The best ways to build up your SIPP

In the days before all the giddy pension freedoms that retirees now enjoy, pension investing was standard fare.

Those saving for retirement would have a balanced portfolio of equities, bonds and property, gradually reducing the higher-risk assets in favour of long-dated gilts as retirement neared.

At retirement they would cash out of their government bonds and buy an annuity. This is no longer an option, for a couple of reasons.

Longevity matters

First, if an investor does not need to buy an annuity, being invested in long-dated gilts with 20-30 years of retirement ahead is unlikely to be the right option - not least because 20-year gilts currently pay just 2.2%, barely enough to compensate for the effects of inflation.

Darius McDermott, managing director of Chelsea Financial Services, says: "The danger with sticking close to the old model is that people 'de-risk' too soon. Even if an investor has only five years to run to retirement, I can't think of a worse portfolio than a 50/50 cash/bond split."

Most investors have a sufficiently long timescale (five years or more) to ride out equity volatility A second consideration is longevity. Richard Philbin, chief investment officer at Harwood Multi Manager, says the first question investors have to ask is how long they are going to live.

If someone is retiring at 65 and living to 90, they will have to support themselves for 25 years. Philbin believes self-invested personal pension (SIPP) investors can be prone to being "recklessly conservative" - under-estimating their likely life expectancy.

Under the new pension rules, therefore, it is likely to be appropriate for investors to maintain a weighting in the stockmarket long after retirement, and certainly while they are still accumulating their pension pot.

The majority of investors have a sufficiently long time horizon (five years or more) to ride out equity market volatility and harness the - usually - stronger returns from stockmarkets.

Model portfolio option

When it comes to deciding where to invest, there are plenty of platforms that will do the hard work for you: the majority have a recommended SIPP portfolio.

Chelsea, for instance, has a ready-made portfolio range, badged with different risk levels - aggressive, cautious etc - depending on investors' age and tolerance for capital loss.

Our sister magazine Money Observer has its own risk-rated combinations in its "Model Portfolio" selection, which investors can implement on the Interactive Investor platform.

An investor's priority should be a growing income to protect against inflation over timeThis type of ready-made portfolio will typically offer a suggested range of funds, with different options based on an investor's risk profile.

For example, says McDermott, the equity portion in the group's cautious portfolio might include funds such as Neil Woodford's Woodford Equity Income or Terry Smith's FundSmith Equity, while the more "aggressive" portfolios will incorporate smaller companies or emerging market funds with a bit more punch.

An investor's priority should be a growing income to protect against inflation over time, says Philbin. He recommends prioritising funds with a track record of growing dividends, rather than a high absolute level of dividend.

"If an investor puts £2,000 a year into a fund paying 3% and with a history of growing its dividend, it is likely to provide a stronger income after 10 years, and should have delivered capital growth as well."

Investing for income

There are a number of funds with a specific mandate to grow dividends year-on-year. The investment trust sector is awash with funds that specifically target a growing dividend.

There are now 19 trusts with 20 years of annual dividend increases, while a further 18 have more than 10 years, so this can be a good place to start for those who are keen to secure a growing income.

Tim Cockerill, head of research at Rowan Dartington, favours trusts such as City of London and Bankers, which have some of the longest track records of growing income.

Philbin recommends rolling up income in the accumulation years and  "switching it on" in retirementAmong open-ended funds, Gavin Haynes, managing director at Whitechurch Securities, suggests Rathbone Income.

"This is a traditional UK equity income fund that invests in a portfolio of around 50-70 dividend-producing companies that provide above-average and increasing income. The fund has a strong record of rising annual distributions."

He also likes Artemis Global Income, which aims to provide rising dividend income combined with capital growth from global equities.

Fund manager Jacob De Tusch-Lec has produced strong returns since the fund's launch in 2010, investing in companies of different sizes, across a range of industries and regions.

Philbin recommends rolling up the income in the accumulation years, and then "switching it on" (withdrawing it) as needed in retirement. This also provides a useful way of varying income requirements at different retirement stages.

Higher-risk possibilities

Investors may require lots of income in the early years when they are travelling, golfing and generationally enjoying themselves, but then less as they get older and less mobile.

Although many investors will want to minimise the swings in their portfolio, with a lengthy time horizon many can afford to dip a toe into higher-risk growth areas.

Smaller companies and emerging markets are higher risk, but could help build a larger pot. A "little and often" approach may also help minimise the volatility.

Sheridan Admans, investment research manager at The Share Centre, suggests the Legg Mason Clearbridge US Aggressive Growth fund. "The managers, Evan Bauman and Richie Freeman, are optimistic about the opportunities for the companies held in the fund," he says.

With the income from bonds at historic lows, should investors be bothering with them at all?"Based on a long-term investment perspective, the fund's buy-and-hold strategy is designed to allow stocks in the portfolio to flourish and grow over time. The fund would be suitable for investors taking at least a medium degree of risk, who don't have an income requirement."

Haynes likes Threadneedle Global Emerging Markets. He admits that emerging markets have been uncomfortably volatile, but believes many of these markets look cheap relative to their longer-term averages, with some at their cheapest levels relative to developed markets since the global financial crisis.

He adds: "Threadneedle has a well-resourced team in this area and the fund provides diversified exposure to growth opportunities."

Another question investors need to ask is the extent to which fixed income still has a role.

Certainly, long-dated government bonds are not likely to assume the same importance, but, after a 20-year bull market, with the income available from the asset class at historic lows, and increasing volatility, should investors be bothering with bonds at all?

Flexible bonds

Philbin is clear that fixed income should still be incorporated, but it should be of the more flexible strategic bond fund variety rather than more conventional options.

He points to funds such as those offered by fixed income specialist TwentyFour Asset Management, which include the Dynamic Bond fund which invests in a range of bonds.

Admans likes the Jupiter Strategic Bond fund: "Ariel Bezalel, the fund's manager, believes interest rates are set to stay low for a long time and there is mounting evidence that the slowdown in emerging markets is starting to affect the US economy, which could leave the US Federal Reserve with little room to raise interest rates above their current level," he says.

Investors must remember the importance of long-term growth, while minimising volatility by holding a blend of assets"In the longer term, Ariel believes that high debt levels and ageing populations in much of the developed world will continue to act as a major impediment to economic growth.

"This is why he has adopted a cautious stance in the portfolio by investing in bonds issued by more creditworthy corporates and governments. This fund should be suited to investors seeking income with a preference for low risk." This could act as a useful ballast to other, higher risk, funds.

Philbin adds that lots of "fixed income" funds no longer provide an income, aiming for pure capital growth. Absolute return bond funds, in particular, have become very popular, aiming to provide consistent growth in different market conditions. They can therefore bring diversification to a portfolio.

There should also be room in a SIPP portfolio for some alternatives: commercial property is a popular choice, but there is a wealth of alternative income-generating options in the investment trust area.

These include peer-to-peer lending (P2P Global Investments, for example, or Funding Circle's new investment trust), senior secured loans (JPMorgan Senior Secured Loans) or niche parts of the property market such as infrastructure.

The modern SIPP portfolio may look very different from the pension products of old. In building an effective SIPP portfolio, investors need to remember the importance of long-term growth, while minimising volatility by holding a blend of assets.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.