Before taking any actions and making any decisions regarding the revamping of the portfolio of my UK friend, it is important to spell out the principles and constraints that will drive the portfolio and its management for the indefinite future. So here they are:
KISS (Keep It Simple Stupid) - The over-riding organizing principle is that the portfolio and its on-going management should be as simple as possible. In the immortal words of Albert Einstein who seemed to have mastered KISS with his famous formula, "Everything should be made as simple as possible, but not simpler." Simplicity is in keeping with the desire of the person owning the portfolio to not spend large amounts of time on managing it. The principle will also enable the owner to understand and to track the portfolio and to make the changes without intervention by anyone else.
Consistent with Financial Theory - The portfolio should accept and adhere to the results of the massive amount of financial research, i.e. that is scientific and generally accepted, conducted in the last 80 years. Perhaps this is too obvious to state but it dictates that market timing be avoided and that diversification be pursued. A standard finance textbook like Bodie et al, Investments, is a good source for seeing what is generally-accepted.
Passive Investing with Index ETFs or Funds - The portfolio will therefore take a passive investing approach, rather than active management, and this includes avoiding ETFs or funds that have active managers. Financial theory says that one cannot and should not try to beat the market so buying the market in the form of funds that track the market is the way to go.
Low Number of Holdings - Too many different holdings will add to confusion and will make it more cumbersome and difficult to do the required re-balancing, especially across the four account types that will need to be used for tax reasons. On the equity side, that arbitrarily will mean no more than ten holdings. This factor is less important than the diversification requirement, which is at the heart of the portfolio approach. Thus, if effective diversification had required more than ten holdings, the number would have to be bumped up. Fortunately, this is not the case. There was a certain iterative process I found in doing this whole exercise where the initial objectives and principles needed to be reviewed and somewhat revised when later steps showed something didn't work quite right and slightly revising an earlier decision made it all fit better.
Implementable / Investable - A good example of this iterative revision happened when I tried to later on find the actual ETFs/funds to purchase for the portfolio and discovered that the UK doesn't have anywhere near the depth and breadth of choices in ETFs or low-cost funds that a Canadian can buy in the US market. UK discount brokers generally don't offer the ability to buy such US-traded funds, with the result that some particular holdings like international value and small cap ETFs are simply not readily available to UK investors. I eventually did come across TD Waterhouse UK, which does offer an account that enables full, direct access to US exchanges (NYSE, Amex, NASDAQ) but by then implementation had already started with another brokerage and it would have been a lot of bother to back and start over. It has been said many times that an imperfect plan properly executed now is better than a perfect plan next month.
Long Time Horizon - The investment assumption for the most part is an investment horizon of many years, twenty or more. That's because the person has a salary more than adequate for today's needs, and a pension that will be sufficient to live off without this portfolio's profits. It will be possible to be patient to ride out the inevitable downs of multi-year equity market dips. As Moshe Milevsky notes in his books and articles, time in retirement can easily reach 25-35 years so that's a good investment planning horizon for this person. The reference to the "for the most part" is the possibility that there will be a desire to help out a child financially, for example, to assist making a housing purchase in the very pricey UK market. That explains why in the preceding Diagnosis post, a fairly high allocation in liquid cash was deemed ok.
Tax Minimization - This is a goes-without-saying objective. A guaranteed tax saving is like an extra risk-free return. Not paying 20% tax on interest-bearing investments increases the after-tax net return by that amount. Putting money into tax-exempt accounts/plans like an Individual Savings Account (see here for how they work) or holdings, like tax-exempt bonds (see National Savings and Investments) within the overall portfolio plan, will be pursued in the revamping.
Cost Minimization - Perhaps not as obvious as minimizing taxes, but paying high annual fees on the 1.5% on the existing funds is to be avoided if possible. A target would be 0.5% as desirable and under 1% the maximum. It has been shown that, on average, higher cost funds produce lower returns for the investor (though I cannot find the link as a reference at the moment). The same goes for brokerage account management and trading fees, though the impact is less (unless one would go to a full service broker who charge a percentage of the assets held). A simple portfolio that can be self-managed on-line lends itself well to lower cost discount brokerages.
Annual Re-balancing - The portfolio will be re-balanced once a year in mid-April. The asset allocations will be re-stored by selling and/or buying the same ETFs or funds already in the portfolio. If there is only a small deviation of the order of less than 1% from the total portfolio target a holding will be left alone. The annual re-balancing frequency has been chosen because research such as here at the Journal of Financial Planning and here at William Bernstein's website indicates it gives close to the best investment results vs risks. Once a year, after tax year-end of April 5th here in the UK, is a convenient time to move investments or put new money into the tax-exempt ISAs. Finally, it becomes a file-and-forget item that makes it easy for this well-organized person to schedule into the agenda.
Diversification - The single most critical element is that the portfolio will seek diversification benefits of higher returns and lower volatility. This is accomplished by selecting holdings that are either uncorrelated or negatively correlated with each other (see explanations such as IndexInvestor.com, and William Bernstein, linked above plus books like that of Richard Ferri which I previously reviewed). This apparently is not an exact or perfect science since such correlations vary considerably from year to year and for many years diverge from long-term averages but the benefit is very considerable over long time periods when such variations even out (thus the importance above of adopting a long planning horizon). That means acquiring holdings among equities in real estate, in small cap companies, in value (i.e. measures of "cheap stock price" according to accounting stats) companies and in international markets.