If you are getting close to retirement, you may have started to think about how you should invest when you have actually retired and need to be drawing an income from your investment pot.
The traditional advice is to dial down the risk and switch to bonds and cash savings, but there is a problem with that. Over the past couple of decades, we’ve seen the collapse of interest rates for cash savings accounts and government-backed bonds, known as gilts.
A changing financial landscape
The situation really is quite grim for those traditional safe-as-houses-type investments. Average gilt yields, for example, have plunged from around 5.6% in 1998 to just below 1.3% last year. And it’s been a similar story with Cash ISA interest rates. Flowing from that, annuity rates have also recently hit an all-time low. Indeed, it really does seem that today’s retirees need to think in different ways compared with previous generations.
And one major consideration is the extended life expectancy we enjoy these days. Because of that, there’s a need to keep your pension pot growing so that it lasts as long as you are likely to. I think there’s a good case for investing in retirement in the same way that you probably invested while building your investment pot, and for me, that means targeting shares backed by good-quality businesses.
The dividend yields available from many shares on the stock market run much higher than gilt yields and cash interest rates — 3%, 4% and 5%-plus are not uncommon from shares. But in retirement you may be tempted to target the highest yields you can find so that you can withdraw the dividend income to live on. I’d caution against that approach because the highest dividend yields can often occur because of problems in the underlying business.
If there is a problem, you will be at risk of falling share prices and dividend cuts down the line. Instead, I’d focus on smaller dividend yields, which have a strong record of growth. If a dividend is growing a bit each year, you could also see an elevating share price boosting your retirement pot. A growing dividend suggests the possibility of a healthy, growing underlying business.
Invest without stress!
But don’t lose sight of the potential joys of retirement by spending all your time hunched over a computer screen investing. I reckon a neat solution could be to put your investment pot into index tracker funds. That way you’ll be able to harvest the dividend yield for your retirement income while maintaining exposure to the long-term growth tendency of the stock market. I’d probably spread my funds between the FTSE 100 and FTSE 250 indices, for example.
And in one final consideration, as well as harvesting the dividends, it’s not a sin to run down your pension pot by cashing in your investments altogether along the way if you want to. I reckon the main goal is to ensure you have enough money to last, wherever it comes from.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.