Weigh up the options to boost retirement income

Retirees in need of income are increasingly turning to non-cash assets including bonds and equities and with inflation set to remain above the base rate well into next year, that’s unlikely to change for some time,

Many newly-retired people have kept their pensions invested in the hope of making up losses incurred during the downturn. However, recent market volatility, which has seen billions wiped off share values, has served as a timely reminder of the risks of investing in the markets.

If you have no other funds to fall back on, taking money out of your savings and turning to potential loss-making investments is extremely risky. If you do have other sources of income and a decent sum to invest, it can make sense, however, depending on your needs, circumstances and appetite for risk.

But the rules of investing in retirement are a little different to saving for retirement. You are unable to plan around a long-term investment horizon over which volatility can be smoothed out and your goals are more likely to be capital preservation, an income stream and the ability to pass any remaining funds on death without a hefty inheritance tax bill.

Ken Taylor, director of Mackenzie Taylor Wealth Management, said: “Most of us will be able to ascertain our income requirement for the next year and place that amount in a cash account. However, the rest of the capital will not be required to produce income for at least a year, which immediately changes the time horizon and allows investors to embrace a degree of investment risk.”

So how can you make a success of investing in retirement? Diversification – spreading your money across different asset classes – is the key. A diversified portfolio is usually comprised of at least equities, corporate and government bonds, property, commodities and cash.

Yet despite their potential value in minimising risks and paying income corporate bonds are being overlooked by many investors, Taylor claimed.

“Returns have outstripped those of the best equity funds over the past three and five years, and have done so with less risk to capital,” he argued. “In the past few weeks alone, when equity markets have been incredibly volatile, these funds have continued to make progress.”

Decent corporate bond funds provide income of about 4 per cent and have a good track record of preserving capital, said Taylor, who recommends the corporate bond and strategic bond funds run by M&G.

Collective funds are also the best bet when it comes to equities. Retired investors are most likely to gravitate towards funds providing income, such as those in the UK equity income sector, or investment trusts in the growth and income or high income sectors.

Most pay income of between 3 and 5.5 per cent a year, generally below that on bonds but with greater potential for capital growth. Historically, UK investors have taken their income from UK-focused funds, although global income funds are increasingly popular. While they may be less risky than shares, however, equity funds still carry the risk of heavy losses and if that prospect is likely to cause a few sleepless nights, then you should think very carefully before diving in.

John Moore, director at IFA Central Investment, said: “If it is yield that you’re seeking, then the risk of capital loss from equities and corporate bonds may be perfectly acceptable provided that you’re confident that the current yields are sustainable.

“There are dangers that corporate bonds could suffer a capital loss if interest rates rise, but this is likely to happen in conjunction with an improving economy and higher inflation, which is likely to be a good environment for equities – as a result, a blended approach is likely to manage risk more effectively.”

The potential for incurring greater losses when investing in equities means independent advice is highly recommended. As Taylor pointed out, investors diving into equities without understanding what is involved are more likely to get their fingers burnt.

“The FTSE 100 index is down around 10 per cent over the past five years, so buying the index via a tracker fund will have disappointed. Even selecting individual funds will have taken a degree of judgment and timing, but might well have produced a more favourable result,” he said.

Tom Munro, owner of Tom Munro Financial Solutions in Falkirk, believes multi-manager funds are especially appropriate for retired investors.

“The chosen fund management team offer a range of risk graded portfolios including those overweight in the fixed income sector, which will generally suit retirees looking for a regular tax efficient income stream and the prospect of some capital appreciation,” he said.

For example, at the height of the credit crunch in 2008, the 7IM Moderately Cautious fund fell by just 2.3 per cent, Munro pointed out. “The portfolio contains around 35 carefully selected ‘sub funds’ from some of the UK’s leading investment groups and is reviewed and realigned automatically every quarter by the company’s 14-strong investment committee,” he explained.

There is another option if you’re looking for a better income stream, in the form of structured products. These are usually market-linked plans that aim to pass on some stock market growth while promising the return of the original capital at the end of the term.

For example, Gilliat is launching a five-year income product that pays out 6.75 per cent a year, provided the FTSE 100 remains above 3,000.

But while the capital is very unlikely to be at risk, these products are subject to counter-party risk (the solvency of the institution providing the ultimate guarantee).

Moore said: “We would only recommend such a product as part of an overall diversified portfolio. By the same token, if Royal Bank of Scotland [the counter-party for the Gilliat product] were to fail, then this is likely to be in conjunction with a systemic failure of the global banking system so it is perhaps fair to say we would have more pressing problems to deal with in such a scenario.”

If investing in riskier assets than cash keeps you awake at night, however, or if any losses would threaten your financial security, then deposit-based saving remains the sensible option.

l Visit www.unbiased.co.uk to track down an IFA near you.