A £100,000 lump sum invested in April 2015 in Fundsmith Equity – the single most popular fund among savers who have entered income drawdown since the pension freedoms were introduced in 2015 – would now be worth £165,100 even after £5,000 a year has been withdrawn to cover living expenses.
This makes it the best performing, as well as the most popular, of the 10 most bought funds among drawdown investors on the AJ Bell platform.
Had they refrained from taking any income, the £100,000 would now be worth £192,100.
“Such growth makes even the punchiest withdrawal strategy look sustainable,” said Tom Selby, senior analyst at AJ Bell. “Based on the £100,000 investment you could have withdrawn £15,000 a year and still have a pot worth £100,000 today.
Total returns + £5,000 per annum withdrawals
Source: Top 10 most purchased funds by income drawdown investors via AJ Bell. Investment performance data from FE Analytics 6/4/2015 – 28/3/2019. *5% of opening fund value, taken quarterly
“There has been a surge in investors using income drawdown since the pension freedoms were introduced and the great balancing act they face is generating a decent income that will last throughout their retirement.
“The good news is that so far, pension freedom investors have benefited from strong stock market returns and even better active fund selection, in most cases generating a golden combination of income and capital preservation.”
However, not all of the most popular funds proved as successful as Fundsmith Equity.
City of London Investment Trust was the fifth most-bought fund among drawdown investors, with its popularity among income seekers having long been cemented due to its record-equalling number of yearly dividend increases – 52 – and its relatively high yield of 4.53 per cent.
However, a £100,000 lump sum invested in the trust in April 2015 would only be worth £96,170 today after withdrawing £5,000 a year as income.
“Even this is still a healthy looking picture though,” added Selby. “Despite City of London being the worst performer out of the 10 funds, the data shows that income-producing investment trusts can be great vehicles for people who just want to withdraw the dividends their investments produce, otherwise known as natural yield, without having to sell any of their funds.
“Murray International and City of London for example would have enabled investors to take £17,590 and £16,830 respectively as natural yield, with Murray International still being worth more today than it was four years ago and City of London just a bit less.”
Murray International is one of the AIC’s Next Generation Dividend Heroes, having raised its dividend for 14 years in a row. It is yielding 4.39 per cent.
Selby said that investment trusts can deliver great total returns, too. The most popular trust – and second most popular collective investment pick overall – was Scottish Mortgage, which has turned £100,000 into £161,110 over the past four years, even with £5,000 withdrawn each year.
Natural yield (or dividends paid) + remaining fund value
Source: Top 10 most purchased funds by income drawdown investors via AJ Bell. Investment performance data from FE Analytics 6/4/2015 – 28/3/2019.
These figures raise an interesting point about income and drawdown.
While investors in retirement have traditionally gravitated towards income-paying vehicles, the three best funds on the list from a total return point of view – Fundsmith Equity, Scottish Mortgage and Lindsell Train Global Equity – were responsible for three of the four lowest dividend figures paid over this time. This suggests that an attractive option for experienced investors may be to hold a growth-focused trust and sell shares in good years to fund their living expenses, rather than holding income-focused funds and relying on the dividends. They may even wish to use a mix of strategies.
“In reality, investors are unlikely to invest in just one fund,” Selby added. “Splitting a £100,000 income-drawdown portfolio equally across the 10 most popular funds would also have proved a very successful investment strategy. After taking out £5,000 a year, you’d still be left with a portfolio worth £122,910, almost 23 per cent higher than four years ago.”
Annabel Brodie-Smith, Communications Director at the AIC, said: “The point about the AIC Dividend Heroes is that shareholders have received a consistent increase in income over time. If you are in retirement you need reliable dividends so you avoid unexpected drops in income which could well affect your lifestyle.
AIC Dividend Heroes
Source: The AIC
“The investment company can retain up to 15 per cent of the income they receive in their revenue reserve to boost dividends when times are tough. This income does not go anywhere but is retained as part of the shareholders’ assets to be distributed when it is needed.
“Shareholders choose to invest in these investment companies because of their consistent income records and the company structure allows shareholders a say in how the company is run including its dividend policy.”
Whether investors choose a growth or income-focused trust, what is most important is that they don’t let themselves fall into a false sense of security.
Separate AJ Bell research suggested 30 per cent of investors have no idea what has happened to their fund since entering drawdown. Selby warned investors against taking the recent strong returns for granted, pointing out that even star fund managers can suffer and the order of investment returns will have a significant impact on retirement outcomes.
“History has shown us that, at some point or another, stock markets are almost certain to blow up, and anyone who enters drawdown and takes big withdrawals at just the wrong time could severely damage their long-term prospects,” he finished.
“In other words, don’t assume the experience of the last four years will be repeated in the next four years.”