Conversations with Kate: Most of our clients are fortunate enough to be able to ride out the rising cost-of-living. But, for those who rely on their assets as their only source of income, it can be worrying.
As prices continue to rise and the cost-of-living crisis starts to bite, some of our clients who rely on their assets for their income have started to feel uneasy. Many do not like taking capital out of their portfolio when the market is weak for fear of eroding their future income. This means rising everyday costs can leave them feeling vulnerable without another revenue stream.
We have been working with individuals and charities in this position over many years to ensure they have the right balance between spending and protecting their portfolios. This gives clients peace of mind while we protect and grow their wealth, both income and capital, after inflation over the long term.
One of my clients, Natasha, recently went through a divorce, with the family assets being divided equally between the parties. When married, she never needed to think about budgeting – her partner’s income covered all of her expenses.
An individual’s personal inflation can be very different to the headline rates.
Now Natasha must suddenly get to grips with all the running expenses of her family home and day-to-day living. She does not want to overspend and have nothing to leave her children. Equally, she is afraid of cutting back too far and making the children face unnecessary lifestyle changes during a difficult time. She is concerned about inflation and rising energy bills, living in an above average sized house. The family is used to having an annual holiday. Can they afford this now?
To offer peace of mind, we gave Natasha some spending guidelines. This was based on the total returns from her portfolio, including both capital gains and income. This can be more tax-efficient than focusing solely on income from dividends and interest, as capital gains are taxed separately and benefit from an additional allowance.
By targeting returns ahead of inflation over the long term, the portfolio holds onto its value in “real” terms even as costs rise. Typically, we find 3-4% per annum is an affordable rate to spend, depending on how each client invests. That means that a client with £5 million invested with us will have £150,000 a year to withdraw before tax. Of course, they can take more but it might erode the value of their assets.
Rather than offering Natasha a blanket snapshot figure, such as 3% per annum, we can smooth out strong and weak markets by taking the average quarterly value of her portfolio over the prior three years to calculate her “income”. We can then pay that figure into Natasha’s accounts as income monthly or quarterly to help her budget her spending and give her income certainty. In time, as Natasha’s portfolio grows her income should also increase as the average value of her portfolio rises.
The importance of smoothing income was highlighted during the pandemic when many companies suddenly cut their dividends to shareholders. Without this, clients who were reliant on dividend income would have been suddenly short on funds. We always recommend that clients maintain a cash buffer of anywhere between one and two years of cash flow to reduce the risk presented by volatile markets.
The importance of smoothing income was highlighted during the pandemic when many companies suddenly cut their dividends to shareholders.
An individual’s personal inflation can be very different to the headline rates. School fees are a good example of this, which have been rising above inflation for many years now. Our cashflow planning is a comfort here, whether you are supporting a child through their school years or giving them a deposit for a house. You need to make sure you have enough money to live off too.
Other ways we support clients like Natasha include ring-fencing money where they have known liabilities, whether it’s a tax bill, they are acquiring another asset such as a house, or giving money to family members. It is equally important that where possible our clients use their tax allowances. In addition to Natasha’s spending plan that uses her income and capital gains tax allowances, we established a stakeholder pension. This helps her to make the most of her pension allowance while planning for later life.
The sophisticated wealth and cashflow planning tools that my wealth planning colleagues use are also invaluable to our clients who are looking to retire and in generational planning.
We see these wealth and cashflow planning tools as our duty of care to our clients who rely on their assets for income. If we understand what their needs and requirements are, we can make sure that we always have that in mind when managing their portfolios.
We weigh up the short-term impact of the rising cost-of-living and the client’s long-term goals. If you have any questions about these topics or your investment portfolio, please contact your portfolio manager.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.
The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.