The autumn years of life, in which most expect not to work, are increasing in number while the age at which people enter the work force is also broadly increasing. This means the capital that generates income from private investments must be productive for longer if it is to provide for retirement.
However, all sorts of options have been opened up by the Government’s new pension rules, whereby the over 55s can draw down from a pension pot, and a fleet of new products from the asset management industry are aimed at the income-ravenous, making the process both more flexible and more confusing.
Here, fund managers and advisers highlight the 10 key rules investors should remember when planning their retirement income portfolio.
1. Asset allocation
Meera Hearnden, senior investment manager at Parmenion, says this is hugely important.
“If you are looking to achieve a certain yield or level of income, there is no point in populating your portfolio with growth style investments. Depending on your tolerance for risk, investors will typically turn to fixed income investments as a first port of call,” she said.
“However, be careful in what you select, particularly in the current environment where interest rates could rise over the coming years. Investors may wish to consider short-dated corporate bonds. If risk allows it and there is a need for a high level of income, select some high yield bonds but be very selective.”
“Property is another asset class to consider with yields in excess of 4 per cent. Commercial property funds can be illiquid, but they are lower risk and offer attractive income. If the intention is not to buy and sell regularly, they would be an excellent asset class to consider. Being sensible about these allocations and the proportions of the weightings is key.”
2. Diversify across asset classes
Aymeric Forest, lead manager of the Schroder Global Multi-Asset Income fund, says diversifying across different asset classes, regions and sectors can help lower risk.
According to the manager: “Investing across a range of different asset classes gives us the flexibility to position the fund in areas with the greatest potential for generating income and growth.”
Forest’s investment universe includes high dividend equities, investment grade bonds, high yield bonds, emerging market debt (local and USD), property and infrastructure (both accessed via liquid listed companies), and other fixed income sectors such as municipals, MBS or ABS.
There are asset class ranges in place to ensure sufficient flexibility and diversification in his fund’s risk allocation, and to help reduce cyclical drawdown risk.
3. Managing risk
Hearnden also says the closer investors get to retirement the less risk most will be willing to take, but they may wish to re-evaluate this approach in the current climate.
“Traditionally most investors would start to lower their risk profiles from the age of 50 upwards. The closer they got to 65 the more they were skewed towards fixed income and cash, as opposed to equities,” she explained.
“In today’s world, the goal posts have changed. Investors are living longer and therefore could potentially take more risk by staying invested in equities for longer, but also picking up income from equities along the way if needed in addition to other assets held.”
“This is of course if an investor’s risk profile permits, but don’t be fooled into thinking a portfolio needs to increase its fixed income and cash allocations at the age of 50 or 60, particularly if people are going on the live beyond 85.”
4. Multi-asset income funds may have advantages over buying an annuity
Multi-asset income funds have become increasingly popular of late. With many offering the potential for a higher level of regular income than an annuity, they also offer the additional benefit of sustainable growth.
While buying an annuity provides a guaranteed and regular income for life in exchange for total cash in your pension pot, funds such as the Schroder Global Multi-Asset Income fund can allow retention of capital ownership and currently offer a higher annualised income as well as one that beats changes in living costs due to inflation.
This also gives further potential for growth or maintenance in the value of underlying capital as well as the opportunity to switch to other yield targeting investments in the future.
However, this does come with the risk of losing capital whereas an annuity is guaranteed for life.
5. Beware inflation
Martin Bamford (pictured), financial planner at Informed Choice, says inflation has a big impact on a retirement income portfolio, especially over the longer term.
Bamford said: “Price inflation right now, at 0.5 per cent as measured by the consumer prices index, isn’t too devastating but when it returns to average it can quickly erode the buying power of income from an investment portfolio.”
“Capital preservation is really important, as often investors in retirement will not have the same opportunities to replace lost capital. Potential to earn or inherit to replace lost capital tend to be limited in later life.”
6. Reinvest income to support the value of your portfolio
Bamford also believes that as much frugality with income from dividends as possible is advisable, as any surplus re-invested into the portfolio helps to added to the overall size of the pot.
“A retirement income portfolio paying a natural yield which is spent as it is received will not last as long as one where some dividends and income payments are re-invested. Only withdraw what you need to spend, rather than spend every penny that is generated.”
7. Be realistic
However, the financial planner adds that investors should remember that the amount of money they can expect may alter depending on the current stage of the market and interest rate cycle.
“Have realistic expectations about the level of income your portfolio can generate,” he cautioned.
“In the pre-global financial crisis days, an income yield of 5 to 7 per cent net of charges was quite common. These days, with the Bank rate at 0.5 per cent, temper your expectations and understand that higher yields require you to exposure more of your capital to higher risks.”
8. Don’t just buy income-paying assets
Mike Deverell, investment manager at Equilibrium, says some growth assets or funds can also be useful to bolster income portfolios and add extra diversification, thereby potentially limiting losses.
“What you want to do is to keep those fluctuations down as much as possible,” he said. “That doesn’t just mean you should just think about income-producing funds. You want some bias to them but you shouldn’t have no growth funds or total return funds in your portfolios.”
9. Keep charges low
Bamford advises investors to keep a stern eye on what they pay in the way of fees, as this is one of the key drags on total returns.
“Keep charges low. High fund management charges, platform expenses and advice charges will reduce the income that the portfolio can generate, especially in the current economic environment where yields are generally very low,” he tipped.
10. Don’t be afraid to take some capital if necessary
Deverell (pictured) also says at times investors can use capital growth to boost income, such as at times when dividends are harder to come by and income may fall otherwise.
“If you’re taking income then there is no reason why you shouldn’t take some of it as capital withdrawals. They can have a taxation benefit outside of an ISA. You have extra allowance there from capital gains tax,” he explained.
“A lot of people don’t like making capital withdrawals and you don’t want to do it when the market is down but that’s the point of a diversified portfolio. You don’t need to take it across asset classes.”