Passive investing: Adviser case studies

1. Mr and Mrs Smith are a couple in their mid-40s with twin children aged 15. Mrs Smith earns £19,000 a year from a part-time job, while Mr Smith earns £56,325 a year. Both children want to go on to three years of higher education at an estimated cost of £10,000 per child per year. Through an inheritance, the couple has acquired £100,000 which they would like to invest with an eye to increasing their monthly income to boost the university funds for their children.

2. Mr Hunt is 54 years old, divorced and has no children. He is a self-employed builder who has been working since he left school at age 16. He has previously invested money in property, but has sold his buy-to-let home and now has £250,000 he would like to invest so he can retire and live off the income. He has no pension pot, but owns his three-bedroom detached property, and has £25,000 invested in Isas and £19,000 in a cash account.

3. Mr and Mrs Jones are in their mid-20s and recently got married, leaving them with a hefty wedding debt to pay off. Mrs Jones earns £29,000 a year and invests 4% of her salary in a matched company pension. Mr Jones, meanwhile, earns £35,000 a year, has debts of £25,000 and has no pension or savings. As part of their wedding presents they received £45,000 and would like to invest it to help save for a deposit for a house.

Jaskarn Pawar, Investor Profile

1. If the investment that Mr and Mrs Smith are looking to make is genuinely for the long term then passive investments would work here. They could choose investments that are particularly offering a higher yield to boost their income. However, they should also be careful not to ‘chase’ income. There can be a tendency to focus too much on income. The final portfolio they decide to invest in should most likely be a balance between income and growth funds, with lower risk and higher risk funds included. This will help them to earn more stable income over time.

2. A passive strategy would work here, whereby Mr Hunt could invest in a range of passive funds that offer a good level of income and in combination are suited to his needs. Essentially the choice of passive versus active is secondary. The important thing to establish is his asset allocation and how he would feel comfortable investing. Once you know the broad strategy then choosing passive funds to fill this becomes an easier task. There are many passive funds to choose from that offer a variety of income yields. His strategy would need to combine a range of yields to ensure he does not solely invest for income but also growth.

3. My advice would be to pay off the debts and consider how long it will take them to save up the full deposit. If they are looking to buy a house in the near future, then long-term investments (passive or active) wouldn’t be appropriate. It would be better for them to feel more secure about what they have saved up towards their deposit by holding the savings in an account paying decent interest.

Pat Connolly, Chase de Vere Independent Financial Advisers

1. Mr and Mrs Smith want to invest to provide a monthly income. Most passive investments are not the best option for this as they will invest in both income-producing and non income-producing stocks. Many markets which might be tracked also have a low yield. A better option to generate income would probably be a combination of UK and global equity income, fixed interest and property funds.

2. While passive investments can provide a good degree of diversification for Mr Hunt, they aren’t usually the best option for those who need to generate a regular and consistent income. A better choice is likely to be a combination of UK and global equity income, fixed interest and property funds, which can provide a steady income and also the potential for long-term capital growth.

3. Their first priority should be to pay off their debt. Beyond this, they should probably look at cash savings, using ISA allowances, to build up a deposit to buy a house and as a ‘rainy day’ cash fund. Passive investments could be a good choice for their pension investments, as they can provide good diversification with low charges, and the underlying funds can be held for the long term without having to be changed.

Martin Bamford, Informed Choice

1. Mr and Mrs Smith are going to need to start accessing the money in three years’ time, which is too short a timescale for investing. They should instead keep the inheritance in cash and settle for a lower potential return. With an inheritance of £100,000 and £60,000 of university costs, they don’t need to take any investment risk with the money to achieve their financial goals. They might consider ring-fencing the money needed for fees and then invest the balance for an additional, longer-term investment goal. Investing the inheritance to generate an additional income is unlikely to yield very much in the current economic environment.

2. As Mr Hunt has no pension income, this money will be essential for him in retirement to support his cost of living. He hopefully has a number of years of income-generating self-employment ahead of him, during which time he should continue to build assets which can later generate income. At this stage, Mr Hunt will want to focus on capital growth before switching to an income strategy at a later date. A passive investing strategy can certainly help with this, allowing Mr Hunt to spread his investment across a range of different investment asset classes and therefore reduce risk.

3. Mr and Mrs Jones need to carefully consider their financial priorities before making any investments. Short-term debts are usually more expensive to service than the potential return from investments, so they might want to repay debts first before investing the money and focusing on their financial goal of buying a property. With such high debt compared to salaries, Mr and Mrs Jones should also think about what would happen if either of them lost their earning capacity, through sickness or unemployment. I would be very reluctant to recommend they invest their capital when they have £25,000 of unsecured debts.

Susan Hill, Susan Hill Financial Planning

1. Mr and Mrs Smith will need to start funding the twins’ further education in three to four years at an annual cost of £20,000. Three to four years is too short an investment timeline to ‘invest’ as such, so my recommendation would be set aside £60,000 to cover the whole projected cost and then consider the investment objective for the remainder. If it is for long-term growth then a passive portfolio of bonds, equities and property would be suitable.

2. The first thing he should do is a cash-flow analysis to determine what level of income he needs, then look at whether the capital would support this income and over what time-scale, so he knows at what age he could realistically retire and the returns he needs to achieve. Then set aside three to four years’ income in cash or fixed interest to fund those first few years of retirement while the remainder is invested for growth and income. He’ll get a state pension at age 67-plus and he could also include future equity release in his cash-flow planning.

3. The first thing is to pay off the £25,000 debt, then decide when they could realistically buy a house, and set that as a savings goal. If the house savings term is anything less than five to six years, place the remainder of the cash on fixed interest to match the goal end-date and set up a regular savings plan into a cash ISA and save like mad. Having a cash-flow plan and analysing their spending will help them to understand what they are spending money on, and why Mr Jones has not previously saved.

Aj Somal, Aurora Financial Planning

1. Passive investing would work for Mr & Mrs Smith. The investment of £100,000 would be held in passive funds, with the targeted income withdrawals in a few years’ time once the children have gone to university. There is a three-year term until the children go to university, and a further three years while they are studying. The total term of six years would allow exposure to passive investing, while enabling sufficient withdrawals to be made to boost the couple’s monthly income.

2. Passive investing would work for Mr Hunt as he requires a long-term investment strategy to provide an income for life, based on a term of at least 30-plus years. The client has cash investments for short-term emergency funds, so a passive strategy would be suitable for the £250,000 pot.

3. Mr & Mrs Jones’ priorities would be to first clear their debts of £25,000. The remaining £20,000 should be placed in cash-based new individual savings accounts (Nisa) to potentially fund the purchase of a house. Passive investing would not be appropriate for this couple at the moment.