Inherited Concentrated Portfolio and Competing Goals
Tom, 47, inherited £850,000 from his father. The portfolio is 62% in one FTSE 100 pharmaceutical stock, 20% in a low-coupon gilt ladder, 10% in a global equity fund and 8% cash. Tom earns £120,000, has a final-salary pension and £60,000 in ISAs. He wants £34,000 a year from the portfolio so he can reduce to four days a week, and plans to spend £120,000 in five years on a house renovation. He describes himself as 'cautious' but says he 'cannot sell the pharma stock because Dad bought it at 50p'. The stock has a £210,000 unrealised gain; the gilt ladder yields 1.2% and matures in 2031. Tom has no investment experience beyond cash ISAs. He is worried about 'losing money' but also about inflation. The portfolio is outside tax wrappers except £40,000 in an ISA.
1. Diagnose the principal suitability risks in Tom's portfolio and recommend a target allocation, with justification.
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Principal risks. The portfolio is 62% (£527,000) in one pharmaceutical stock. That is an undiversified, idiosyncratic risk: a drug failure, litigation or dividend cut could remove a large part of Tom's income and renovation fund. The gilt ladder yields only 1.2% and matures in 2031, so it is exposed to inflation risk. Cash is 8%. The global equity fund is only 10%. Tom calls himself cautious but holds a concentrated equity position and wants a 4% withdrawal (£34,000) plus £120,000 in five years (14% of the portfolio). His stated risk attitude and actual capacity for loss are not aligned.
Target allocation. Ring-fence £120,000 for the renovation in short-dated gilts or cash held to maturity. Hold £68,000 (two years' income) in cash. For the remaining £662,000, a 45–50% equity allocation is defensible if Tom can tolerate a temporary fall: about £300,000 global equities, £230,000 diversified bonds, £80,000 alternatives and £50,000 cash. The single stock should be reduced to below 5–10% over two or three tax years, using the annual CGT exemption and ISA allowances. The allocation should be documented in an investment policy statement with a review trigger.
2. Evaluate the tax and sequencing of funding the £34,000 income and the £120,000 renovation, including CGT and wrapper use.
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Income. Tom needs £34,000 a year. Natural dividends and gilt coupons should be used first. Capital withdrawals should be small and regular, not a single sale. The £120,000 renovation is a five-year liability and should be held in short-dated gilts or cash, not equities; duration should match the spend date. It should not be funded from the pharma stock at the last minute.
CGT. The pharma holding has a £210,000 gain. If sold in one year, after the £3,000 annual exempt amount, the gain is £207,000; at 20% (Tom is a higher-rate taxpayer) the CGT is about £41,400. Spreading disposals over three tax years uses three annual exemptions and could save roughly £1,800, but the larger benefit is managing the 20% rate and avoiding a forced sale. Bed-and-ISA can shelter £20,000 a year; the existing £40,000 ISA should be used first for income-producing assets. If Tom is married, inter-spousal transfers could use a spouse's exemption and lower rate, but that is not stated.
Sequencing. Build the cash/gilt reserve first; sell the pharma stock gradually into diversified funds; use ISA allowances each year; keep the renovation money separate. Do not use EIS or VCTs simply for tax relief, because they add risk and are illiquid.
3. How would you address Tom's behavioural biases and establish his true capacity for loss?
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Tom's language shows anchoring: 'Dad bought it at 50p' is a reference price that is irrelevant to the stock's forward risk. He may also be displaying endowment effect and loss aversion: the shares feel like part of his father, and selling feels like a loss even if diversification improves the portfolio. Regret aversion is likely if he sells and the stock subsequently rises.
The adviser should separate attitude to risk from capacity for loss. Attitude is what Tom says; capacity is what his income need and five-year renovation liability allow. A structured risk questionnaire is not enough. Use scenario analysis: show the effect of a 40% fall in the pharma stock on his £34,000 income and the renovation fund. Reframe the purchase price as a sunk cost and compare the portfolio with and without the concentration. Discuss the purpose of the money and the downside he cannot afford.
A phased implementation plan reduces regret: sell in tranches, set a written schedule, use a decision journal, and agree a review date. An investment policy statement should record target allocation, rebalancing bands and the reason for diversification. If Tom still cannot sell, consider a discretionary manager with a diversification mandate, but only after he understands the cost. Capacity for loss should be documented explicitly.