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Warning on drawing investments' natural yield

Warning on drawing investments' natural yield

Royal London is warning the old mantra of not touching capital in retirement is no longer suited in today’s economic environment.

Instead of living purely off the natural yield from their investments, pensioners should be reinvesting dividends, coupons and interest payments back into their fund and generate an income by selling units of capital each year to live off, research from the pension provider suggested.

The analysis found that due to the current low return environment, chasing a natural yield “almost inevitably involves taking a large risk with capital”.

Low interest rates result in very few asset classes delivering 5 per cent returns, which people used to set as the benchmark withdrawal rate to be able to live on the income from their savings.

The Bank of England left interest rates unchanged at 0.5 per cent in its last Monetary Policy Committee meeting in May.

A recent paper from the central bank concluded that low interest rates and the quantitative easing benefited the incomes of the young more than the old, by making borrowing cheaper but hitting interest rates on savings.

Those seeking an adequate level of natural yield are now driven towards more exotic high yield investments like peer to peer lending and aircraft leasing, the provider said.

This, it warned, will also leave individuals with a poorly diversified portfolio which exposes them to considerable volatility during periods of market stress.

But going to the other extreme of being ultra-cautious in retirement will generate very poor levels of retirement income.

This is due especially to low interest rates and increasing longevity, and could increase the likelihood of the pension pot running dry too soon.

The provider’s solution for savers to get the right level of risk is to invest across a range of asset classes that generate both income and capital growth.

Multi-asset investing is more diversified and therefore reduces volatility, and seeking both income and capital growth opens up a much wider range of potential investments, it added.

According to Trevor Greetham, head of multi-asset at Royal London Asset Management, “the strategy of hoping to generate enough income in retirement from the natural yield on investments may have worked before the financial crisis, but is highly risky in today’s low interest rate environment”.

He said: “Savers need to realise that chasing after high yielding investments today can involve investing in an unhealthily narrow range of assets that could suffer large capital losses as interest rates rise.

“Our research shows that it is possible to have a good standard of living in retirement by investing across a risk-controlled mix of assets, targeting both income and capital growth.

“Investment conditions today are a world apart from those before the financial crash, and retirement investment strategies need to change accordingly.”

Alistair Cunningham, financial planning director at Wingate Financial Planning, argued that he has run a total return strategy for over a decade as he doesn't "believe those drawing down from their pensions and investments should focus on income only".