James Sumpter: In our bespoke portfolios, we generally look for investments with higher yields. Dividend investing for retirement makes a lot of sense.
For example, you should be able to generate 2.5-3% in a dividend yield from a retirement portfolio and then have to withdraw less of your capital to live off, which preserves the value of your investments. Investing in high quality companies with secure dividends - which tend to fall more slowly than share price in a downturn - really helped out our clients in the 2008-9 crash. That's the benefit of dividend investing for retirement.
What many of my clients decided to do was tighten their belts and live only on the dividends - which were a little higher back then than 2.5-3% - and not touch their capital investments. If they had a cash reserve, it proved extremely helpful. Let's say one of my clients had a retirement plan to take 3% income from dividends and 1% from selling shares, in those bad years, he or she could simply have chosen to take the 1% from cash and therefore not reduce their capital investments until such time as the capital value of their investments had recovered.
That was certainly an effective strategy. What you have to be a bit careful of, though, is investing entirely for yield and not getting the growth in capital value which you need to keep pace with inflation. You can certainly go too far - buying only investments which offer yield and no growth doesn't make sensible dividend investing for retirement - there's a balance to be struck. If, for example you invested only in companies that promised a consistent 5% yield but offered no or negative growth, you'd miss out on some of the companies which are going to quadruple in value.
William John: How do you deal with your clients' emotions when things don't go as expected with their retirement plans - for example when the market crashes just before or just after they retire?
James Sumpter: Well it is quite difficult because you never quite know how each person is going to react until something unpredictable happens. When we start representing a new client we have them take a psychometric test to find out what their attitude to risk is. This gives us an indication of whether the new client is more or less risk averse than the average. This gives us some indication of whether you would cope well emotionally with the downside, should the market tumble and we would alter the exposure to the stock market accordingly.
What we really don't want to do is offer clients investment strategies which are more risky than they would feel comfortable with. There is certainly a benefit to having a greater exposure to the stock market - but there is also the risk of timing when it comes to retirement. That said, you really don't know entirely how someone will react until something life-changing happens. For example, if you had invested in 2010, it's only in 2018 that you had a considerably negative year. An extended long run of good times really does make people forget what the downturns feel like.
We have to do a lot of work with clients when there is a fall to say "Don't panic!" We go back to the cashflow and we re-evaluate where we are and where the values are.
We almost always have to persuade clients not to change their investment strategy, because selling is the worst thing to do at that point. Clients typically call us when the markets are going up, saying they want to take more risk and when markets fall they call us again and tell us to sell everything, which of course is the polar opposite of what you want to do. That's where we have to earn our money really.
In 2009 after the big falls of 2008, we were desperately trying to tell people that this was the time to take more risk. Back then you could buy corporate bonds that were yielding 7% from companies that had the cashflow to comfortably pay that for 25 years. These were literally the bargain of the century, but of course that's hard to persuade yourself to invest you're reading the financial pages telling you that it's armageddon in the markets with Lehman brothers going out of business and GDP down 5% in a year. For most retired clients, though, it's sensible for them to stay on a safe strategy for the whole of their retirement. For them the message is: "Keep cool, you will be fine, just don't look at the valuation of your portfolio too much!"
William John: Final question: What have you learned for your own retirement plan?
James Sumpter: Probably that I've got to continue to strive to earn more money! That's a message that I always have to pass on to my clients as well really - you can budget and save only so much. If you don't have high enough inputs, then you'll have a lower income in retirement - it's pretty much as straightforward as that. There's no way you can reliably get a 7% return from investments when everyone else is getting a 4% return.
The other thing is to understand the tax rates that retired people pay. For example, a retired person withdrawing £50,000 a year from their pension in the UK only pays around £7,000 in tax - around 15% and pays no national insurance contributions.
Once you understand that, you can see the value of taking advantage of tax breaks where they're available on contributions to your pension during your working life. Using your pensions allowance is crucial. In the UK the government is likely in my view to close the window on tax-free pensions contributions soon and if you're working in the private sector you have an opportunity to maximise your pensions contributions now, so even if you have to take money from somewhere else, I believe it's worth doing.
The government is capping pension contributions and it's very likely in my view that they will soon end higher-rate tax relief on pensions contributions in some way in the near future, so if you're in your 30s or 40s, this may be your last opportunity to take advantage of valuable tax relief especially if your employer boosts your contributions in one way or another, so I would even consider taking money out of an ISA and putting it into a pension just to get the tax relief and see the benefit of compounding on the extra amount you will have saved in tax, even though you have to pay tax on it when you withdraw. If you run the maths on putting untaxed income directly into a pension, rather than paying higher rate taxes and then investing the net sum into an ISA, you're better off with the pension, but you've got to be aware of the liquidity issue - you can't get your hands on any of that money once it's in a pension at all.
William John: Fantastic advice, James. Thanks so much.