Think forward to life in your 60s – the next phase of life (note I didn’t say retirement!).
Question: Do you take your bank statement/portfolio value to purchase your groceries?
Answer: No – you bring your income, or cash.
The two critical things you need to ask yourself are:
- is your income enough for your spending needs? and
- is that income increasing throughout time to offset the rising cost of living (or inflation)?
With those as your tests, a fixed income approach (such as interest from a deposit account) may not provide you with much confidence.
I agree with my friend Nick Lincoln, who believes that bank statements should come with a risk warning of their very own – “the true value of your cash has fallen by another 2 per cent or so in the last year. Every year it buys you less. Eventually it will be pretty much worthless. But please do carry on thinking that risk is about short-term ups and downs in the stock market.”
In comparison to the fixed interest approach mentioned above, there is the ‘variable’ interest approach cash dividend from a collection of some of the world’s largest, best run and financed businesses in the form of the S&P 500 – which grew from $12.09 in 1990 to $56.70 in 2020.
That is a compound annual growth rate of 5.8 per cent. The cash dividend grew just under five times in comparison to two times growth for inflation1. And that is not share price growth – this is just the cash dividend! And what I find really interesting is 85 per cent of the companies in the S&P 500 hate cutting their dividend – and, in fact, over the last 60 years have cut theirs ‘substantially’ only a handful of times2 .
The advantage of the variable return approach versus the fixed interest approach could be illustrated by the example below:
Say a 60-year-old couple used assets of circa £1m to secure a fixed income of £60,000 per annum by investing in deposit accounts to cover their current living expenses. Now, let’s say their expenses went up by 3 per cent per annum i.e. inflation. This annual increase would mean they start eating into the £1m pot they started with by age 78 – just to sustain their current lifestyle.
From age 79 onwards they would need to eat into more of that £1m pot, the next year more and so on. The best they can hope for is that they die before they run out of money!3
A million pounds may seem like a lot of money. However, if you compare it to the amount of money you would need to purchase an income equivalent to the current State Pension of £179.60 per week (which is linked to inflation) – it would be circa £210k. A very sobering thought! As ever, past performance is no guarantee for future performance and values of investments can go up as well as down.
Working with a high-quality financial planner to build and stress test a robust financial plan to ensure your money doesn’t run out before you die could be the key to a long and stress-free next phase of life (note I still didn’t say retirement!)
Raj Shah is founder of Blue Wealth Capital and has been shortlisted for Financial Planner of the Year and Investment Adviser of the Year. Raj can be reached at:
Fiona Shah is operations director at Blue Wealth Capital. Fiona can be reached at: firstname.lastname@example.org