Retirement income from the Markets. Safety.

by David

If I need all my income from my market dividends in order to live, then am I not very exposed:

1. if the market drops for a long period I starve
2. I can actually lose money completely if companies go end up
3. if I use all the income then after say 10 years my initial capital will still be, say, £1m, which inflation will have reduced by 30% at least. If this £1m were in bricks and mortar then I may not GAIN in buying power, but I will have the same relative capital AND have had the income from rents. This applies even allowing for inflation, management costs, voids, tax, repairs.

I just do not understand the logic of 'Mike - the six figure dividend earner' Would you not be richer, both in income and capital security and growth, with sensibly purchased property, fully managed.?

I cannot get an answer to this conundrum because all you guys out there seem wedded to the markets. You mutter about spreading the risk and reinvesting dividends and over 20 years markets do better than property. Not one site proves this to me.

I regard myself a bear of very little brain, but my cv would suggest that I should easily understand all this.

But I just do not get it. HELP, please and keep it simple.

Thank you so much - I have learnt masses from your site.

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Jan 13, 2019
Retirement Income from markets
by: Mike

Hello David,

Thank you for your message. I enjoyed reading it and you raise some very valid points that are worth exploring in more detail. I also really like your scepticism. It is very important that everyone involved in investing understands the risks and what can go wrong because (unfortunately) stuff will go wrong. It has happened to me and it will happen to every serious investor out there if you do it for long enough. This means it is always good to approach an investment opportunity from a defensive position.

Before I continue. It is important for me to reiterate that I don't know your personal circumstances, I am not a financial advisor, and therefore cannot give you comprehensive advice. All I can do is give you a very general overview of some of my thoughts on retirement income, investment, risk, and other asset classes. Here are some of my thoughts on the points you raise below:

1. if the market drops for a long period I starve

OK - we need to make it clear that the market will drop and sometimes it will drop very severely. The most famous drop in modern history is the DOW JONES dropping by 90% between 1929-32. In the UK, the worst drop in modern history was between 1972-74 when the old FT30 index (the main index before the FTSE 100) dropped by 75%. It is almost certain that if you are investing for a 30-50 year period, you will see some very large falls in equity markets of at least 30%. If I was to guess, I'd say you'd probably see this sort of drop 2-3 times over a 40-50 year period. You MUST always be prepared for this as it can come without warning (like in October 1987).

How do you prepare for this? Well, firstly it is vital that any money you need in the next 5 years (as a minimum) does not end up in the stock market. For short term money, I would not reach for yield. Just stick it in bank accounts. Currently in the UK (Jan 2019), up to £85,000 is protected by the government should a regulated financial firm fail. So for short term money, I'd be putting away up to this amount in financial institutions that are FCA regulated. In the UK, you also have the option of using NSandI savings products that are fully guaranteed by the government.

For longer term money (as I said, at least 5 years but preferably longer) where you are trying to create investment income, then I'd recommend looking at cash generating investments. The two best examples are the stock market and the property market. It is vital, though, that you go for investments that you understand and feel comfortable with. If you feel more comfortable with property and can't stand shares then that is fine...just stick to property. I don't talk about property much but here are some thoughts on it:

Over time, property will probably do ok. Most rental yields in the UK are in the 3-8% range on your capital and clearly you should expect to earn that minus expenses and any void periods. Property prices can certainly move around although are unlikely to be as volatile as share prices. My own view is that property has benefited massively from falling interest rates over the last 25 years. I don't see interest rates falling as much in the next 20 years so I don't think property can do as well as it has in the last 20 years unless there is a lot of wage inflation. Over time, though, property should do ok as you are able to push up the rents you receive at least in line with inflation and this can give you a perfectly reasonable passive income. Property also gives you the ability to borrow more easily than shares (you don't need to borrow on margin) which can elevate your returns. Finally, it is worth noting that in the UK you are (currently) taxed more favourably with shares than property (except your primary residence) plus you can have more day to day hassle with property you manage yourself. If you go for property, just make sure you can service the mortgage payments even if we see interest rates go up significantly in the future.

The other asset class to consider is the stock market. Here you need to decide if you want to do the work on companies or not. There is no problem if you don't as there are now plenty of perfectly good, low cost index trackers that will merely follow the index over time and pay you the income they receive. For example, you could look at something like the Vanguard FTSE 100 tracker (ticker is VUKE). You can also easily buy trackers that follow the S&P 500 in the US and the MSCI world index. Trackers will go up and down in price (sometimes severely) but if you continuously buy them then over a long period of time you should do pretty well and your income should grow. My strong advice would be to stick to trackers of the major indices, do no worry about their day to day price movements, and avoid any levered ETF or anything like that - those can go very wrong!

If you decide to do the work yourself and look for individual companies then we'd recommend high quality companies that are selling at reasonable prices. Clearly our website is dedicated to this but here are some of the things I look for: consistent high returns on equity, consistent cashflow generation, a scalable business with pricing power, a management that has demonstrated commitment to treating owners (shareholders) well, a very solid balance sheet (little or no debt), and a reasonable price based on most valuation measures such as p/e ratio, free cashflow ratio, discounted cashflows, dividend yield etc etc. I would then look to buy them overtime and, if you can, reinvest into these companies. It is important to remember that the market will always go up and down but it will be the underlying performance of these businesses that determines your success as an investor. I cannot give you better advice for market movements than Ben Graham who said this:

"The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizeable declines nor become excited by sizeable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down." The Intelligent Investor

2. I can actually lose money completely if companies go end up

This is of course true. Companies go bust all the time and if you own the shares in them then you could lose 100% of what you invested. This is why we think it is important that if you are to invest yourself that you look for companies with very strong balance sheets that are highly cash generative. This should at least lower the odds of them going bust. You should also look to diversify both the number of shares you have and the type of assets you own to lower this risk. The risk will always be there, though, but that is why equities as a whole generally do better than cash sitting in a bank account. It is more risky (especially in the short run) and you must be aware of that.

3. if I use all the income then after say 10 years my initial capital will still be, say, £1m, which inflation will have reduced by 30% at least. If this £1m were in bricks and mortar then I may not GAIN in buying power, but I will have the same relative capital AND have had the income from rents. This applies even allowing for inflation, management costs, voids, tax, repairs.

You raise a very important point here and that is inflation. That is why it important you think about real (after inflation) returns. Many companies will not protect you from inflation because as inflation goes up, their costs rise and they are unable to maintain their margins. This will reduce their profits and the amount of cash paid to you as a shareholder. The very best businesses should over time protect you from inflation because they will be able to raise their prices at least in line with inflation. This will grow their profits and protect their margins. You also mention that if you spend all your income then you'll lose purchasing power. This is true but remember that most companies do not pay out all their profits in dividends. They only pay out a partial amount in dividends. The rest is then reinvested back in the business. If this money is reinvested well then it should grow the profits of the company which should result in higher future profits and dividends in the future. This is why a company like Unilever is now paying 5x more PER YEAR to my Grandfather than he originally invested some 50 years ago.

Finally, it is worth noting that in some markets (including the UK) property did outperform general equities in the decade from 2000. Over very long periods of time (again at least 20 year periods) equities have usually been the superior asset class although getting comprehensive data is not that easy. Credit Suisse did a study on this last year in their "Global Investment Yearbook 2018".

The reality is that you are best to go through life consistently purchasing cash generating assets at reasonable prices that you expect to pay you a decent and preferably growing income. You will undoubtedly have setbacks but if you keep making sensible choices, stick to what you know and understand, and are aware of all the options, you should do pretty well over an extended period of time.

That was long answer - I'm impressed if you're still reading.



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