Although the market crash has left soon-to-be retirees with less of a nest egg, it has created an opportunity to boost your retirement income.
Mike Ronald, of Marriott Income Specialists, says Marriott is approaching the market with caution but some asset classes now offer better income opportunities. “Yields have increased and there may be some interesting opportunities,” he says.
Ronald says the dividend yield on equities — about 4%, with some equities as high at 6% — is above the long-term average. If dividend yields increase further, retirees looking for income could add equities to their income portfolio.
Bonds are not as attractive as they have been historically, with yields under 10%, says Ronald. This is because of a shortage of bonds in the market, but this should be short-lived as government and parastatals are expected to issue bonds to finance infrastructure plans.
When buying for income in a living annuity do not be confused about total return, which includes capital gain. In the case of bonds, when yields rise, the capital value falls. If you buy when yields are lower you run the risk of capital loss when the they rise again and you are locked into the lower yields.
Ronald says listed property yields are marginally more attractive at about 10%, but Marriott would prefer to see the yields closer to 12%.
He believes there could be further weakness from property and equities, but it is dangerous to sit in cash for too long as it is not an inflation hedge. Ronald advises income-seeking investors to start moving out of cash and, gradually, into the markets.
“If you can find an investment where prices have bottomed out, add it to your portfolio because it gives you a higher-than-average income stream with the opportunity of a rerating when the company yield normalises. But buy companies that produce reliable income.”
Both property and equities offer protection against inflation. Rentals tend to increase with inflation and dividends increase more than inflation over time, whereas a money market fund will be determined by interest rate movements, which can go down. Economists expect the next interest rate move to be downwards, which would reduce interest income from a money market fund.
When buying for income it is important not to get caught up in potential capital gains and to focus on yield.
If your capital goes up 40% it does not mean your income will. By the same measure, if the price falls 40% it does not mean your income has fallen. But buying above average yield usually results in capital gains as a higher yield means you are buying your investment for less, so the potential for capital gain is higher.
Focus on income in a living annuity
Investors run into difficulties with traditionally managed living annuities when the market experiences a severe correction. Mike Ronald, of Marriott Income Specialists, says this is because traditional living annuities draw down on capital rather than income to produce an income flow during the months when income is not earned. When markets fall, the investor has to sell more units to receive the same income.
A traditional product invested in unit trusts would sell off units every month to provide the income. Any interest or dividend income generated in these investments would be used to replenish the units. This creates timing issues in volatile markets. You may be selling units when the market is down, eroding your capital base, but buying units when the market has recovered. You may also find that the income you earn is not equal to the capital you have drawn. Eventually your capital declines with the ability of that capital to generate an income.
Ronald says investors should rather match their income needs to the income generated from the investment and have only the income paid out rather than selling units.
“Sometimes sights are set too high and the investment’s underlying income is too low,” says Ronald, who adds that this results in the slow erosion of capital. This may work when markets rise and each unit is worth more, but when your investment falls by 20%, it can give you a pretty big shock.
In retirement the movements in capital value are irrelevant; it is the consistency of the income that is critical and which will preserve your capital.
Ronald recommends that income-seeking investors invest in high-income assets that will consistently produce an income which will keep up with inflation. Money markets are one of the worst investments for long-term income as they move with interest rates and cannot produce consistent income.
You may need to be more realistic about how much income you need to live on and rather cut back today so that you do not run out of funds in 10 years’ time.