Question
May I ask a question in respect of sustainable rates of withdrawl from a diversified investment portfolio. It constantly excerses me in terms of augmenting our retirement income.
Conventional wisdom has it that a rate of 3-4% pa rising with inflation should be sustainable over the longer term with out denuding the real value of the portfolio ( we want to leave the kids something). The state of the markets over the past years seem to have worked against this and in our case we have managed a 2% withdrawl rate over recent years.
I wonder if this question is one that you could use to bring out some points. For example how would you construct a portfolio to meet the longer term objective of an inflation proofed income.
Hope thats not too much of a question to ask. By the way your web site is first class and like the novel way you present information.Answer
Glad you like the site, sorry I've neglected it somewhat it recent months but starting to spend more time on it again now.
In simple terms there are two ways to consider regular portfolio withdrawals.
The first is to withdraw the natural income produced by underlying investments (e.g. interest and dividends) hoping that the investments themselves rise in value over time to generate some growth.
The second is to simply withdraw a certain amount, regardless of actual income, in the hope that growth (including any reinvested income) is sufficient to fund this and at least keep pace with inflation.
In practice both approaches will likely fail when markets are falling, but the former will probablybe the more reliable route.
What types of investment might be suitable?
Cash is the simplest investment and it's safe. But if you withdraw the income (i.e. interest) your capital won't grow, you'll just be left with whatever you originally invested. Plus interest seldom keeps pace with inflation - it might be high at times and low at others - you can't rely on it to consistently rise over time.
Dividends (paid by companies) tend to have a better track record at keeping pace with inflation long term. In general terms board's like to consistently raise dividends, unless the company is in trouble, to send out positive signals and keep shareholders happy (perhaps in the hope they won't get a hard time over their excessive pay packets!). Trouble is, while dividends tend to consistent, share prices aren't. A dividend won't be much consolation if the share price has just dived 20%.
Commercial property is, on the face of it, a good way to generate inflation beating income long term, as the underlying rental income agreements with tenants usually have pre-agreed rent increases. However, property values can fluctuate and while generally stable in the past, they took a big wobble over 2007/08.
Fixed interest (e.g. gilts and corporate bonds) can struggle to keep pace with inflation as, like cash, yields fluctuate over time - largely dependent on interest rate and inflationary expectations. Unlike cash, there is scope for the capital value to rise or fall. The exception is fixed interest linked to inflation, e.g. index-linked gilts. In this case both the initial investment and interest payments rise with inflation until redemption.
However, index-linked gilts/bonds are not necessarily as attractive as you might imagine. Firstly, you'll only enjoy the full benefit if you buy an launch and hold until redemption, buying and selling meanwhile via the open market means you might end up better or worse off overall - as the price will vary based on inflationary expectations. Secondly, the interest payments might start at a very low level, for example the index-linked gilts issued last year (redeeming in 2062) have a starting income of just 3/8th of a percent, i.e. 0.375%. Yes, this will rise with inflation, but it'll take many years to get to anything near a respectable level. Even when inflation has doubled you'll still only be receiving 0.75% annual interest.
Finally, gold is often touted a good inflationary hedge. I don't think there's any hard evidence to back this up and it doesn't produce an income, although it might make a good long term investment.
So where does that leave us?
Well, there is no sure fire way of generating inflation beating income and growth. Holding shares in stable companies with a history of raising dividends looks sensible and commercial property investments might suit the objective well. Both should generate a natural annual income (yield) of around 3-6%, but involve risk and could backfire if markets fall, especially shorter term.
Cash doesn't really work, but is nevertheless a sensible holding in almost all portfolios, especially in times of high uncertainty as at present. And index-linked fixed interest, while potentially useful if you believe inflation will be high, are not the golden panacea you might think.
So in practice you'll probably want to combine a mix of all the above (as you may well be doing already), the exact mix dependent on how much risk you're comfortable taking. But this means accepting that things might not go to plan short term and taking a 10+ year outlook - which is hopefully be long enough to ride out all the short term volatility we're experiencing at the moment.
May I ask a question in respect of sustainable rates of withdrawl from a diversified investment portfolio. It constantly excerses me in terms of augmenting our retirement income.
Conventional wisdom has it that a rate of 3-4% pa rising with inflation should be sustainable over the longer term with out denuding the real value of the portfolio ( we want to leave the kids something). The state of the markets over the past years seem to have worked against this and in our case we have managed a 2% withdrawl rate over recent years.
I wonder if this question is one that you could use to bring out some points. For example how would you construct a portfolio to meet the longer term objective of an inflation proofed income.
Hope thats not too much of a question to ask. By the way your web site is first class and like the novel way you present information.Answer
Glad you like the site, sorry I've neglected it somewhat it recent months but starting to spend more time on it again now.
In simple terms there are two ways to consider regular portfolio withdrawals.
The first is to withdraw the natural income produced by underlying investments (e.g. interest and dividends) hoping that the investments themselves rise in value over time to generate some growth.
The second is to simply withdraw a certain amount, regardless of actual income, in the hope that growth (including any reinvested income) is sufficient to fund this and at least keep pace with inflation.
In practice both approaches will likely fail when markets are falling, but the former will probablybe the more reliable route.
What types of investment might be suitable?
Cash is the simplest investment and it's safe. But if you withdraw the income (i.e. interest) your capital won't grow, you'll just be left with whatever you originally invested. Plus interest seldom keeps pace with inflation - it might be high at times and low at others - you can't rely on it to consistently rise over time.
Dividends (paid by companies) tend to have a better track record at keeping pace with inflation long term. In general terms board's like to consistently raise dividends, unless the company is in trouble, to send out positive signals and keep shareholders happy (perhaps in the hope they won't get a hard time over their excessive pay packets!). Trouble is, while dividends tend to consistent, share prices aren't. A dividend won't be much consolation if the share price has just dived 20%.
Commercial property is, on the face of it, a good way to generate inflation beating income long term, as the underlying rental income agreements with tenants usually have pre-agreed rent increases. However, property values can fluctuate and while generally stable in the past, they took a big wobble over 2007/08.
Fixed interest (e.g. gilts and corporate bonds) can struggle to keep pace with inflation as, like cash, yields fluctuate over time - largely dependent on interest rate and inflationary expectations. Unlike cash, there is scope for the capital value to rise or fall. The exception is fixed interest linked to inflation, e.g. index-linked gilts. In this case both the initial investment and interest payments rise with inflation until redemption.
However, index-linked gilts/bonds are not necessarily as attractive as you might imagine. Firstly, you'll only enjoy the full benefit if you buy an launch and hold until redemption, buying and selling meanwhile via the open market means you might end up better or worse off overall - as the price will vary based on inflationary expectations. Secondly, the interest payments might start at a very low level, for example the index-linked gilts issued last year (redeeming in 2062) have a starting income of just 3/8th of a percent, i.e. 0.375%. Yes, this will rise with inflation, but it'll take many years to get to anything near a respectable level. Even when inflation has doubled you'll still only be receiving 0.75% annual interest.
Finally, gold is often touted a good inflationary hedge. I don't think there's any hard evidence to back this up and it doesn't produce an income, although it might make a good long term investment.
So where does that leave us?
Well, there is no sure fire way of generating inflation beating income and growth. Holding shares in stable companies with a history of raising dividends looks sensible and commercial property investments might suit the objective well. Both should generate a natural annual income (yield) of around 3-6%, but involve risk and could backfire if markets fall, especially shorter term.
Cash doesn't really work, but is nevertheless a sensible holding in almost all portfolios, especially in times of high uncertainty as at present. And index-linked fixed interest, while potentially useful if you believe inflation will be high, are not the golden panacea you might think.
So in practice you'll probably want to combine a mix of all the above (as you may well be doing already), the exact mix dependent on how much risk you're comfortable taking. But this means accepting that things might not go to plan short term and taking a 10+ year outlook - which is hopefully be long enough to ride out all the short term volatility we're experiencing at the moment.
Read this Q and A at http://www.candidmoney.com/questions/question573.aspx
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