We get asked about retirement portfolios designed to generate ‘income’. The idea being that by relying on the ‘natural’ yield from their portfolio, retirees can avoid drawing on their capital or selling fund units.
For example, a £500,000 investment may rise to £600,000 or dip to £400,000 in terms of investment value, but the investor does not touch the capital.
We think there is no logic in such an investment policy (with perhaps the exception of certain trusts that do this by design). There are 8 reasons why we think this:
- Dividend yields fluctuate significantly over time. That means the retirees income will do the same!
- Even if the yield is stable in percentage terms, the income received in £ terms will still fluctuate as the capital value fluctuates.
- Adjusted for inflation, natural income is very unlikely to meet the income needs of most retirees unless they have very large amounts of capital. Or conversely, if you have a large amount of capital and are looking to leave a legacy, there are more efficient ways to invest than by simply ‘hunting’ for income.
- There is no empirical evidence that this is a sensible strategy.
- The fallacy of the free dividend. When a dividend is paid, the share price drops by the amount paid out. There is no free lunch!
- Currently, on the back of the Covid-19 crisis, dividends are being slashed aggressively. Again enforcing the fact that this strategy creates an income that is too volatile for most retirees.
- Many companies don’t pay dividends. Apple didn’t pay one until 2012. Amazon has never paid one! There are also entire sectors that historically pay little in dividends (biotech for example).
- Dividends are generally taxed at a higher rate than capital gains. The capital gains allowance for 2020/21 is £12,300 vs £2,000 for dividends. For higher earners, capital gains tax is 20% vs a dividend tax of 32.5%.
At Clara Wealth Management, we think the best approach is a robust financial plan that accounts for a wide range of market conditions and is appropriate to your attitude to risk and capacity for loss.
Please contact Clara Wealth Management at email@example.com with any questions or comments.