Generating an income from large lump sum

BLB53

- is the likely 4% return gross or net after charges have been deducted ( I never know whether yield figures are gross or net)

You should easily manage a starting yield of 4% net

>The better option is investment trusts as they have more flexibility and dividend payments are much smoother.

Investment trusts (not unit trusts) do not have to distribute all the income but can and often do hold back up to 15% of dividends in any one year and build up a reserve to be paid out in years when dividend income is not so good. OEICs are not allowed to do this.

Another difference is that OEICs usually have higher charges to cover commission paid to intermediaries like IFAs. A typical annual charge would be 1.5%. ITs do not pay commission and annual charges are typically 0.5% - 0.8%.

gadgetmind

BLB53 wrote: »

You should easily manage a starting yield of 4% net

I agree, but that's different to my sustainable 4%. That 4% is what you can take (in real terms, so index linked) from a portfolio of about 80% equities and 20% bonds for a multi-decade period without a significant risk of running out of funds. This has been back-tested over all multi-decade periods in the past, including the great depression.

What we need to know is -
1) What percentage drawdown the OP needs pre state pension.
2) What they need afterwards.

Given this data, backtesting can be done using various portfolios to see what works - why take more risk than you need to?

Firecalc is a great tool for this "what if" but you need to know what you're trying to achieve.

A starting yield is great, but many ITs have *not* raised dividends in line with RPI, and even a three year reserve can't bring the worst of times.

phuket

Ideally at the moment I need to generate an income of about 5% of the capital sum so it seems this may be achievable.

TCA

Interesting thread. Like the OP I also have a lump sum - mine is currently invested in a mix of fixed rate bonds (up to 5 years, averaging about 4.6% p.a). I'm not UK resident but a UK citizen, so still entitled to a personal allowance - my income from this lump sum almost equating to that amount, so is effectively tax-free. Although not reliant on that income, I would however like to maximise it and see this becoming increasingly more difficult as good fixed rates disappear. I cannot invest in ISAs or get tax breaks from pension contributions any more, so investment trusts look like an interesting option, as I would still get a capital gains tax allowance.

My lump sum will most likely form part of my final pension fund. I'm 43 now with a small pension fund but have some small lump sums coming to me in the next few years, so should be able to invest more. Although I have a small local income which I get by on, it's not guaranteed to last, so ITs might be a useful way of building a pension fund and producing an income at the same time. It was never my intention to hold cash long term as I appreciate has been said on here many times.

Would a decent lump sum invested in a mix of half a dozen or more ITs (as mentioned above), be sufficient in their own right to produce an annual income and a final lump sum with good growth (for ultimately a pension purchase) or would it be necessary to use other financial instruments for investment? I would always keep a stash of cash, but other than that?

BLB53

Would a decent lump sum invested in a mix of half a dozen or more ITs (as mentioned above), be sufficient in their own right to produce an annual income and a final lump sum with good growth (for ultimately a pension purchase) or would it be necessary to use other financial instruments for investment?

Many ITs have been around for many years and have a good track record of rising income year in year out. I think for City of London this is the 45th year of increase.

I will be moving my pension sipp into drawdown this year and will be using the ITs mentioned above as the basis for generating the annual drawdown. The 25% tax free lump sum will be going into this years isa and again invested in a number of ITs to generate more income.

For a more detailed overview of generating income from ITs I would recommend 'Slow & Steady Steps..'
http://www.amazon.co.uk/Slow-Steady-Steps-Wealth-ebook/dp/B007EBLN3G/ref=sr_1_3?s=digital-text&ie=UTF8&qid=1337794869&sr=1-3
With annuity rates being at rock bottom, I think this method is a reasonable alternative.

Rollinghome

TCA wrote: »

Would a decent lump sum invested in a mix of half a dozen or more ITs (as mentioned above), be sufficient in their own right to produce an annual income and a final lump sum with good growth (for ultimately a pension purchase) or would it be necessary to use other financial instruments for investment? I would always keep a stash of cash, but other than that?

The answer is that no one knows for sure: just smile politely at anyone who pretends otherwise.

We're in very unusual times and no one knows what the long-term effects will be or how long the uncertainty will last. The Nikkei crashed from 40,000 over 20 years ago and has never recovered. It's still at just 8,500 today, less than a quarter or it's former value.

People like to say that "over the long-term" etc which of course is nonsense: if you can't predict over the short term, be it the weather or financial markets, then long term predictions are inevitably still less reliable. The best approach is to accept that markets are unpredictable and position yourself accordingly.

What you can be sure of is that any investment will go up and down in value. You can reduce the effect of that by spreading your money across assets that are as uncorrelated as possible: so that when one asset goes down in value that's balanced by another.

Here is the chart for F&C, the oldest and one of the biggest ITs, started 1800 and something, and has given a return that's about average for the Global Growth IT sector. Click maximum to give you the data back to 1999.

As you can see it's been a bumpy ride but is still up 42% over that time which looks reasonable even when inflation of about 38% for the period is taken into account. It yields about 2.5%.

Obviously, it's total return, what you get in divis and what happens to your capital that counts. It's easy enough to get a high income if you disregard the erosion of your capital.

Tick FTSE100 to compare that and you'll see that's down 15% over same period though with a slightly higher yield. Quite how either will do over the next 10 years brings us back to the difficulty of long-term predictions.

jamesd

phuket wrote: »

Ideally at the moment I need to generate an income of about 5% of the capital sum so it seems this may be achievable.

Yes, that should be fine and you can reasonably expect to do that and increase with at least moderate levels of inflation for the rest of your life, without doing more than very gradual depletion of the capital that won't cause you to run out. It will take the investment use but this isn't anything unusual for an IFA to help with.

jamesd

TCA wrote: »

Would a decent lump sum invested in a mix of half a dozen or more ITs (as mentioned above), be sufficient in their own right to produce an annual income and a final lump sum with good growth (for ultimately a pension purchase)

Yes, bit there will be variation along the way.

Take a look at this post, particularly the Equity Gilt Study PDF illustrations that it refers to.

There's never a guarantee with investing but you can in general rely on it given enough time and by spreading your money around.

Rollinghome

jamesd wrote: »

Take a look at this post, particularly the Equity Gilt Study PDF illustrations that it refers to.

Always remembering to treat the sales material of banks, including Barclays, with an appropriate degree of wariness. See also http://www.investorschronicle.co.uk/...

jamesd

That's one of the most respected studies of long term investment returns publications on the planet.

That Investor's Chronicle story is somewhat funny:

1. Those who buy shares directly are assumed to be more skillful at market timing than those who buy funds, for example, so he arbitrarily deducts 2.2% from the returns of those who use funds and 1.3% from those buying shreds directly.

2. He's completely wrong about survivorship bias in an index if you're using an index tracker fund - dropping the ones that grow more slowly or shrink or are newly added should help the performance. But he's right about long term direct shareholding.

3. He's paying 2.5% in trading commissions on shares? Those must be pretty small trades or a _really_ expensive broker!

4. Stamp duty? Maybe he knows that in most of the world there is no stamp duty to pay.

5. 0.5% initial charge for funds? Nope, not going to be paid, it's been largely eliminated by competitive providers.

6. TER, yes, can be lower if bought without trail commission though, about 0.5 to 0.75% lower.

He's essentially taken more than 3% from returns just by assuming that people are buying inefficiently and at the wrong times and mainly in the UK and another 1% by outright error in his assumptions about how survivorship bias on companies in an index works.

That does tell me I don't want him giving me any financial advice.