Taking an Income from Pension Drawdown
by George Hatjoullis
This blog is written as a direct response to a rather simplistic article in the Daily Telegraph, 10/11/2014, (http://bit.ly/1zGyDhY) entitled Invest £100,000 in shares and take an annual income. How long till you’re bust? The premise is that because markets can fall one will experience the dual of averaging-in, namely averaging-out, and thus run out of money. This is so simplistic as to be barely worth commenting on but as it has appeared in the DT some comment may be helpful to the hapless pensioner.
The key assumption of the Daily Telegraph article that when you start drawing income you are fully invested. No adviser worth her salt would suggest this starting position. Assume you have £100k and want an income of £5k per annum. A very cautious strategy would be to put £25k in cash and invest £75k. You do not need to touch the share portion for 5 years. Assume now that your equity investment grows by an average 4.6% p.a. over the 5 year period. At the end of the 5 year period you will have £100k again and have met your income target irrespective of the path of the stock market. The assumption of 4.6% average growth is not unreasonable if one notes that the average dividend yield on UK equities is well over 3%. Moreover even if you are unlucky enough to have started your pension at the peak and there is a bear market at once (typically 18 months years from peak to trough and three years from peak to peak), you are likely to have seen some growth after 5 years. You might even re-invest some of the cash during the bear market trough. After 5 years you simply repeat the exercise.
The above example illustrates that it is quite hard to run out of cash if you follow a sensible policy.Of course, you have to be sensible about the income you draw. This rather depends upon how risky is the chosen investment strategy. As a rule, and assuming 5 years of income in cash, the ‘natural yield’ plus expected average real capital growth is the most one should take. If you choose to take more than this then capital erosion is likely. However, this has nothing to do with averaging-out.