Spend the income not the capital: the Perpetual Annuity
Heather Mostert, Head of Marketing at Marriott, shares some ideas with retired investors.
Living annuities have been a popular retirement investment since their launch in the late 1980s. What separates living annuities from other retirement products is their ability to survive the investor and hence form part of the retiree’s estate. Despite the many advantages of living annuities, they continue to receive bad press: investors can easily get caught in a downward spiral if they draw an income that erodes their investment capital. When you look closely at the reasons for the failure of many of these products they often point to the same thing: the investor’s objectives (income in retirement) are not aligned with the fund manager’s objectives (long term capital growth).
- Few investors are aware of how much income their portfolio is producing, consequently they don’t (or can’t) match their income requirements to the amount of income produced.
- Even when an investor does try to match income withdrawals to the income produced, this proves challenging as the income produced generally fluctuates: a consistent income stream is seldom the objective of the asset manager.
Given these shortfalls, Marriott created a unique product in the industry, the Perpetual Annuity, a product that aligns the investor’s income needs with the asset manager’s objective: to produce a consistent, reliable income stream which enables an investor to budget from month to month without ever having to erode capital to fund income needs.
The concept is simple enough - spend the income, not the capital - and reminds us of the old fable ‘don’t kill the goose that lays the golden egg’. If you spend more than you earn, you will erode your capital (unit base) and ultimately erode your income. When it comes to investing, particularly in retirement when capital preservation is paramount, this age-old wisdom should be brought to mind.
Marriott has two suggestions for retired investors:
1. Match the income withdrawn with the income produced:
Investors should draw no more than the income produced by the underlying fund - should they wish to draw more, it would be with the knowledge that they are now eroding capital. With this in mind, Marriott funds are managed with an income focus – to produce a certain amount of income and income growth.
This investment style is in stark contrast to conventional living annuities where the investments are invariably managed with a capital growth objective, where an investor determines the level of income required with no reference to how much income the investment is producing. The basis that investment growth would offset the income withdrawals works while market values increase and the erosion of the capital base is masked by the market’s rise. When markets decline, however, the value of the investment can decrease sharply due to the twin effects of an eroded capital base and decreasing unit values.
2. Seek a consistent income stream:
Research has shown that the more consistent the income produced by the fund, the less the threat of capital erosion.
This can best be explained by way of example:
(Click on image to enlarge)
The charts show two funds: an Income Fund (typically used within a living annuity to cater for a client’s income requirements) which produced the highest income in its category in South Africa over the last five years, and the Perpetual Annuities ‘High Income Fund’. In both cases, a similar level of income (R2300 per quarter) was drawn by an investor over five years. What can be seen with the Income fund is that there are periods where the income produced declined, forcing the investor to erode capital to supplement the income. The Perpetual Annuities ‘High Income Fund’ provided a consistent income stream. This enabled the investor to re-invest excess income produced which contributed towards capital growth. Similar findings are achieved when comparing the highest income producing funds in the Money Market, Bond and Varied Specialist categories.
Marriott’s determination to produce high, consistent income streams whilst providing investors with long term capital growth has meant that investors can now have more certainty in retirement rather than living in the hope that the markets will keep running!
