We will be posting regular comments from Brian Tora, who is a respected writer and broadcaster on investment issues. He is a consultant to our investment partner, JM Finn & Co. Brian has enjoyed a long and distinguished career in the City. Any opinions are his own and should not be construed as advice from JM Finn & Co or Brunel Capital Partners Ltd.
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Benjamin Graham once famously said that “The investors chief problem and even his own worst enemy is likely to be himself.”
Graham was a British born American economist and professional investor who sadly died in 1976. Warren Buffett described him as the second most influential person in his life after his own father.
In part one, we highlighted that retirement is an income problem. In part two, we will discuss how this can be achieved.
For the purposes of this article, there are really only two kind of investments from which you can choose: fixed income investments, and rising-income investments. Without stating the obvious, the more fixed-income you hold in a world where costs keep rising, the greater your chances of running out of money. Whereas the more rising-income investments you hold, the greater your chance of keeping pace.
Fixed-income investments, such as money market funds, bonds, gilts and fixed annuities have always been thought of as being “safe”. Your view on this will depend on your view on the correct definition of risk. Is it losing your money or running out of money? A rising income most reliably
comes from the constantly rising dividends of the great companies in the UK and the world. In other words, EQUITIES.
Since 1984 (almost 30 years – the average length of a couples retirement) the FTSE all share has risen from 1108 and currently stands at 5699, a rise of 514%. In that period, there have been single year declines of -10.5% (1985), -12.5% (1990), -11% (1994), -14.7% (2001), -23.4% (2002) and more recently -30.9% in 2008. (Source – FT)
When you finally accept and embrace the idea of defining true safety in terms of the preservation (and even accretion) of purchasing power in retirement, you see that equities are much safer than bonds. There has never been a 30 yearrolling period where equities have produced a negative return, even if you ignore dividends. That’s the real tragedy of today’s so called risk- averse retiree: not that he’s going to be killed fighting the wrong dragon, but that he is going to be killed fighting a dragon that doesn’t exist.
We are often approached by new clients who have accumulated substantial amounts of money over their lifetimes and are about to make the single biggest, scariest financial decision of their lives. It also involves the largest sum of money they will ever have to move. They are about to retire and turn their capital sum in to an income. In that first meeting, we are often asked for our current market outlook.
Our answer is always “Our market outlook, well we must have one I suppose, and it must be around here somewhere. I confess, I don’t pay much attention to market opinions-ours or anyone else’s -because it’s essentially irrelevant to do what we do. But you’re certainly entitled to know what our outlook is and I will go and find it. Before I do that though, may I ask you a question of my own, that I think may be even more important?
As you sit here today, looking out at the balance of your lives – of both of your lives – are you highly confident that your income will always be enough to sustain your lifestyle? Or have you become concerned that at some point during your retirement you might actually start to run out of money?”
Any discussions about market and economic outlooks can therefore be deferred until this huge issue has been addressed.
Financially speaking, retirement is an income problem. You would think this would be intuitive, but a lot of people we deal with start off thinking it’s a capital problem. You don’t ask on any given day, “Do I have enough capital to fill up the car, do the weekly shop or go out to dinner?”
The fundamental challenge to income throughout retirement, which on average is 30 years, is erosion of purchasing power. In simple terms this means that every year, everything you need to buy will cost more. At a 3% annual increase in consumer prices, it’s going to take £2.45 in the 30th year of retirement to buy exactly what £1.00 buys today.
Therefore, the only rational goal of a retirement portfolio is to produce an income that rises through the years at more or less the rate that your cost of living. Only that way can your income keep pace with your expenses. And only that way can you expect to continue to purchase dignity and independence in retirement.
In part two, we will talk about how this can be achieved.