A relative of a roughly similar age to me asked a question that I’ve heard several times over the last few years:
“How do I know how much income I’ll receive in retirement?”
From which you’ll infer that he – like most of us these days – can’t rely on a defined-benefit final salary pension scheme, which would have made answering such a question relatively straightforward.
No: my relative has a well-stuffed SIPP and a fast-growing ISA, but no final salary pension scheme of any consequence.
Traditionally, my answer to such questions has involved explaining the idea of annuities (about which most of people are shockingly ignorant), pointing people to handy ready-reckoners such as the one published in The Sunday Times each week, and explaining the benefits of impaired health and dodgy lifestyles. (Beneficial, that is, from the perspective of an annuity!)
But with the government’s impending changes in how individuals can access their pension savings, all that is history—at least for investors with a reasonable savings pot.
Because from April there’s an alternative solution, and one which will suit my relative down to the ground.
Pension freedom
As I’ve written before, from next April it becomes possible to effectively treat SIPPs as bank accounts, withdrawing pension savings from them at will.
Forget government-imposed GAD limits, forget drawdown regulations: take out what you will, when you will.
Conceptually, the idea is to give individuals the freedom to work out their own drawdown level, enabling them to pace the consumption of their pensions to match their own anticipated remaining lifespan.
So if the doctor gives you the news that the Grim Reaper will be calling in a year or so’s time, booking that first class cabin on your final world cruise becomes a realistic prospect.
But frankly, for wealthier pension savers like my relative, there’s another prospect, which is eating into capital only very modestly – if at all – and simply withdrawing the SIPP’s natural income.
Income transparency
In which case, the answer to the question “How do I know how much income I’ll receive in retirement?” can have a different answer.
Namely, in the immediate run-up to retirement, I think it’s sensible to actually begin building that income, switching investments from things like growth funds and index trackers into income-focused shares, investment trusts, and funds.
At which point, it becomes very straightforward to estimate the retirement income generated by a SIPP. It’s basically the income that is already being generated, plus the natural growth in income that is (hopefully) delivered by rising dividend payments.
That – to me, at least – seems a much better way of going about things. No more hawking your SIPP around various annuity providers, rate-tarting your way to the biggest annuity payout you can get.
An annuity payout, it is worth stressing, which has seen a considerable decline in recent years as gilt and bond yields have plummeted earthwards.
Annuity rates may at some point start to climb up to levels seen ten or more years ago.
But frankly, Euro-deflation, negative interest rates, and lacklustre global growth make the prospect seem increasingly remote to me.
Risk reminder: The income from an annuity is guaranteed. Dividend income from shares or investment trusts is not. There are many income investment trusts that have delivered a rising payout for decades, but that is not a guarantee they will do so in the future. So one pragmatic response to creating a secure retirement plan could be to look for a minimum income floor from safer investments, and then to augment it if you’re able to with higher risk / higher reward investments such as investment trusts.
Eat your own dog food
As it happens, I was able to impart one other piece of information to my relative.
Which was that this was the very strategy that I was pursuing myself.
Beginning this year – and partly impelled by the various post-RDR changes that we have seen in platform fees – I have been gradually switching my SIPP out of funds and index trackers, and into income-focused investment trusts.
Less urgently, I’ll also be doing the same with the ETFs and direct shareholdings that my SIPP contains.
(Why less urgently? Only because the fee structure of the platform in question penalises these less onerously.)
Longer term, I anticipate that income-focused investment trusts will be the prime constituent of my SIPP, thanks to their inbuilt diversification and income-smoothing properties.
Put another way, that is certainly where all my reinvested income is going, plus any capital that’s freed-up by cashing out of individual shares and recovery plays. (Message to Tesco: hurry up, please!)
Data desert
But which investment trusts to buy? Therein lies another interesting tale.
The paucity of hard data with which to readily compare investment trusts is shocking. Citywire has recently launched an online tool comparing investment trusts’ prevailing discounts and premiums, but I’ve found nothing really similar with respect to the data I’m most keen on – comparative costs.
Moreover, there’s another problem with the materials found on-line regarding investment trusts, which is that Citywire (and other online sources, such as Baillie Gifford and Hargreaves Lansdown) tend to celebrate individual managers a bit too much for my liking.
For an investor brought up to regard active management as zero sum snake oil, that slightly sticks in the craw.
Although, that said, I am prepared to accept that some managers seem better than others at devising resilient income strategies, which isn’t quite the same thing as zero sum active management.
Work in progress
So over the Christmas break, I began building my own data source.
Yep, a spreadsheet.
Naturally, it isn’t yet complete – real life, alas, invariably gets in the way.
But I’ve made a start.
Moreover I’ve begun the process of switching, based on what the spreadsheet is telling me.
Next month, I’ll hopefully be in a position to post the spreadsheet here. But in the meantime, if you’ve thoughts to share regarding your own favourite income-focused investment trusts, feel free to share them in the comments below.
Further reading:
- The Government has produced a handy guide to the new Pension Flexibility changes, which you can download as a PDF and read with a cup of hot cocoa.
Ha! I’ve recently been doing much the same i.e. compiling a spreadsheet of the most likely suspects. theaic.co.uk/aicstats.co.uk seems to be the best data source, with dividend histories going back as much as 40 years.
Couple of useful press releases from the same site
http://www.theaic.co.uk/aic/news/press-releases/dividend-payments-increasingly-regular-aic-publishes-list-of-investment
http://www.theaic.co.uk/aic/news/press-releases/investment-company-dividend-heroes-2
And just to prove I am not an AIC stooge, the John Baron portfolios are also a good source of info
http://www.johnbaronportfolios.co.uk/site/disclaimer1.html
I have held the following (among others) since 2009 for the reasons stated:
City of London (CTY); growth and long term smoothed dividend-increase record; charges acceptable.
Schroder Income Maximiser (SZIM – accumulation); growth coupled to a useful covered-call strategy; note higher charges.
Thanks for a great column!
stormcloud
Interesting and slightly surprising!
It seems there is an obsession in the UK with income generating assets as opposed to the broader measure of total return. I take more the US “boglehead” view that it does not matter whether you get your money from capital growth or from dividend payments. Capital growth is probably more tax efficient both for the individual (taxed only on gain, bigger exemption, lower rates, ability to offset with losses) and in some countries such as the US for the companies too. Over the medium term, the return will reflect the cash generating ability of the companies – Apple being the poster child for this view of the world. The downside is that in the short term, whereas dividends are reasonably stable and IT dividend’s even more so, the capital variations are influenced by speculation both to your benefit and detriment. (Of course with ITs you have to navigate the discount/premium to NAV aspects.)
The other risk with the income-focussed approach, as you can see on the various HYP boards, is it becomes a search for yield and this must be increasing risk and decreasing diversification. That said I recognize that an IT is much more diversified but skewing your asset allocation to higher income generating assets is by definition reducing diversification compared to the whole market.
The final factor for me is that while IT costs are much less than their equivalent active funds they are still pretty high compared to a Vanguard tracker. In a world where perhaps 3% is a safe withdrawal rate for a portfolio I dont want to be giving 1% away to anybody. Look forward to seeing your spreadsheet.
FWIW I plan to stick to a globally diversified bond/equity portfolio, run a two year cash buffer to help me iron out the ups and downs in capital value and take my annual income from both the natural yield and selling down assets. A sort of DIY passive investment trust!
With 6 months to run until my notice period ends, this is a question that remains bugging me. Love the idea of investment trusts, but being a passive investing stalwart junkie, looking at my FI portfolio with it’s laser focus on low costs, they don’t sit naturally with me. Currently on a 70/30 Stock Bond Mix with a income or around 3.5% gives me a good diversification and an acceptable income (about 50% over expenses) without touching the capital – Ever. Can’t wait to see your findings, would make a massive difference to nudge this income up and get rid of some of the hassle (First world problems eh!) of managing a portfolio of about 25 holdings. Plus, have to move the company pension somewhere, so an Investment Trust could be an attractive option while I wait the 14 years before I can touch it. Great Post, look forward to the follow up……
The Association of Investment Companies has ostensibly decent comparative information about IT charges:
http://www.theaic.co.uk/aic/analyse-investment-companies.
@helfordpirate – academically you are absolutely right that there’s no theoretcal difference in taking the income as dividends or selling down an appropriate number of accumulation units per year.
But the difference is in doing it. Selling acc units feels like running down capital, whereas spending dividend doesn’t. Plus you have judgement calls to make – you look at the hellacious noise signal that Mr Market sticks on top of your portfolio value and have to ask yourself “what is the real value of this” – for instance I would say at least 20% of the headline value of my ISA is market froth at the moment. So if I were taking a SWR of 5% that had better be 4% at the moment. It’s a finger in the air guess, and if I depended on it that would worry me.
We’re not all brains on a stick. Sometimes it’s better to accept some inefficiency to make the ride feel better. Some people can take the theory and turn it into practice. People also get conservative, and sometimes fearful when there’s no defined value to stick on the Income side of Micawber.
From observation of my portfolio the income spun off is a lot less volatile year to year than the capital value number I get from Mr Market every year. That makes me feel more comfortable that it’s repeatable. Maybe the more analytical among us would correctly see that as a chimera. But if it lets the more jumpy of us sleep easier, well, that’s what ITs are selling people for their higher charges. I’m prepared to pay the 10% premium (of the potential real return thrown off, not fees) in many cases 😉
Be aware the the US aversion to dividends is very much influenced by their tax system.
It the UK an investor can get *un-sheltered* income of £35,000+ from dividends before they pay a penny of tax. The situation is not so attractive in the US, which is one reason why companies there held back dividends and switched to buybacks, though it has improved in recent years.
(In reality of course, most retirees will have built up their portfolios of shares/trusts/ETFs/funds inside ISAs and SIPPS, where it’s all tax free).
I have a spirited debate now and then with The Accumulator, who is in the mindset that total return is all that matters and that you should simply sell a proportion of your capital to generate an income.
Right in theory, but as Ermine says we live in practice. Even if it’s just in resignation to my behavioural flaws, I’d much rather not have to sell to generate an income from my portfolio once into retirement/financial freedom:
http://monevator.com/try-saving-enough-to-replace-your-salary/
Again, US investors — who dominate the investing discussion — don’t really have the option of realistically getting 4+% from dividends except by going into high-yield companies such as MLPs, so even as they approach retirement they are only ever thinking ‘sell’. (Which is one reason why the 4% withdrawal rate debates invariably talk about selling capital).
I think there are ETF and index strategies you could use in the UK that could get you to the same place, in terms of living off an income. You would have to accept greater volatility of income in exchange for the lower costs, and you’d have to understand that you were at the mercy of the market rather than a income trust manager trying to manage a portfolio for the benefit of his/her income mandate (at the possible expense of capital gain — it’s a zero sum game remember! 🙂 )
So if you want to go down the passive fund route, then I think it’s perfectly doable so long as you set up a cashflow buffer system as I’ve described before:
http://monevator.com/how-to-live-off-investment-income/
As for which ETFs/funds to use, I’ve asked T.A. for his thoughts before, but it tends to lead only to that total return discussion! 🙂 Perhaps Greybeard can be persuaded to survey the passive equity income landscape for us some day.
There are definitely plenty of iShares ETFs for example holding mainstream / blue chip companies that yield 2-4%.
I’m with both helfordpirate and ermine on this one (if that’s possible). Logically, total return is all that matters. My belief is that income strategies work mainly because they help people maintain the psychological discipline to keep their withdrawals to a safe level. Where they are risky is if encourage yield chasing to ‘force’ income beyond the yield of the whole market. (I know, value premium, yada yada, but I think the main reason they work for a PI is psychological).
I haven’t actually kept separate track of the income generated by my portfolio – that’s one for the ‘to do’ list, but not helped by holding accumulation units in tax sheltered accounts – but it feels like its currently pretty low (<2%?). So I'm not sure how I would operationalize an income strategy with my current investment strategy. I guess that's a vote for an article on passive income strategies 😉
vanguardfan makes a good point. My portfolio currently has an estimated historic yield of 2.05%. I have a 60/40 equity bond split and the bond part has a good chunk of inflation linked yielding nothing and global bond funds yielding 1.2%. To get to a 4-5% natural yield I would probably both have to give up on safe government bonds (which I am definitely not going to do!) and take a lot more risk on the equity side. Even then it might not be possible.
It seems you would almost have to adopt the purist HYP mentality: go 100% equity, only look at the income and try to ignore the capital value. For me behaviourally I know I need a chunk of assets in my portfolio that will survive another 2008/2009 without drama.
Another good article.
My head is with Mr Pirate but my heart is with The Ermine.
I’m currently in capital accumulation mode so accumulation units all the way. Might review when I get closer to retirement.
I’ve not discounted annuities – if the rates are (much) higher when I retire – as I very much like the idea that my essential expenses are covered for life via State Pension, DB work pensions and annuities. I could then spend and enjoy the rest of my savings (if I can find anything I really want to buy after a lifetime of saving). If I needed my investment pot to cover an income shortfall in retirement I think I would be overly cautious with spending that pot.
Thus, peversely, buying a, possibly not good value, annuity might in a sense “free up” the rest of my pension pot to spend and enjoy. It might not be best value when looking at overall £££, but it would probably allow me to take greater value out of my savings while alive than otherwise. If it wasn’t for the possible huge end-of-life care bills…
Thank you helfordpirate. And the Lifestrategy funds only have yields of about 1.5%. In fact probably the only index fund (vanilla cap-weighted) that generates ‘enough’ would be a FTSE 100 tracker, and you can’t put everything in that! Well, you could, but I wouldn’t.
Hence the attractions of income ITs, I suppose.
This living off investments malarkey is a bit more complicated than it first seems.
It would be good to get some input from people who are in the withdrawal/spending phase.
I was as surprised as Helfordpirate about moving everything to Income producing ITs.
Assuming I live as long as forecast, then there’s 30+ years for stockmarket returns waiting after I ‘retire’. I’ll want to have some Growth investments to ride up with the market over that time. Maybe not a total focus on growth, in case it’s all the promised ‘Jam tomorrow’. I’d take some of the Jam today in Income, to mitigate the risk of tomorrow never coming…
I foresee that I’ll have pyramid comprising…
top/ a 2 year cash buffer for daily spending ( + the State and a small DB pension )
mid/ some tax free income producers within ISAs and VCTs to top up the cash buffer when needed
base/ mainly equity investments to keep on growing ( perhaps selling a few of these to add more cash, and to use my CGT allowance and to make sure my asset allocation doesn’t get too far out of kilter )
The cost difference between Funds and ITs seems to be disappearing ( if you hold them on a cost-effective platform for your situation ). But when the next great stockmarket drop comes around, and all ( well, nearly all! ) ITs are running at a 20%+ discount then I will be transferring all my Funds to ITs to be there for the bounce back. Now, at the ‘top’ of the market, seems like the worst time to be going from funds to ITs, especially into Income producing ITs that everyone wants. I’m just about to sell some Income producing Property ITs that are trading on a 13-20% premium ( but I’m glad someone is happy to buy them from me at that premium! 🙂
I am not going to argue that anyone who says they want to stick to passives or focus in on total returns or a capital liquidation policy is wrong to do so.
This is not a dogmatic matter-of-faith issue, however much some (not anyone on this thread, thankfully! 🙂 ) try to spin it that way.
But I would just say if you’re not familiar with UK income investment trusts, for example, it’s worth reading up on their history before presuming that investors have previously had to sacrifice capital for income.
For instance, one I like and have held in the past (and my mum is invested in), the City of London Investment Trust (Ticker: CTY), is up 75% over 10 years, versus a 40% gain for the FTSE 100.
Since 1992 it’s up roughly (I am eyeballing a chart here! 🙂 ) 228% versus 156% for the FTSE 100.
This is not unusual for the best long-running UK income investment trusts.
And remember, this is on a capital-only basis. On a total return basis, they will have done even better.
Are they unique alpha generators? Did gearing help them? Were they all on a discount 20 years ago and the discount has now closed? Did the focus on dividends give them a slight value-tilt that has helped offset their high charges versus the index? Have we been in a boom time for income-seeking strategies?
All of the above, I’d say, and I agree you’d much rather have been buying them six or seven years ago when they were going cheap as I wrote at the time, compared to now.
The point is simply for those not familiar (again, not speaking to anyone directly here, just readers 🙂 ) not to assume there’s been a big sacrifice of capital for income in the past couple of decades. In reality, quite the opposite is true.
Even if (when?) reversion to the mean occurs, I wouldn’t expect their under-performance to be catastrophic. The big ones hold mature blue chips, not crazy self-liquidating income vehicles etc. Such companies might (/will) eventually lag in a capital growth phase, but they are unlikely to go out of business en masse. (We saw that script in the dotcom days. It didn’t work out! 🙂 )
For the well heeled VCTs pay dividends income tax free and carry an up-front 30% income tax break (plus various other tax breaks)
In practice most of the VCT managers now recycle the vast majority of their capital gains on investments as special dividends
Of course the annual fees are not low
Looking forward to seeing the outcome of your new IT income spreadsheet when ready.
As you may know, I use a basket of trusts to generate the income for drawdown within my SIPP. I used some trusts during the ‘build’ phase together with many individual shares but when I moved to drawdown in 2012 I simplified everything by selling the shares and adding to the basket of ITs.
One of the main advantages is the predictability of income they provide – which is very handy when you rely on that income to pay the bills!
Maybe it would be easy to sell down some of the annual growth from low cost trackers and operate a reserve but somehow, in practice, I’m not sure I would feel comfortable if the capital was falling year-upon-year.
Drawing down the rising income from the ITs is, for me far more straight forward.
As to trusts to consider – for me, top picks would be City of London, Edinburgh, Finsbury Gr & Inc., Temple Bar, Aberforth Smaller and Schroder Oriental.
Good luck with the process!
Do you have a target date for publishing your IT spreadsheet?
Thanks
Interesting and topical, thank you.
There’s an article in February Money Observer (investment trust quarterly supplement) which proposes an IT portfolio to generate and income of £10000. The investment required for their plan is around £250000. I don’t know if the article is available to non-subscribers online but it is there at the newsagents right now!
there’s a few ways to increase yield while staying passive and without doing anything too risky …
within equities, increasing your UK weighting helps, since the UK is a relatively high-yield market. (this may make sense as you get older, anyway.)
for global equities, vanguard’s all-world high dividend yield ETF (VHYL) gives you a 3.85% yield, with a very diversidied portfolio.
there are also a few vehicles for passive UK high yield equiites, though i’m not sure which i’d go for.
within bonds, you can get yields up to about 3% by going for (funds/ETFs holding) investment-grade corporate bonds. perhaps reasonable for at least part of your bond allocation. (i wouldn’t suggest putting much in non-investment-grade / junk bonds, because the risk is much higher there – you could easily lose all the extra yield, or more, in losses from defaults.)
Try Henderson Far East Income (HFEL). It pays 5.5% pa because it is Guernsey tax domiciled and so does not need to deduct the 20% advance corporation tax as UK domiciled ITs do. Dividends are paid quarterly. Held in an ISA or SIPP it is a compelling investment.
@vanguardfan – The Vanguard FTSE U.K. Equity Income Index has a 4.14% yield before fees, the best index fund yield I’ve seen, and has outperformed Vanguard’s total UK equity index fund handsomely over the last few years. Not very diversified though.
https://www.charles-stanley-direct.co.uk/ViewFund?Sedol=B59G4H8
@ john pearce
Do I have a target date for publishing the spreadsheet? Yes, as the article says: in next month’s article, which will be published at roughly the end of the month.
Is this a guarantee? No. But I do hope to publish at least a work in progress.
Hi All
Following this thread with interest as it is where I am at!
Retired 11 years with Vanguard Trackers( Total Stockmarket ex UK (26%)plus a UK Fund for stocks-(4%) plus a Total Stockmarket Hedged Bond fund for Bond portion-70% cos I have enough!
Costs 18 Basis points to run(.18%)
Some cash in a High Interest Bank Account for day to day living.
I pull money as required from the Portfolio which are SIPPS and ISAs.
Keeping it balanced 30/70
Why would I change a successful investing strategy just because I am retired?
Gone through the 2000 and 2008 downturns with no problems.
Taking about 3.5 to 4%
It it is simple- as I get older- probably chose a Vanguard Life Strategy Fund for everything as I reach 75+ for even more simplicity- my wife could then probably take over!
xxd09
I must say I am a little disappointed by this article and some of the comments. Having been a bastion of common sense investing during the accumulation phase (keeping clear of high active management charges, ignoring past performance in decision making, survivorship bias, etc.), it now appears that Monevator is advocating the abandonment of everything learned and leaping back into bed with the active fund management industry upon retirement. Why? The active managers will add to risk and leach away at your assets in exactly the same way in retirement as they would have done when you were saving.
There are of course psychological/behavioural traits that almost everyone has that make selling investments difficult; is it the right time, if I hold on a bit longer I may make more money, the market is down since last year so I will be crystallising the loss, etc. But there were similar psychological issues during the accumulation phase and the way to overcome our behavioural biases in retirement is the same as it was in accumulation – make a plan and stick to it.
All a passive investor needs to do to take an income from a portfolio of trackers is continue as before, but instead of regularly adding new money, withdraw it. Simply take the dividend/interest paid out and every year, when it is time to rebalance, withdraw capital instead of reinvesting it all into the laggards. That will mean selling after market falls, as well as after market rises, which is difficult and why we need a plan. If it makes someone feel better by upping the yield a bit, e.g. by holding more in UK trackers or the higher yielding Vanguard UK tracker and world tracker ETF, then do that, but don’t feel as though you have to. The fund rebalancing costs, fees and withholding taxes of the higher yielding trackers are higher, but these may be offset over the long term by the tilt to value.
In retirement, rational investors should continue to ignore the market geniuses who say market XXX has been “over bought”, we are due a correction, now is a good time to invest in YYY, look at the income you would have received had you been investing in ZZZ over the last 10, 20, 100 years, etc. In addition, investors should not increase risk by abandoning gilts and investment grade corporates for high yield bond funds just because the income yield on investment grade is low.
It sounds as though the Accumulator may not have abandoned his rationality, so there is hope yet for Monevator. Any chance of an article to redress the balance?
@Naeclue — You should please note that Monevator has never been entirely about passive investing. Typically Tuesdays articles are always passive, and a big chunk of Thursdays are, and the ‘house view’ is that passive is likely best for most (as in well over 90%) of people.
But I invest most of money myself, actively, in stocks and trusts I pick, and there’s oodles in the archives with an active bent.
I think your comment is constructive and sets out the counter-argument very well, so thanks for that.
But I am always wary of (/catastrophically projecting) Monevator comments turning into passive versus active spats.
I tend to delete some of the more ignorant ‘passives are rubbish’ comments we get on the passive/Tuesday articles when they threaten to undermine the point the author is trying to make. If it came to it I would do the same on the actives, if it derailed the discussion, though there’s no sign of this happening here and I’ve not had to do it yet. 🙂
Anyway, there will always be articles like this here, is my point. Feel free to ignore them. 🙂
Just on the topic, I personally believe there is a case for trusts for retirement income. You outline a method of generating an income, but outsourcing it to an active manager of an income trust for a fee (high charges) isn’t irrational if you’re doing it because stability of income is more important to you than maximizing total returns.
And someone could always hedge their bets with a mix of different vehicles (which is what I’d do, though I’m a long way from needing to…)
to naeclue, there is passion in your views. But I don’t think there should be room for ideology when investing. There is much to be said of passive investing but, today, there are alternatives.
Take for example Bankers Investment Trust. True, the ongoing charge at 0.47% is slightly more than the comparable Vangaurd EFT (VWRL) at 0.25%. But the fact I can buy Bankers at a discount (3%) and with a slight 4% gearing advantage, surely means it is worth considering. In a rising market that easily makes up for the 0.22% cost difference. I say ‘advantage’ knowing it can work the other way – but if I didn’t think the market would rise in the long term I wouldn’t be in equities in the first place!
@Naeclue:
I’m sorry that you find the article disappointing. I’d stress that it explains what I personally am doing with a portion of my investments, namely my largest SIPP. Universal advocacy it ain’t.
Two other SIPPs remain wholly invested in low cost index trackers, although I suspect that in time, they too will go down the low-cost IT route.
You’re welcome to ignore what the article says, and from your comments I guess that you will. But I’d stress again that in no sense am I advocating low-cost ITs for everyone — I’m simply saying what I’m doing.
Yes, I could sell passives each month to bring in income, but I choose not to. It’s a hassle, and in any case, I have this phobia re: capital consumption. For another reason, look at the comment regarding the performance of CTY.
The key, of course, is to be invested in low-cost ITs, not ITs full stop. I find it striking that some of the ITs that I’m looking at have TERs virtually identical to those charged by leading index trackers a few years back, such as L&G’s popular UK Index tracker.
So another way of looking at it is that I’m getting active equity income management for the same cost as I was happy to pay ten years ago for passive equity management.
@Greybeard, @ Investor
I should not have used the word disappointed, surprised would have been better. I think the article is very good and I agree with most of it. There are 2 areas I would disagree with. The first is the assumption that retirees need to increase the running yields of their portfolios. This is a very widely held belief, and I accept that intuitively it seems the right thing to do; invest your capital and live off the income stream is a great plan. The difficulties come in the implementation of the plan. This involves sacrifices that I do not like such as increasing risk, reducing diversification and increasing running costs. The second area I disagree with, which to a degree stems from the first, is the need to switch into active management, with all the potential drawbacks involved such as poor stock picking, active asset allocation, excessive trading, higher fees and for ITs, risks with discounts and gearing. For anyone still convinced that active management is a good thing, then they will have no problem with this, but for those of us who don’t buy it and prefer passive trackers, this is anathema.
The income smoothing that some ITs provide is certainly desirable and if there was an IT that invested passively but paid out a regular high and increasing dividend derived from capital and income, then I would be all for the outsourcing, even if a modest additional management fee was applied. Some kind of wrapper for a Vanguard Life Strategy Fund, for example that regularly sold part of it’s assets and distributed the cash. A product such as this would help with the self discipline difficulties of sticking to a plan. Some SIPP providers come close to this, such as Fidelity, but I am not aware of any cheap ISA providers that will pay out a regular monthly or quarterly income.
@ Savvy, I may sound ideological but I am not, nor am I against active investing. In the past I have bought ITs on large discounts and invested where I think the market has mispriced some obcure security or other. For extra diversity I also hold active funds where index funds cannot deliver, such as VCTs, preference shares, private equity and small/micro caps. The starting point for me is a passive portfolio of trackers, rebalanced annually. Get that in place and dabble around the edges where it is likely to add value or diversification benefits.
As for Bankers, the 0.47% fee is not too objectionable to me, but the extra active management risks are for just a 3% discount to NAV. The gearing could be achieved in a passive portfolio by increasing equity allocation and reducing bonds. If the gearing was through bank borrowing rather than debentures, you could just increase the bond duration a bit to reflect the short cash position.
@Naeclue — Thanks for the follow up. I completely understand what you’re saying.
Nae Clue and Helford Pirate have argued the counter case, very well, I’d just add that many will not be able to live solely from income because they won’t have accumulated enough assets come retirement time. I’ll probably be in that camp myself because I intend to retire early.
If you’re worried about selling when the market is down, well, hopefully you’ll be selling from the government bond side of your portfolio at that point, which will hopefully be pitching up as investors flee to safety.
Or if you run a buckets strategy like Mick, you’d be spending from cash.
For me, an income strategy adds complexity and cost and decreases diversity – that’s why I’d rather avoid it.
But I’m very interested in the experiences of those who do run income strategies, it’s always useful to consider alternative approaches, so thanks for a thought provoking piece and a great thread!
@naeclue. From your original post it sounded as you were against all actives on idealogical grounds. Thanks for clearing that up.
From your views on keeping costs down (which I agree) I’m interested to know how you can own VCTs. Over the years I have declined this route on cost grounds. VCTs usually have an upfront c. 4% charge then c. 3% annually which means I pay c. 20% over the 5 years I need to keep the shares to retain the tax allowance. Given VCTs often are illiquid and trade at constant c. 10-20% discounts, the attractions for a low-cost savvy investor is not obvious.
One can be against active investment on principle, having come to a considered position based on evidence and logic. I think describing that as ‘ideological’ opposition is inaccurate and unnecessarily emotive. (not that I’m trying to second guess Nae Clue whose position is clearly more complicated than that).
Superb discussion and illumination. I can go back to sleep reassured that I don’t need to worry about creating a basket of investment trusts to replace my earned income.
I do hold both the Vanguard high yield global ETF and the vanguard UK income index fund, but my rule is not to invest more than 10% in dividend tilted funds (and not more than 10% in small cap funds) – to combat my tendency to go chasing after the next New Shiny (and inevitably more expensive) index. My other broad rules are around 25-30% bonds (all UK gilts, half index linked) and a tilt to UK of not more than 50% of equities. Its all quite broad brush but I find using quite broad limits helps overcome my inability to decide on an exact asset allocation – keeping me ‘roughly right’ rather than ‘precisely wrong’. Its all in the head, this investing lark.
@Savvy, VCTs are expensive products. No denying that. They invest in an entirely different section of the market than mainstream ITs though, even small cap ITs and you are not going to be able to invest here for a few bps per year. You can save money on the up-front and trail commission by using a discount broker such as Cavendish. Due to the illiquidity you mention, my preference over the last few years has been for limited life VCTs. These liquidate completely within 6 years, with the bulk of the return around 5 years. Internal rate of return on them including the tax refund, is somewhere between 6.5% and 10% tax free and after charges, which is actually quite good if you compare with corporate bonds of similar duration. VCTs are risky investments, but the limited life ones have a lot of asset backing, which is another reason I prefer them. On the whole I find them good portfolio diversifiers.
@vanguardfan, my investment approach is really just pragmatic. There is empirical evidence and theoretical reasons (as explained in Monevator “Is active investing a zero sum game?”) that has convinced me that there is no point paying for active management in the main large/mid cap world equity markets. Some funds will outperform, but the chances of me (or Hargreaves Lansdown, BestInvest, etc.) picking them in advance are less than 50%. That does not mean that I do not believe that the market does not occasionally throw up opportunities, but they tend to be in less heavily researched places.
@naeclue, that’s helpful insight. However I question how a VCT can be viewed as a diversifier. They are firmly equity investments and, contrary to a diversifier, are highly correlated to the wider equity markets ( incl. income investment trusts)….
VCTs may be diversifiers in the sense that you are prepared to pay eye-wateringly high charges for Alpha. If so, fair enough.
But it would then be illogical to conclude that actives with low charges (i.e. Bankers IT as above) cannot deliver Alpha or are too risky, as you state.
@Savvy, VCTs and in particular limited life VCTs are diversifiers because returns are not strongly correlated with equity or bond markets. Most of the the VCTs I invest in also have a lot loan finance, often asset backed, or infrastructure such as solar power with 20+ year index linked income streams, so they are closer to fixed income investments (higher risk end of course) than equity.
Venture capital/PE cannot be done on the cheap. The costs and remuneration required for competent people to properly assess investment opportunities, carry out due diligence and draft contracts makes this impossible. Look at 3i’s costs for example. Don’t confuse ITs with VCTs. Venture capital in unquoted companies is an entirely different activity to mainstream fund management, although some AIM VCTs are arguably quite similar. VCTs might happens to share the same closed ended company structure to ITs such as Bankers but that is where the similarity ends.
As noted earlier, the evidence I have seen and theoretical arguments leads me to conclude that alpha is negative when it comes to active management in liquid large/mid cap equity markets. But that is not the same thing as saying a fund cannot outperform the market for a period.
Forgot to mention, it is the up front 30% tax refund that makes VCT returns acceptable. Without that they would be lousy investments.
@naeclue. This doesn’t address the point. Your VCTs are high risk equity products and granted some may have some security built. But they are not diversifiers of risk or in asset class.
VCTs are only diversifiers in the sense that if I own two shares I’m more diversified than if I own one. But if the market corrects they are likely to move in exactly the same direction.
ITs also diversify in the sense you suggest. Some are pure equity, some commodities, some fixed interest and some have a blend of equity/bonds. One doesn’t need to pay eye-wateringly high fees for that kind of diversification.
Back to the point though. Logically if the risks of VCT manager under-performing is acceptable, I see no reason to object to the risks of IT managers in general.
Look forward to the spreadsheet. Going through this thought process myself, currently CTY is my only IT, making up 10% of SIPP with 90% in tracker ETFs. Nice yield and low costs as far as ITs go. Probably quite an overlap with my FTSE100 tracker, and would I want to add yet more exposure to FTSE100 UK blue chips when I have no FTSE250 exposure at the moment – and look at how that has slain the 100 in total return in the last 5-10 years.
As for the automatons VHWL (Vanguard World High Yield) has been trounced by the VWRL regular All World tracker in the last year, so ignore Total Return at your peril.
@Savvy, I think I understand what you are saying. “Logically if the risks of VCT manager under-performing is acceptable, I see no reason to object to the risks of IT managers in general.” You are implying an inconsistency in my logic because I am willing to pay high fees for VCTs, but not for ITs, but there really isn’t one. I am not opposed to paying fees, whether they are solicitors, accountants, plumbers, electricians, brokers, or indeed fund managers. But if I pay a fee, I want something in return. That something could be for a service I simply cannot do, or one that I can do but am not inclined to. When it comes to fund management in mainstream equity/bond markets, I am not prepared to pay the fees of active management because I am not getting anything in return compared with passive funds. In fact, I am likely to get worse returns over the long term by paying for active management in these markets compared with a portfolio of simple passive trackers. (I might make an exception for ITs trading at a large discount to NAV).
The article mentions the income-smoothing properties of some ITs. That is an example of a service that may be worth paying for and as I have said I would consider paying for this if I could get it without the extra baggage that comes with it that I do not want. Some investors may place a much higher value on income smoothing + higher distribution yield than I do, in which case I completely understand the attractions of certain ITs that offer this. When it comes to VCTs, I am willing to pay the fees because they provide a service at a price that I consider worthwhile. Similarly I invest in REITs and for the US a REITs ETF so I am paying 2 sets of fees for that, but again I consider the fee worth paying for the service provided.
Regarding VCTs, you are wrong about them being correlated with mainstream equity markets. Or investment grade bond markets for that matter. As an example, I have calculated the correlation between one of my better performing VCTs, Foresight Solar VCT (FTSV) and the FTSE 100 tracker ISF since shortly after the launch of the VCT. I used month end prices with dividends added back in on XD date. The result is a correlation coefficient of just 9%. That is less than would typically be observed for investment grade corporate bonds.
It may be worthwhile pointing out that most of the return from limited life VCTs comes from the up front tax relief of 30%. So if a VCT makes no money at all over it’s entire life, the total tax free return will be 43%, equivalent to 7.4% over 5 years.
@naeclue. Good to see my point is acknowledged, even though we don’t agree!
As for VCT correlation, I would have thought that if VCTs are correlated with ANY asset class, I could buy an ETF instead — and thereby achieve similar diversification. That would avoid me having to pay for the fund manager’s Bentley.
Investment Trust data.
I was surprised by the Data desert heading in The Greybeard’s article. For example the Youinvest website has free access to reasonable Morningstar data. Go to the Research tab on the Youinvest homepage; select Investment Trusts tab; filter as you choose; if you look at the analytics tabs you’ll get cost comparisons. You can read the individual research sheets for the ITs of most interest to get fuller information.
I use the Youinvest platform for some direct investments. The website is a bit clunky, but the costs are competitive (not the absolute cheapest but I wanted an organisation of reasonable size – e.g. Interactive Investor is maybe cheaper but tiny).
I hope this helps.
If your relative is old enough he should consider the annuity-like merits of deferring his State Retirement Pension, and also of buying 3ANICs. It means trusting HMG, but then so does buying gilts.
Apologies if this has already been mentioned and I missed it, but what I find truly impressive about certain Investment Trusts is their incredibly long record in maintaining and increasing their dividends. This makes them quite a compelling proposition for someone who would otherwise opt for the security of an annuity.
There are several high yield, low cost ITs that have managed to increase their dividends EVERY single year for several decades. Some are coming up to 50 straight years of increasing their dividend. This includes City of London, Bankers, Murray Income.
So, they have kept this up through the Vietnam War, the oil price shocks of the 1970s, rampant inflation, Black Monday, the tech crash, the global financial crisis, a variety of wars and numerous other calamities. There is no guarantee they will continue to maintain this record, but it seems about as close to a certainty as you get in the investment world.
And as far as I can tell, we are not talking about trickery where the dividend might increase, but it does not match inflation.The AIC recently published analysis to show that the UK equity income sector managed to produce dividend growth that far outstripped inflation over the last 20 years.
I agree with some of the comments above, that in theory a better long-term net return could probably be derived by investing in even lower cost trackers and taking a prudently small annual income from it, investing excess income and gains in the good years, and selling investments in the bad years. If that’s the alternative that you’re considering and you think you have the nerve to make the right judgements about how much you can prudently take out each year, then great. It might even be what I decide to do when I retire.
But many investors in retirement are really just looking for a high level of income, which keeps track of inflation, and is guaranteed not to fall. Such a person might be tempted to go for an annuity, although if you want one that keeps track of inflation you have to sacrifice quite a bit of initial income. And of course your capital is gone.
In comparison, a portfolio of high yield, low-cost Investment Trusts looks pretty good, because it probably offers a higher yield than an annuity for all but the truly elderly, and is highly likely to beat inflation. Furthermore, you get to keep your capital. Now, it may well be the case that your capital is likely, over the long term, not to grow quite as fast as it might have done if instead you invested in the lowest cost trackers and drew down from your portfolio a similar level of income. But for most retirees, this shouldn’t make any difference whatsoever, because the only thing they need is income to live on, until they die.
It might mean that the inheritance received by their children is slightly lower than it might have been, but this really shouldn’t be a priority for any retiree.
Thank you everyone, this is a very informative debate. What are the alternatives to ITs? Sell off a percentage of your passive index tracker instead? Find a passive dividend focused fund?
What do people think about the Vanguard Target Retirement 2015 Fund https://www.vanguard.co.uk/adviser/adv/detail/mf/overview?portId=9665&assetCode=BALANCED##overview
Hi,
It seems a long time since anyone left a comment on this thread so I hope people are still interested in this debate.
From a my point of view I’ve been wrestling with what is the best portfolio for my retirement (very very soon). I’m absolutey sold on the passive always beats active in the long run debate. However, I’m not sure I want to have to handle and cope with all the potential up’s and down’s (even with a cash buffer).
I must admit I’m finding the option of a IT portfolio more and more appealing. If I can put together something which will generate a generally consistent and growing income then I’m up for that.
After many weeks/months of research I’m ready to populate my SIPP with the following distinct model portfolios:-
40% – John Baron’s IT Winter Portfolio – immediate income.
40%- Money Oberver IT/Fund Hotel Portfolio – immediate income.
10% – BlackRock Index tracker Consensus 85 portfolio – long term steady growth.
10% – Vanguard LS 80% – long term steady growth.
About 26 Funds in all.
I’d be interested in any comments and further debate on this.
I’ve had a quick look at the spread of 26 funds. Seems quite tricky to determine your aggregate asset allocation. How much does this give you in say UK equities, overseas equities, gilts, corp bonds, property, gold etc? Do you have that info to hand, and to share?
For me, that split would be the first thing to consider.
26 funds seems a lot to keep track of. Though at least in a SIPP you won’t have to worry about CGT etc.
Also, the Blackrock and Vanguard funds are very similar in terms of asset allocation, so I’d suggest you only need one. At 80% equity, I’d also quibble a bit with the idea that they would provide ‘steady’ growth – if you want relatively low volatility, maybe 60% equity might be better?
My personal approach is much simpler, all trackers and probably no more than about 12 different funds held across my entire portfolio (six accounts between myself and spouse). If I were going for ITs for income generation, I’d probably split between global and UK focused, maybe three of each (random number without logical justification!) I agree also with Chris above that you should have some idea of your intended overall asset allocation and this should drive your choices.
Hi Chris
26 Funds-cripes!
Now 71-retired 15 years. Have to have 4 Accounts -my SIPP,her SIPP and his and hers ISAs-minimum
Got down to same 3 Funds only in each account-UK Tracker,Rest of World Tracker and Global Bond Tracker. All in Accumulation Units
12 “Fund”areas to watch!!-that’s enough
Regard all investments as one Portfolio
Sell chunks of units as required-£10000.00 at a time from a SIPP or ISA to top up the Cash fund (which holds 1 years requirements)
That’s enough!
xxd09
Thanks for your quick responses and views.
Chris –
I’ve listed out the JB’s Winter portfolio (IT Based) as it currently stands. It’s about a 75% Equity/Other and 25% Bond split. Diversification is roughly 80% – UK, 12%-NA, 4%-Europe and 4% – AP:-
Bonds
New City High Yield (NCYF) 7.5%
Invesco Perpetual Enhanced Inc (IPE) 6.5%
TwentyFour Select Monthly Inc (SMIF) 6.0%
Henderson Diversified Income (HDIV) 5.0%
UK Shares
Shires Income (SHRS) 6.0%
The Merchants Trust (MRCH) 5.0%
Henderson High Income Trust (HHI) 4.0%
Themes
HICL Infrastructure Company (HICL) 6.5%
John Laing Environmental Assets (JLEN) 6.0%
Bluefield Solar Income Fund (BSIF) 5.5%
SQN Asset Finance Inc Fund (SQN) 4.5%
BlackRock Commodities Income (BRCI) 3.5%
GCP Infrastructure Investments (GCP) 3.0%
Commercial Property
Regional REIT (RGL) 6.5%
Standard Life Property Income (SLI) 6.0%
AEW UK REIT (AEWU) 4.5%
Schroder European Real Estate (SERE) 3.0%
Cash 11.0%
Total 100%
Current stated yield for the portfolio as a whole is 5.5%.
Vanguardfan –
I take your point on the two tracker funds being similar. If I were to choose I think I’d go for the Consensus 85 as the equity/bond allocation is regularly reviewed and changed in-line with the UK Pension fund industry generally.
Malcolm –
I have a similar approach as you in my ISA (FTSE UK All Share + Global Ex-UK + Short term 1-5 Gilt tracker + Cash). Nothing wrong with this.
Just feel I need a bit more of a focus to help generate a regular income and there seems to be a growing interest in IT’s that offer very attractive consistent dividends – even through volatile times.
I’m also attracted by model portfolios which are constantly managed and updated.
This would be a great post to update since so much has changed since it was written.
I second the motion RS…