Ironically, living longer is presenting a problem. Do clients have enough money to fund a potentially very long retirement? Nick Samouilhan, multi-asset manager at Aviva Investors, considers one approach.
Life expectancy has risen dramatically over the years – and, while this can only be seen as a good thing, it does bring a problem with it. Namely that planning for retirement has got a tad more complicated. Someone who wants to give up work at 65 might be faced with having to plan the funding for a further 25 years of life. And that, in turn, may well need to include a contingency for full-time care – never mind the question of leaving a legacy for those who follow after.
The chief focus has to turn to capital preservation, for two main reasons. Income is equal to yield x capital, so capital falls will impact on income in the pocket. What’s more, if capital is eroded by more than the income you have taken out then you would have been better off putting the cash under the bed and withdrawing from the pile each day. It used to be that retirees could rely on bonds or gilts to keep the gremlins away; but these days, with fixed-interest products and cash struggling to hold their own against rising prices, there needs to be a new way of thinking.
So, for many, the new priority is to achieve a balance between keeping the capital pile reasonably intact while at the same time providing a healthy income for what might be a very long haul.
The Natural Income Theory
Natural income means paying out income from the income generated on your investments, as opposed to paying out the capital to clients as income. That’s quite a different approach from the more usual way, in which you draw down capital in order to maintain a level income when times get tough.
So the capital sum is sacrosanct and is left to grow within the usual market forces. And because you’re avoiding capital withdrawals, the fund does not have the added pressure of having to grow. Most managers are not looking to grow the capital sum per se. What concerns them most of all is to look for sufficient capital growth to offset the deduction of fees. Of course, to the extent that it does not erode the capital, it does maintain the integrity of the income stream on which investors depend.
Natural income funds are ideally suited for retirees, as they should ideally generate higher levels of income but preserve the capital sum. That, at least, is the theory. The downside, of course, is that clients need to bear in mind that income levels do fluctuate – as, indeed, can the capital level. What’s more, income funds may take charges from the capital, so this needs to be factored into the equation.
It will be clear that the income from a natural fund will probably be smaller than from a fund that depletes capital – but this can be particularly useful (and tax-efficient) when the yield is regarded as a supplement to state or defined benefits.
The rights and wrongs of a particular choice are of course dependent on a person’s individual circumstances. But one thing’s for sure – the phrase natural income is going to become an increasingly important part of the financial vocabulary in future years.