There are a couple of other things that you can do when it comes to investing for longevity, as well as the cashflow ladder.
Use Tax Allowances Where You can
As I mentioned, in order to give your portfolio the very best chance of outlasting you, you will need to have a mind to minimising the tax payable on it. Both ISAs and Pensions are very tax-efficient while the money is in there, so there’s no issues there.
You’ll pay income tax on the way out of a pension of course, so make sure you’re using every scrap of personal allowance available to you if it isn’t being used by other sources. If you have money in an ISA tax isn’t an issue, so there’s nothing to do there.
Any interest you get on cash is tax-free for the first £1,000 a year, or £500 if you’re a higher rate taxpayer. Any dividend income is tax-free for the first £2,000 in any one year. Make sure your money is managed as tax-efficiently as possible within your individual situation.
Spend from Bonds if You Have to
Let’s say you set up the Cashflow Ladder and you’ve got it all planned out nicely, and then for some reason you need to lay your hands on £50,000 that you weren’t expecting. That might be hard to imagine ever happening, but you never know. Worse still, that need arises while markets are down.
In fact, friend of the show JL Collins (absolutely my favourite ever interview episode) recently blogged about selling assets even in the current climate, because he needed to buy a house.
If you do need to do this, the best thinking according to the studies I’ve seen is to take that money from bonds rather than equities. The logic of course is that equities will be the asset class the recovered most strongly when markets turn back North, so you want to hold on to them, whereas bonds will probably have been shielded from the worst of the market declines, so selling out of those won’t be so damaging.
Not all bonds are created equal of course, so I imagine that if you can, you’d want this to be from Government bonds rather than corporate or high-yield bonds, which can also be vulnerable in market declines.
If you have built your own portfolio of tracker funds in each asset class, it’s easy to just sell down bonds. But if you’re in an off-the-shelf, multi-asset fund, you won’t be able to separate out your bond holdings; you’ll just have to sell shares in your multi-asset fund, and in so doing will sell down some equities as well.
But you can fix this by understanding what your equity/bond mix was before the sale, and then adjusting for the fact that you will have had to sell down some equity allocation by rebalancing, and maybe adding a pure equity tracker fund to compensate.
For example, let’s say you have £200,000 in an exactly 50:50 equity:bond split. You have to sell down £50k. What’s left is still 50:50 of course, but if you had been able to sell out of bonds, you would have been left with £100k of equities and £50k of bonds, which would have been a 66:34 split.
In order to arrive at that split, you would need to work out how much to switch from your 50:50 multi-asset fund into an equity tracker to recreate the 66:34 split. The answer in this case is about £48,000.
Of course, that means that you’re now in a much riskier portfolio than you might otherwise be comfortable with, so you may just accept the fact that fate has dictated that you sell out of your multi-asset fund when you’d really rather not, take a deep sigh and move on, or you can do something about it, and maybe adjust accordingly.
Work one Year at a Time
When you’re spending from capital you need to work one year at a time, reviewing progress and being intentional about your moves. You can do this in one short-ish session once a year, then just keep half an eye on things in between times. At review, you need to be asking:
- How was spending last year? More or less than I thought?
- What do I need to spend next year?
- How is the portfolio placed right now?
- Should I rebalance things to move money down the ladder? Or do I wait, if the current markets are very volatile?
The benefit of leaving two years’ worth of money in cash is that hopefully you should be able to see out any market dips, although that’s theory rather than practice. Think these things through, make the decisions you need to make, execute the portfolio changes and you’re done.
Take an Adult Approach to Spending
Finally, part of that review process will be taking an adult approach to spending. If your portfolio has taken a battering, maybe you’ll need to rein in your spending next year a bit. That isn’t the end of the world; it’s the adult thing to do.
Maybe you’d hoped to make a big purchase next year, but you can see now that in order to do that, you might have to ravage your portfolio at a time when you really don’t want to do that, so weigh up the two. Can you just wait a while to make your big purchase or going on that big holiday, and in so doing give your portfolio a chance to recover? That’s the adult thing to do.
I’m always encouraged that the skills and disciplines that get people into the position where they can afford to retire, don’t desert them when they finally get there. If you can make adjustments to spend less while the market is down, notwithstanding the two years’ in cash etc, then that will serve you very well.
OK, now we'll explore how you can optimise your retirement.
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