You’ve spent 40 years saving and investing towards your retirement. You’ve got pretty good at putting together and maintaining an investment portfolio, and you've reviewed everything. That’ll just carry on into retirement, right? Well, not necessarily.
Investing in retirement requires quite a lot more nuance than when you’re going all-out for growth. Why is this the case? Well, now you’re most likely drawing down form your portfolio and so you’re looking for a balance of growth and downside protection in order to make sure you avoid the worst possible outcome: outliving your money.
Pound Cost Averaging can Work Against You in Decumulation
Most wealth builders know and understand the principle of pound cost averaging. This is where you’re paying into an investment regularly, buying shares in whatever you’re investing into at different prices each month.
When prices are low, you buy more shares for you fixed monthly contribution. When prices rise again, you’ll buy fewer shares, but the ones you bought more cheaply will have risen. Overall this has the effect of smoothing the ups and downs in the share price over time.
But now you’re thinking about doing the opposite, not buying in but selling out of your investments each month, or at least you could be. We’re going to be talking about NOT doing this in a later post.
One could argue that this has a similar smoothing effect, just in reverse, and it does. But the issue with it is that you really don’t want to be selling out of investments when they’re down, even if only a month at a time.
Every share sold to cover income needs while markets are down, is a share which cannot recover when markets rise again, and so the impact on your overall portfolio is magnified. You may have heard this called pound cost ravaging, which is an appropriately violent-sounding word to describe what’s going on.
The impact can be profound if a) you’re drawing out a large amount expressed as a percentage of the whole portfolio and b) the downturn is prolonged. We’ve all heard about the so-called 4% rule, which is actually a rule of thumb, not a hard-and-fast rule.
Well, let’s say you have a portfolio with a value of £100,000 and you’re taking out 4%, which is £4,000. Now let’s say there’s a market decline of 35%, much like the one we’re currently experiencing and your £100,000 investment pot becomes £65,000.
£4,000 income as a percentage of £65k is a 6.2% withdrawal rate, which is punchy to say the least. 16 years and the money’s gone, not 25. If you’re dependent on having that £4,000 to maintain a basic standard of living, and if the markets stay low for a year or three, you’re in trouble.
Managing Costs is More Important Than Ever
Remember also that ANYTHING being taken from your portfolio is potentially having the same effect, and that includes tax and costs. Pensions, of course, are taxable, so there’s not a whole lot you can do there.
You may be able to use personal allowances to take some of a pension tax free, depending on your other sources of income. 20% tax is better than 40% tax, of course, so avoiding higher rate income tax makes sense.
Platform costs, drawdown review costs, fund management charges and advisers’ charges are all taking a chunk out of your portfolio, so make sure you’re getting value at each level and try to keep those costs as low as you can. Common sense really, but especially important once you’re drawing down from your accumulated wealth, rather than adding to it.
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