‘Bonkers’. What a wonderful British word. The first citation in the Oxford English Dictionary is from a 1945 Daily Mirror article: “If we do that often enough, we won’t lose contact with things and we won’t go ‘bonkers’.” Three years later, Eric Partridge included it in A Dictionary of Forces’ Slang: “Bonkers, light in the head; slightly drunk. (Navy.) Perhaps from bonk, a blow or punch on the bonce or head.”
This article tells you about an investment strategy that is totally bonkers, and one that is a lot more sane.
‘Natural yield’ means not drawing on your capital or selling fund units. Writing in the Telegraph, Sam Brodbeck describes it like this:
“The idea is to ignore the fluctuating capital value of a portfolio and only take the natural yield. An original £100,000 investment might dip to £80,000 or rise to £120,000 in terms of value, but investors should resist the urge to touch the capital.”
Relying on natural yield makes your portfolio much more risky and restricts your income. It’s a bit like investing in property that makes you brick-rich not cash-rich, because the only return you can spend is income.
Abraham Okusanya of research consultancy FinalytiQ calls it a “totally bonkers retirement strategy,” and draws out these four points:
- Dividend and bond yields fluctuate significantly, meaning that your income will change year on year, and making it impossible to budget
- Once adjusted for inflation, natural income yield is highly unlikely to meet your spending pattern (unless you’re extremely wealthy and rely on other sources of steady income)
- Even if yields appear stable in percentage terms, the income received in £ terms will still be calculated in relation to the outstanding capital, which invariably fluctuates over the retirement period
- Proponents of a natural yield retirement strategy focus on recent percentage yield of the FTSE 100 or FTSE All Share and have offered little empirical evidence to back their theory. Most retirees are more likely to have a portfolio consisting solely of bonds and shares, and it’s crucial that any retirement income strategy works over a long period and under various market conditions
Regardless of retirement date, a retiree relying only on natural income experiences unacceptable levels of fluctuation in their income from year to year, as shown in his yoyo graph:
By contrast, the ‘total return’ approach we use here at Tucana ignores the difference between capital growth and dividends, and seeks to draw income from both in a sustainable way.
Ankul Daga of Vanguard Europe says: “Maintaining a given number of fund units is not equivalent to maintaining capital value. In many instances, it may even be the opposite. Put plainly, the higher the yield, the more the capital is likely to be at risk.”
There are four main advantages to a total return approach:
- Portfolio diversification: A portfolio constructed for total return can maintain broader diversification and avoid unnecessary risks
- Control of withdrawals: Investors make an active decision to take capital as income or opt to delay withdrawals by simply doing nothing
- Tax efficiency: A total return approach will generally be more tax efficient for most UK taxpayers
- Portfolio longevity: The above three points combine to help maintain the portfolio’s value
You can find out more about total return investing in last year’s article: Please don’t punch the puppy
For a final word on the matter, let’s ask Dizzee Rascal.