Guaranteeing an income for the period of one’s life we used to call retirement is now ‘astronomically’ expensive. Not my word, but that of a speaker from Legal & General at a roadshow I recently attended.
The L&G speaker ran through some worked examples of how much you would have to save in order to buy an annuity giving you two thirds of your final salary. As someone who is trying not to think of himself as middle-aged, but finding that increasingly difficult, I found this pretty terrifying.
As I listened, the prospect of that round-the-world cruise seemed to float off into the sunset.
The speaker’s conclusion was that for many of us, an annuity will no longer be how we finance our retirement. That conclusion carries more weight when you consider it is coming from a company that sells annuities.
In the rush to cook up and promote new products to solve this retirement income quandary, there is a danger that one established product will be overlooked. Investment companies have been around for nearly 150 years, and a good number of them have provided unbroken runs of income growth for multi-decade periods.@Image-95174136-094d-43a8-a8f4-597a6b033c28@
I wish I could say this was purely down to the skill and wisdom of those in the investment company industry. But in reality, it is also thanks to the ability of investment companies to reserve up to 15 per cent of the income made in any one year to pay out in future. Judicious use of this ‘revenue reserve’ has enabled UK and global investment companies such as City of London, Bankers, Foreign & Colonial and Witan to grow dividends for more than 40 years in a row, never once holding or cutting them, through all sorts of upheavals and varying market environments.
Typically, these ‘dividend heroes’ have enough reserves to pay out income for around one year, even if they received no income at all from their portfolio. That could cushion the blow of the dividend cuts many fear from FTSE titans. With UK payout ratios looking stretched, the dividend heroes are poised to draw on their reserves and defend their hard-won records.
Investment companies have a few other tricks up their sleeve when it comes to income. They can pay dividends out of capital profits, enabling non income-generating asset classes such as private equity to provide a dividend stream. They can also invest in a far wider range of income-producing assets than an open-ended investment company or unit trust could.
Take infrastructure, for example. Though there are open-ended infrastructure funds, they cannot invest directly in infrastructure projects, which are too illiquid. But infrastructure investment companies can directly access the stream of government-backed, inflation-linked payments from a contract to operate a road, bridge, school or hospital. If you are looking for income that is not correlated to equity markets, this fits the bill. The track record here is much shorter, admittedly, than those of the dividend heroes. But in the 10 years the asset class has been around, income has been very stable.