The accumulation and decumulation phases of retirement investing can be accomplished using the same portfolio and the same investment strategy. All you have to do is switch from reinvesting dividends to drawing them as retirement income.
I’ve been covering the accumulation phase for a long time with the UKVI Defensive Value Model Portfolio.
That portfolio started with a virtual pot of £50,000, an amount which I think is a reasonable starting point for running a widely diversified portfolio of individual stocks. The goal of the portfolio is, as you might expect, to build a retirement pot through capital growth and dividend reinvestment.
Now it’s time to start applying the investment strategy and tools that I use to run the accumulation portfolio to an income portfolio. I want to get some feedback, improve the strategy if required, and hopefully demonstrate that the strategy and tools work for income as well as accumulation portfolios.
Moving from dividend accumulation to dividend income
In practical terms, there’s very little difference between what you need to do to run an accumulation portfolio compared to an income portfolio. The only differences as far as I’m concerned are:
- Keep the equivalent of about one year’s dividend in the portfolio as a cash buffer. At the moment that means a cash buffer of around 4%.
- Drawdown any dividend income from your shares rather than reinvesting them.
The important bit is the cash buffer as it allows a progressive dividend income to be drawn, even if your portfolio’s shares pay out slightly less in dividends in one year than the year before.
If you have a sense of deja vu about this article it’s because I started an income portfolio back in October 2013, but that portfolio had a starting value of just £50,000, which is far too little if the dividends are to cover a fairly normal level of living expenses. And so I’ve decided to start again, but this time with…
A half-million-pound retirement portfolio
This new income portfolio has a starting value of £500,000, which I think is a reasonable, minimum size where the dividend income is intended to provide all of an investor’s income.
At £500,000 a 4% dividend yield would provide £20,000 in cash. Assuming the portfolio is in an ISA (and therefore no income tax is paid) then I think that’s a reasonable minimum income. Of course, if you can build a one or two-million pound portfolio then all the better.
The portfolio has a start date of 1st March 2011 and replicates the trades from the existing accumulation portfolio. This means that the income portfolio has held the same shares, bought and sold on the same dates, at the same prices, as the existing model portfolio (so past holdings include companies like Mears and Aviva, while current holdings include Shell and Vodafone). The only difference is that the income portfolio and its position sizes are about 10 times larger.
An equity income benchmark
The existing accumulation portfolio is benchmarked against the FTSE All-Share as that’s a good zero-effort alternative.
However, the income portfolio exists to produce a progressive dividend, which the All-Share doesn’t provide, so I think a better benchmark would be a group of progressive dividend-paying investment trusts.
These are also likely to be very similar to the income model portfolio in terms of size and type of company, i.e. predominantly large-cap dividend growth stocks.
Fortunately, there are quite a few of these trusts to choose from and so I settled on a basket of five. These are:
- Temple Bar Investment Trust
- The City of London Investment Trust
- The Merchants Trust
- Alliance Trust
- Foreign & Colonial Investment Trust
The benchmark portfolio is split evenly between these investments; so that’s about 20% each. The benchmark also has a starting value of £500,000 and a start date of 1st March 2011. The initial investments on that date have been recorded using the share price of each trust at that date.
This benchmark represents a zero-effort portfolio which I would expect to pay a progressive dividend income that grows at least in line with inflation over the longer term.
Dividend income so far
So, with about three years behind these income portfolios, what sort of dividends have they paid? Are they progressive, and are they beating inflation? Let’s take a look:
| Date | Investment Trust Portfolio | Annual Increase | UKVI Income Portfolio | Annual Increase |
| 01/03/11 | £500,000 | £500,000 | ||
| 06/04/12 | £502,418 | 0.50% | £478,251 | -4.30% |
| 06/04/13 | £578,778 | 15.20% | £519,658 | 8.70% |
| 06/04/14 | £644,500 | 11.40% | £604,076 | 16.20% |
In this very short period of time, you can see that an investor who went with the investment trusts has at least received a progressive income in the first three years. This is exactly the feature that makes investment trusts so interesting to those who are in draw-down mode.
However, the growth rate has barely kept up with inflation (CPI or RPI).
The UKVI income portfolio on the other hand has grown its payout slightly more quickly and slightly above inflation. Its income in 2011/12 and 2012/13 was deliberately set to equal the income from the investment trust benchmark but, thereafter, will increase by as much as possible, within the confines of it being both sustainable and progressive.
Of course, three years is a very short period of time in which to compare two income portfolios. Hopefully, after five or ten years any differences between the incomes generated will be more pronounced, but at least the ball is now rolling.
Capital growth without dividends being reinvested
The beauty of an equity income strategy, as opposed to say a fixed income strategy, is that both the income and the capital should maintain their value in real terms over the long-term. Again, three years is a very short period, but let’s have a quick look anyway to see how the capital side of things are going so far.
| Date | Investment Trust Portfolio | Annual Increase | UKVI Income Portfolio | Annual Increase |
| 01/03/11 | £500,000 | £500,000 | ||
| 06/04/12 | £502,418 | 0.50% | £478,251 | -4.30% |
| 06/04/13 | £578,778 | 15.20% | £519,658 | 8.70% |
| 06/04/14 | £644,500 | 11.40% | £604,076 | 16.20% |
As you can see the capital values of both portfolios have grown far ahead of inflation, but the value of the UKVI income portfolio is slightly behind the investment trust benchmark. Of course, I have a long list of excuses to explain this, with the main one being a significantly higher cash balance in the UKVI income portfolio which you can see below:
| Date | Investment Trust Portfolio Cash | UKVI Income Portfolio Cash |
| 06/04/2012 | 0.01% | 29.40% |
| 06/04/2013 | 0.01% | 18.50% |
| 06/04/2014 | 0.01% | 7.60% |
This excess cash position is a consequence of a gradual allocation of cash into the UKVI portfolio’s 30 holdings, whereas the investment trust portfolio was fully invested from day one. However, the UKVI portfolio is now more or less fully invested with cash at just 7.6%. It will always hold a small but important cash buffer of something like 3-5%, and so the negative impact of excess cash going forward should be all but eliminated.
Active investing in retirement
I realise that living off the dividends of an actively invested portfolio is not that common. Most people want to relax in retirement and any nest egg they’ve built up is typically handed off to a fund manager of one sort or another, even if the capital was built through active stock picking.
Personally, I enjoy reading about companies and digging through the numbers, so I see no reason why I should ever let someone else manage my capital (and if Warren Buffett is anything to go by, active investing in old age is a pretty good way to keep your grey matter fit and strong too).
Fortunately, an equity income strategy is well suited to both the accumulation and draw-down phases, and I look forward to using the same strategy for both.
Note: Is £500K realistic for most people? Assuming a £50K starting point as per my existing accumulation model portfolio, it would have to double 3.3 times. Assuming a growth rate between 7.2% (doubling approximately every 10 years) and 14.4% (doubling every 5 years) and no additional saving, that would take between 16.5 and 33 years which is well within most people’s investment lifetime.
Interesting article as usual. My comment is only about the last point, regarding whether £500k is realistic for most people.
Given your growth profile (which you may or may not argue is possibly slightly optimistic over the long term), then yes it’s definitely possible to get from £50k to £500k by retirement, given 20-30 years to grow the portfolio. But you haven’t factored in the effect of inflation on the value of that £500k.
In your article, you’re looking at the £500k from an angle of “If I retired today with £500k, I could draw down a progressive annual income of around £20k, which is (possibly) enough money to live on today (and due to progression, in future)”.
But starting on £20k per annum in 20-30 years from now, it is not going to look anything near so rosy.
So I understand your points around progressive income, but the implication that all you need is a £50k starting balance and 20-30 years for the portfolio to grow in order to retire on an income that will comfortably cover your expenses is not true, unless you can grow your portfolio a long way better than inflation.
If you look at the pension (or superannuation) arrangements in Australia, they are very focused around this issue – what do I do over the 30 odd years of my career to build up enough nest egg such that the income from my nest egg can comfortably cover my living expenses in retirement.
The solution to that problem involves at least 10% of a person’s annual income being invested across the entire working life, not starting with a large lump of cash and relying solely on growth. Allowing for the difference between success of the investor can explain some of the difference, but unless you are far ahead of inflation, the extra contributions (or lack of) make a huge difference.
It’s also interesting that even with this approach in Australia, retirement is still not easy for many. From news articles I’ve seen in the UK, talking about pensioners being happy once they have £15k per year of income, I think Britain has a long way to go in raising its expectations of how much capital, contributions and retirement income are needed to be “safe” and “comfortable”.
Hi Bob, yes I thought I might have been opening a can of worms with that last paragraph.
You are completely right that the last paragraph is effectively wrong and perhaps slightly (unintentionally) misleading. I’ll briefly cover some of your points, but I don’t want to dwell on this for too long:
I didn’t factor in inflation because the example was so unrealistic anyway (any implication that it was some sort of plan to follow was completely unintended), but yes, you’d need 9-16% growth rates rather than 7-14% to have the equivalent spending power of a £500k portfolio in 15-30 years.
Those growth rates are less realistic, although 9% is reasonable I think so the 30 year period still stands.
Of course it’s a rubbish example anyway, but it wasn’t intended to be an example; it was just a simple (perhaps too simple) way to link up my two portfolios – A £50k accumulation portfolio and a £500k income portfolio, sort of like the two ends of an investment lifetime (conveniently skipping out the zero to £50k bit).
In the real world people do keep saving, and 10% a year for a working lifetime is as sensible approach as any.
As for the £15k ‘happy’ threshold, I think that’s too high. My parents get along fine on about £20k between the two of them (£15k of which is the state pension). Taking a week to paint a picture can give more pleasure than a cruise around the Mediterranean, and one is considerably cheaper than the other. An unfortunate side-effect of capitalism is that it drives people to consume for please rather than create for pleasure, and consuming is typically much more expensive than creating.
There was also a good article recently with lots of comments over on the Monevator website about sensible drawdown rates:
http://monevator.com/weekend-reading-can-you-withdraw-as-much-from-your-pension-as-you-plan-to/
I think this kind of thing is a good exercise even though it has its faults. Investment isn’t an exact science, there is a good deal of ‘luck’ involved and all manner of things happen over 30 years. I would look at a different portfolio of ITs, City is good for income but the others could do better. Have a look at Lowland, Bankers and Murray International. They have good records of dividend growth, there are plenty more, check out the AICs website.
ITs are the cornerstone of my portfolio, but for serious divi growth individual shares are the way to go, you could do a lot worse than buying the top ten holdings of a good performing income IT.
Hi Dylan, I think I’d agree with pretty much everything you’ve said there. As for the exact ITs I’ve picked, they’re just a representative group of high yield/lower risk trusts, they’re not supposed to be “the best” or anything, if it was even possible to pick out “the best” in advance.
Personally I like trusts because there is less pressure on the investment manager to perform in the short-term (or avoid underperforming in the short-term) in order to stop (short-sighted) investors from pulling out. They can just get on with the job of managing the funds as best they can. Although of course I’d still rather invest directly in the underlying companies…
Looking forward to this year’s update on this.
Cheers