For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
The benefits of pound cost averaging are well understood in the industry. Has anyone considered income cost averaging?
Pound cost averaging refers to the practice of making frequent regular investments over time, such that you participate in the market as a buyer at all times. This has the effect of smoothing the cost of your investments and, by taking a disciplined approach, avoids the risk of panicking during sell offs. You remain a buyer whatever your perception of the market conditions.
The great benefit of this approach is it avoids the risk of mistiming investments, naturally we tend to feel more positive around market peaks and cautious during sell offs. If we were to let this guide the timing of decisions relating to our savings, we might end up with poor outcomes due to buying at the top and selling at the lows or at least not making additional investments when markets are low.
We believe a very simple, but somewhat true, adage is that time in the market matters much more than timing the market.
How can this approach be applied to income investments and retirement planning? The objective of a natural income approach to retirement planning is to build the income from a portfolio over time to cover post-retirement spending needs. Just as capital values in a growth portfolio will be volatile, so the income that is available in income strategies will vary over time.
Were an investor to pursue a growth strategy right up to the point of retirement, and then switch into income on a single day, their outcome will depend greatly on the relative attractiveness of income strategies at the time. This is just the same as being dependent on annuity rates at the point of retirement.
As income and growth strategies perform relatively differently over time, we believe it is much safer to gradually transition into a post-retirement portfolio in the years preceding and immediately post-retirement, than to make the whole switch rapidly.
The chart shows the performance of the IA UK Equity Income Sector versus the FTSE All-Share Index since 2000. While income has done well, there have been periods where it does less well.
IA UK Equity Income Sector vs FTSE All-Share Index
Source: FE Analytics from 31.12.1999 – 06.08.2024
Past performance is not a guide to future returns.
A well-run income strategy should see income growth over time, so making the switch early should enable the income to grow as retirement approaches. The investor is able to see how the income in their portfolio is building over time and hence understand how their investment journey is building retirement income. Focussing on this income growth can make the volatility of capital values seem much less important. If a client can see their retirement income is growing, the day-to-day ups and downs of the markets may seem to matter less.
Investors who start their investing journey early, making consistent investments regularly, take advantage of the income and growth over time. This is also true when taking a similar approach to building retirement income.