An income generating approach in decumulation

Rathbones Income Fund Manager Carl Stick explains how dividend-paying equities can play a key role in supporting retirement income.

Equity income funds can play a key role in effective decumulation plans. That’s because they have the unique ability to balance three critical, but competing, requirements in the run-up to and during retirement: generating sustainable income, maintaining capital growth and managing risk exposure effectively.

The retirement landscape has changed hugely in recent decades. Investors may want or need to extend their working lives. On the other hand, personal circumstances may prevent them from working into older age. Physical and mental health, financial wellbeing, education, training, and experience, where people live, their family situations and dependents, will all impact on hugely complex choices that used to be so simple. And all this complexity is further magnified by the fact that we as individuals and collectively as a nation are generally living longer, just as the working population seems to be shrinking through demographic change. There are no easy answers!

As they move into the decumulation phase, investors face the considerable challenge of funding withdrawals without unduly eroding their capital—a risk that’s heightened by longevity and market downturns. Equity-based income strategies offer several critical benefits, specifically around income, total returns and appropriate levels of risk.

Sustainable yield 

Equity income funds should provide a steady and reliable stream of dividend payments, reducing reliance on capital drawdowns to fund living expenses. This can help preserve the underlying value of investment portfolios, particularly if investors need to make consistent withdrawals throughout their retirements. Open-ended investment funds, offering accumulation as well as income units, can provide the flexibility to switch this income stream on and off as necessary. That flexibility is extra-relevant now that retirement has become less of a cliff-edge event for many and more a fluid and gradual process.

Capital growth

Unlike bonds or cash, equities offer meaningful capital growth potential. That’s crucial for retirees trying to combat inflation and to extend the longevity of their investment portfolios. Equity income strategies, with their inherent focus on value disciplines to secure attractive yields, arguably offer a decent margin of safety that may enhance capital appreciation potential. It’s worth remembering that the biggest contributor to the future returns from any investment will be the price first paid for it. Strict valuation disciplines can, therefore, prove crucial in determining the success of decumulation strategies.

Appropriate risk

Moreover, equity income products, especially those run with a focus on valuation as well as income provision, can offer an attractive risk profile. If retirees expect to live longer, and therefore need their savings to work harder for longer too, they need to consider very carefully what levels of risk it may be appropriate to take. Overly conservative allocations risk inadequate returns, increasing the likelihood that retirees outlive their savings. 

At the same time, the increasing volatility of markets of late means investors should focus on strategies that can protect their retirement income while still allowing for some capital growth. 

The Financial Conduct Authority is looking closely at how our industry helps people in later life and requires all firms offering retirement advice to review their approaches against the findings of its recent Retirement Income Advice Thematic Review. That review identified risk profiling as among the areas where the FCA expects firms to make improvements and raise standards to better meet the needs of customers in decumulation.

As the co-manager of an equity income fund, I firmly believe that retirees may benefit from prioritising income generation through a portfolio of dividend-yielding equities that generates stable and growing income streams. In volatile markets, it’s important to think about jam today rather than the promise of jam tomorrow, without neglecting capital growth. Effective diversification may promote better portfolio stability.

By incorporating equity income strategies into their decumulation plans, retirees may increase the probability of meeting their long-term income needs, while minimising the dangers associated with sizeable drawdowns and capital depletion.

Issued by Rathbones Asset Management Limited