My wife’s grandmother has a spare £100,000 that she wants to earn some income from to supplement her state pension. She has no private pension and is fed up with terrible savings rates.
She does have more cash savings that will be kept separate, but she wants to get this money working harder, earning at least 3-to-5 per cent a year.
However, she does not have any investing experience and whilst she knows some exposure to the stock market will be necessary, capital preservation is paramount.
Nice little earner: How to invest £100,000 safely in order to earn a regular income?
This is Money says: One orthodox avenue is for your grandmother-in-law to consult with an independent financial adviser, who can appraise her overall financial circumstances and recommend how she can place her money to achieve her objectives.
But this will obviously involve costs that will reduce any return made from the portfolio.
We asked three experts from the investing world to give their suggestions, while we have a bonus idea that is presented at the end.
Sam Pitts-Tucker, Senior Client Adviser at Netwealth: Assuming the reader’s grandmother-in-law is in good health and at an age where she can expect to live for another 10 to 20 years, this provides a sufficient timeframe to consider investing to help her meet her goals.
Generally, the longer the investment time horizon, the greater the capacity to take risk. However, understanding her risk tolerance will also be fundamental as it is not just about capacity for risk but a willingness to take it too. That said, it is important to emphasise that all investments carry some degree of risk.
Given she wants exposure to the stock markets while ensuring capital preservation, she may want to consider a balanced portfolio with a moderate risk level, comprised of half equity and half bonds.
A balanced portfolio should strike the right tone if she is willing to accept periods of negative performance in order to strive for higher total returns from a combination of income and capital growth.
This should help generate her desired income, whilst protecting against the effects of inflation over time.
If she were to achieve average returns of approximately 3.3 per cent per annum over the next 20 years, she could draw an income of £200 per month inflated by 2 per cent each year whilst still maintaining her £100,000 of capital.
Importantly, in order to generate average annual returns of 3.3 per cent, she should be prepared to accept that in any given year her investment pot could fall in value, while in the long run she can expect overall positive returns.
She should also consider the impact of taxes on her net returns, utilising both her capital gains allowance and personal allowance for income.
It would make sense for her to think about moving £20,000 a year into Isas to minimise the impact of tax, a process that can be automated by an adviser like Netwealth.
Many investing platforms offer ready-made portfolios to fit savers’ objectives and levels of risk aversion. This is how several ‘medium-risk’ portfolios at some of the major online platforms have performed over the last three years.
Jason Hollands, managing director at online investment service Bestinvest: These are incredibly tough times for income seekers. Interest rates on cash savings are an all-time low, UK gilts – bonds issued by the UK Government – are yielding a paltry 0.27 per cent (less than inflation which last month climbed to 0.6 per cent) and many UK listed companies slashed their dividend pay-outs last year due to the uncertainty created by the pandemic.
While the worst is likely over for dividend cuts, with some previous cutters already recommencing pay-outs, it will take a few years for UK dividends overall to return to the levels last seen in 2019.
The most important message is therefore that in this extremely low-yield environment, there is no easy answer to achieving an income of 3 to 5 per cent without taking a degree of risk.
However, I note that your reader states that ‘capital preservation is paramount’ for their grandmother-in-law’s savings. Even very cautious investment funds carry the risk of capital losses alongside potential gains over particular periods in time, for example in the event of a sharp fall in the markets.
For those who can take a medium to longer-term view, of at least five years, these are risks that can be worth taking as there will be time to recover from short-term dips, such as those seen last March.
However if your reader’s relative might need access to this cash at short notice and cannot tolerate the potential for a dip in value without causing them worry, then it may be better to draw on the cash to supplement her pension income instead, particularly if she is very elderly.
If some risk can be tolerated and her cash can be committed in expectation that the capital won’t be need for a reasonable period of time i.e. five years, then an income-generating investment fund with a high emphasis on trying to preserve capital that might be considered is the Ninety One Diversified Income fund.
How he Ninety One Diversified Income fund has performed in the last five years.
This invests in a mixture of asset classes including shares, corporate bonds, government bonds, infrastructure and property and it also techniques known as ‘hedging’ to try and limit risk. Currently the fund has 17 per cent exposure to equities (shares), the most volatile assets class, after the effect of hedging.
The overall approaches seeks to provide a far less erratic approach than a typical investment fund while aiming for a target return of 4 per cent per year through both income and growth, with the focus on the former.
The current yield on the fund – the level of income paid-out – is 3.88 per cent, but it is important to realise that this isn’t fixed.
The fund can be held in a Stocks & Shares Isa so that distributions are not subject to dividend tax.
Adrian Lowcock, head of personal investing at investing platform Willis Owen: To get a decent income from her savings she will have to accept some level of risk and invest in shares and bonds. The higher the income required the higher the risk she would need to take.
However this can be reduced by diversifying investments and increasing exposure to less risky assets. A higher exposure to bond funds, which are typically less volatile than equities would help.
For an investment of £100,000 I would typically suggest a portfolio of 10–20 funds. Here I suggest some representative funds to illustrate.
Having 70 per cent in bonds is suitable for a cautious investor and I would suggest the Janus Henderson Strategic Bond which yields around 3 per cent. The managers John Pattullo and Jenna Barnard are an experienced team who can invest anywhere in the bond market but have a focus on valuations.
How the Janus Henderson Strategic Bond fund has performed over the last five years.
This could be complemented by the Royal London Corporate Bond fund which invests in the lower risk end of the bond market, but the team will also look for opportunities in unrated bonds to boost the income generate.
They manage the risk by conducting detailed research. The fund yields 3.36 per cent.
How the Royal London Corporate Bond fund has performed over the last five years.
Equities also form an important part of any income portfolio. They offer the ability to grow income over time, which is important given that inflation means prices are generally rising. Many dividends were cut in the UK in 2020 but we believe that is more of a reset and dividends will recovery over the coming years.
The Trojan fund, managed by Francis Brooke has a capital preservation philosophy and looks to invest in companies which can produce a steady long term income and some capital growth. The yield is 3.5 per cent.
The UK is not the only place to generate an income and it is important to diversify any equity exposure to other markets which offer access to different economies and cultures. The Fidelity Global Dividend yields 3.18 per cent and is managed by Dan Roberts.
The focus on companies with stable finances and strong cashflow will help underpin the reliability of dividends. The fund has 31 per cent invested in North America and 15 per cent in Asia. Whilst the yields on equity income are low, these could recover and grow as economies come out of the pandemic and things return to normal.
This is Money adds: A cheap and easy option would be to look at some of the ready made portfolios offered by passive funds provider Vanguard. Their popular LifeStrategy funds offer a variety of combinations of exposure to government and corporate bonds and equities.
The most conservative option is the 20 per cent equity fund that devotes 80 per cent to bonds. It returned 7.5 per cent in 2020, 9.9 per cent in 2019, lost 1.1 per cent of its value in 2018, and returned 10.4 and 4.4 per cent in 2016 and 2017 respectively.
How Vanguard’s 20% equity LifeStrategy fund has performed in each of the last five years.
While this past performance does not rule out the fund suffering losses in the coming years, it suggests it holds up well in a variety of circumstances. The fund fee is 0.22 per cent plus there are account charges, but these are low by industry standards.
She can set up a regular withdrawal to provide an ‘income’, for which there is no charge. Vanguard do not have many specifically ‘income-orientated’ options, preferring a focus on total returns.
‘This means that [investors] can have a more diversified portfolio and hence manage risk better,’ they say.
‘Capital can be sold in order to top up income to bring it to that 3 per cent or 5 per cent as required. With a capital gains tax allowance of £12,300 and capital gains tax rates being lower than income tax rates, this also means investors’ money goes further,’ they add.
Your relative will have to think about tax: only £20,000 can go into an Isa each year so the other £80,000 would have to go into a general account, and any income from this would have to be declared on top of her state pension.
Her tax-free allowance is probably £12,500 a year.
How a lump sum put into Vanguard’s 20% equity LifeStrategy fund five years ago would have performed.
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