce the capital value of a portfolio and therefore, potential income.

Shifting more of the portfolio into safer bonds can help dampen portfolio volatility and provide a higher income. There is no need to rebalance in one go, and each investor will have their individual preference for the optimal mix of assets.

A typical approach is to aim for around two thirds of the portfolio in stable fixed interest bonds and the rest in equities. There is also the option to shift the equity portion towards funds and shares with an income bias.

Depending on individual circumstances and general health there is no need to rush though, given the average life expectancy is 79 for men and 83 for women.

Some investors may prefer to move to part time working before hanging up their boots for good and taking income from a pension can come in handy during this period.

Investors looking to retire early should remember that while ISAs can be assessed at any time, private pensions are only accessible from the age of 55. From 2028, the age restriction moves up to 57. The state pension can be taken from 66 years of age for both men and women.

For many people this means the gap between early retirement and drawing from a pension is too large to be practicable unless they have a large ISA pot to rely on or property income.

One option to consider, which had fallen out of favour due to the low interest rate environment which prevailed before the pandemic is to purchase an annuity, providing a guaranteed fixed income for life. You do not need to be fully retired to purchase an annuity.

Interest in annuities has surged with annuity sales spiking by 40% in 2023/24 compared to the previous year.

It is not surprising given the big increase in interest rates seen over the last two years. Annuity yields are closely linked to long term bond yields. With the Bank of England on a path to lower official interest rates, investors are looking to lock in the higher rates on offer.

To give an idea of the change in annuity rates, we can look at 15-year gilt yields as a proxy. In January 2020 gilt yields troughed around 0.4% whereas today they yield 4.3%. Other factors affect the price of annuities such as age, health and whether they are single or joint life.

Tom Selby, director of public policy at AJ Bell reminds investors: ‘Anyone going down this avenue needs to be absolutely sure about the decision as once you lock into an annuity, there is no going back.

‘It is critical before buying an annuity that you shop around the market not just for the best rate, but for the product that is most appropriate to your circumstances.’

An alternative popular option is to choose to enter drawdown from a pension pot which provides flexibility.

Tom Selby says: ‘For those choosing to access their retirement pot for the first time, drawdown remains the overwhelming top choice, with the number of people entering drawdown surging 28% year-on-year to almost 280,000.

‘Those choosing this route can benefit from flexibility and the potential for their fund to enjoy long-term growth.’

A quarter of the value of the pension can be withdrawn tax free while future withdrawals are taxed.

The lifetime allowance was abolished from 1 April 2024 and replaced by a lump sum and death benefit allowance of £1,073,100 which affects both lifetime withdrawals and death benefits.

Nominated beneficiaries of a pension drawdown receive remaining benefits tax free if the pensioner dies before the age of 75. 

Disclaimer: Financial services company AJ Bell referenced in the article own Shares magazine. The author (Martin Gamble) and the editor (Tom Sieber) own shares in AJ Bell.

WE WANT TO HEAR FROM YOU

We are looking for individuals or couples to share their experiences of managing their own investment portfolios.

If you would like to take part, we want to know why you chose certain stocks, funds or bonds, why you might have subsequently sold some of them, and what you hope to achieve from investing.

We will pay £50 in John Lewis vouchers as a thank you to anyone whose story is published in the digital magazine.

Drop us a line with your name and two lines describing your investment experience. For those picked to feature in the magazine, we’ll be in touch to get the full story.

CONTACT: shareseditorial@ajbell.co.uk with the words My Portfolio in the subject line.

DISCLAIMER: Shares/AJ Bell does not provide advice or personal recommendations. The My Portfolio articles are for information only. You must do own research and consider your own personal circumstances before making investment decisions.

‹ Previous2024-10-03Next ›