Watch what you withdraw from your portfolio

Instructions for regular withdrawals from unit trust portfolios are probably most often given by retirees and widowed persons, as they require regular income payments. Regular withdrawals also make sense in other instances, such as enabling parents to provide regular payments to their children studying at university.

Unit trust-linked life annuities, which have become popular in recent years, are one such type of investment vehicle enabling a withdrawal plan. These life annuities enable one to withdraw a specific amount from a unit trust portfolio at regular intervals, for example monthly, quarterly or annually.

Although convenient, regular withdrawals pose a risk. If the withdrawal rate exceeds the portfolio’s growth rate, the investment could be depleted during one’s lifetime – especially in an equity bear market. It is thus important to do a few projections to estimate how long your capital will last under various assumptions and with annual withdrawals.

The success or failure of a withdrawal plan depends on several factors:

· The size of your nest egg. The more you have in your investment portfolio from which you are drawing, the better.

· Your annual withdrawal percentage. The less you withdraw every year, the better. Keep your withdrawal amount as low as possible to prevent your capital from being depleted too soon.

· The expected ‘real’ return on your unit trust portfolio. This is equal to the projected nominal return on your portfolio less the expected inflation rate. It is essential to take inflation into account in your analysis.

· The withdrawal frequency.

If you intend withdrawing money from your unit trust portfolio faster than it will grow, you need to consider how long your capital will last. Say you invest R1million in a balanced unit trust portfolio with an expected return of 10% per annum. You decide to withdraw 10% per annum and also want to adjust your withdrawals for inflation by increasing them by 5% annually. Initially you will withdraw R100000, the next year R105000 (R100000 x 1,05) and so forth, as shown in Table1.

The year-on-year analysis shows your original capital will last only 13 years. In the 14^th year you will not be able to meet your need, having only R5703 at your disposal. Table 2 shows the same for this and several other scenarios.

In the second table, look at the line for 5% annual return. This is a real return, determined by taking the fund’s nominal return of 10% per annum less the projected inflation rate of 5% per annum. Move to the 10,5% column, which shows the annual withdrawal rate. The figure where it crosses the 5% line is the number of years that your capital will last. In this case it is 13.

To make your money last longer, you will either have to withdraw less or try to earn a higher return. This can be done by switching to a portfolio consisting mainly of equity unit trusts that have the potential to provide a higher return.

If you reduce your initial withdrawal rate from 10,5% to 8,5%, for instance, the 2 percentage points reduction would make your money last for 17 years. If you are satisfied with a withdrawal rate of 4,5% while earning a real return of 5% (10% nominal less 5% inflation), your capital would last for an unlimited period of time.

Table 2 can also help you to determine an appropriate withdrawal rate, based on how long you would like your capital to last. If your nest egg has to endure for at least 20 years, during which time you expect inflation of 5% per annum, how much can you withdraw? If you expect your unit trust portfolio to generate at least 7% per annum in real terms, you could withdraw up to 8,5% annually. In this case your capital should last for 21 years. However, it would be better to withdraw less to provide for lower than expected returns.

Substantial volatility in the annual return on a unit trust will significantly affect a withdrawal programme and withdrawal rate. Withdrawing money after your portfolio has suffered a major setback can obviously cause problems and be a severe blow to your pocket and your nerves.

So, if you are following a withdrawal programme with retirement capital (for example from a unit trust-linked life annuity) and you have little other investment capital that can generate additional income if things go wrong, consider a more moderate or even conservative balanced fund. With these funds, the price movements are less volatile. Also adjust your withdrawal rate accordingly, as the lower the risk, the lower the expected return.

Your projections for any withdrawal plan should be adjustable and, in the case of retirement planning, your situation should be reviewed at least annually. Based on the figures in Table 2, revise your estimate of how long your capital could last. Keep your withdrawals conservative to allow your remaining balance to grow as much as possible.

The decision to sell is often more difficult than the initial decision to buy. It is complex, as several factors are involved, including emotions. Withdrawing from funds often and then buying again is not a good strategy. Those who do so usually do not fare as well as individuals who are disciplined and patient. Have a well-considered investment plan that you follow consistently over the years. By sticking to it you are less likely to be affected by short-term market movements.

If withdrawal plans are constructed and monitored properly, they could be an effective way for retirees to sell a small portion of their nest egg systematically every year. The biggest risk you need to guard against is that you might outlive your assets. So be conservative when you decide on your withdrawal rate.

Source: Plexus Asset Management

Source: Plexus Asset Management