I read a great article recently from US Financial Adviser Michael Lynch where he talks about how people spend more time worrying about the fluctuations of their investments rather than the income generated from them.
As he rightly points out, we live on income, not capital. The money we have in investments and pensions is there to provide us with an income in retirement. This income might come from the natural interest or dividends produced from our returns or it may come from capital withdrawals. Either way we need money from our savings and investments to spend.
So I thought I would explore what happens if we focus on income generated by portfolios rather than the capital fluctuations. What’s surprising is that if you look at it this way, cash savings are actually extremely risky.
Income from cash savings
Let’s go back to January 1988. The bank base rate at the time was 8.4%. Move forward a few months and by October 1988 the bank base rate was 14.9%.
So at this point, if you had £100,000 in cash you could have been generating £14,900 per year income. Probably a bit more if you consider actual savings rates are usually a bit higher than the bank base rate.
The bank base rate has not been higher than the October 1988 peak since.
In 2007 the bank base rate was still at 5.5% meaning more than £5,500 per year income on your £100,000 in savings.
But then we all know what happened next.
The great financial crises and a global pandemic have well and truly left interest rates on the floor having now been below 1% for over 10 years.
Today the base rate is at 0.10% meaning your income on a £100,000 savings is just £100 per year.
Let’s look at this in terms of income returns. In 2007 you were receiving £5,500 per year and now £100 per year. That’s a 98% loss of income in 14 years which is half the average length of retirement. Worst, it’s been a permanent loss since 2009 with interest rates barely moving.
Your capital that you thought couldn’t fluctuate in a bank account is now going down and down permanently as you take more withdrawals from capital to maintain your original income.
Income from investing
When you invest your money in the stock market (the great companies of the world) you earn a return over time through capital appreciation (through increases in share prices) and also via dividends paid out by these companies.
Since 1988 dividends released by companies who make up the UK stock market (FTSE All Share Index) have usually hovered between 2% and 4%. So your income from a £100,000 investment has stayed around £2,000 to £4,000 per year, over the period income from cash has crashed to £100 per year.
Now of course a £100,000 investment will have fluctuated during this time. So what would have happened to capital?
From 1988 to 2021 you would have earned a 322.15% return on capital appreciation alone by investing in the FTSE All Share.
That means your capital of £100,000 would have grown to £322,150.
So which has seen the most volatility when looking at income? Cash or investing?
As Michael Lynch says in his article, “if stocks ever approached the volatility of interest rates, investors would run for the hills.”
Here at RTS Financial Planning we specialise in retirement planning for professionals, executives, senior managers and directors who are financially well off and earning a good salary. This will be your first retirement, but for us, we have done it over 100 times. So please get in touch for a no obligation, free 15-minute conversation so we can help you understand where you stand and what you need to do next.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
