Interest rates and bond yields are still close to historic lows while dividend cover looks stretched. So is this the right time for clients to draw on capital?
‘It’s harder for people who are looking after their own investments to take a fire and forget approach,’ said Jeannie Boyle, director at London-based EQ Investors. ‘This would involve just sitting on capital and taking the income.’
Following years of quantitative easing, Boyle said many people expect a bear market in bonds. As such, income investors could be exposed to a downside risk in bonds that is ‘higher than normal’.
Helen Lindo, director of Nottingham-based advice firm Russell Ulyatt, added inflation is starting to rise faster than natural income from many investments. ‘One form of natural income could be cash in the bank and you’d be lucky to get 2% on it,’ she said. ‘But the consumer prices index is currently 3% and the retail price index is 4%. Consequently, money left in a bank is losing buying power.’
Should advisers be more willing to cash in investments for clients’ income needs? Boyle said: ‘Today you have to look beyond the traditional way of investing in capital and living on the income. We need to have more regular reviews of clients and make sure they are taking profit in addition to the regular yield.’
There are also tax advantages to taking profit from investments. Boyle pointed out £11,000 of tax-free withdrawals are available every year through capital gains tax (CGT) allowance.
Indeed the dividend allowance will, in April, be cut from £5,000 to £2,000, ‘which will have an effect on people living off dividends,’ she said.
Meanwhile Lindo agreed a natural income approach can lead to clients paying more tax than necessary. ‘If you take a natural income from an investment and don’t reinvest it, it’s harder to control the taxation,’ she said. ‘And with the yield on various investments fluctuating, it’s not always easy to match natural income with income requirements.’
In addition to the CGT allowance, Lindo uses ISA allowances. But she also uses the personal allowance for pension income and/or bond income.
Even so, Lindo said she currently tries to avoid income units and income funds, ‘due to such low yields and, therefore, unreliable yields’. She said: ‘Buying the whole of the global market gives investors a good long-term return. However, we have a bias towards small cap and value using Dimensional funds.’
Lindo pointed out the importance of considering people’s overall financial planning needs, rather than just their income requirements. ‘And through cashflow planning we aim to ensure any investments today add real value in the future,’ she said.
Sarah Elson, director of Leeds-based advice firm Berry & Oak, uses cashflow planning for all clients. She said: ‘We deal more with ad hoc inflows rather than regular income.’
Elson said she often runs three pots for clients. The first pot is cash, which is ‘held for one or two-year requirements’. The second pot is low-risk investments, for a two-to-five-year time horizon. And the third pot is generally medium to high-risk investments, for a time horizon of more than five years, although this depends on the age and timescales of the clients. Elson said the three pots are topped up ‘as necessary’.
She added: ‘The fact yields or interest rates are lower today is neither here nor there, because we are looking for inflows driven by cashflow planning.’