Pension Review - One Year Gone

I described my plan for income during retirement with a self invested pension last year.  You can see what I wrote here: Further Pension Musings

After a year, let's see how the cunning plan is going.  The current investment split looks like this:

The pie chart at first glance looks virtually the same - but the percentage splits are slightly different.  The SIPP is now a smaller percentage of the overall stash, with the other three pots all slightly increasing.  This is exactly what I would expect to see.  I started drawing down from the SIPP in September.  This is providing the bulk of my income - topped up by dividends from the VCT and other investments.  The ISA remains untouched, with dividends being reinvested. 

Overall, the dividend income has more than covered my expenditure, with the excess going towards additional ISA contributions.

However, Covid-19 has happened.  Before I retired, I tested my portfolio against a number of 'What if' scenarios.  What if the dot com crash of 2000 occurred again?   What if the financial crash of 2008 occurred again?  What if the UK had a deep recession triggered by Brexit (or some other cause)?    And so on.  In each of them I was satisfied that the mix of investments I had would be OK overall.  I did not consider a world wide pandemic that would have an economic impact across almost every industrial sector and every geography.  I think it's fair to say that 12 months ago, no one could have predicted we'd be in the situation we're currently in.

This has impacted me in two ways.

First, the value of my stash has dropped considerably.  From 17th January to 23rd March, the stash lost over a third of it's value.  Since the 23rd March, stock prices have partially recovered, and as of today, I'm about 14% down from the pre-Covid valuation.  But the valuation isn't something that I'm overly worried about.  I explain why here: Chickens and Investing

Second, lots of companies have stopped or suspended paying dividends.  As an income investor, this is far more worrying and has a very real impact on me. Eleven companies I'm invested in have stopped dividends altogether, a further four have reduced their payouts and I anticipate that as results come out in the months ahead, more will follow.  There's not much I can do about this.  There is reason to be optimistic that this is temporary and there will be a resumption of profit and dividends as lock down restrictions lift.  Many of the companies are still operating profitably and are simply being prudent at this time.  On the other hand, some companies are sustaining real economic damage during this period and although they may resume dividends at some point, they may well be at a lower level.  There are three things that mitigate my concern: 1) with lockdown, our expenditure has also dropped; 2) Linda is still working and my retirement planning was always that we would be able to afford for her to stop working too, so while she works we have a margin of safety; 3) my portfolio has little direct exposure to some of the most impacted companies (airlines, cruise ships, holidays,  travel, restaurants).

I'm sure the year ahead has more surprises in store for us and I'll be paying close attention for potential investment ramifications.

The Virtual Portfolio update

Last year, I introduced a virtual portfolio, that mirrors my core investments.  It illustrated how you could invest 100,000 pounds for long term income.  This is what it looked like:

During the year the BMO MSCI UK Income Leaders fund shut down and in January the value of the stocks within the fund was returned to shareholders.  The settlement price was 2644.57p a share giving me £10,578.29 to invest elsewhere.  I decided to split the proceeds 50/50 between Edinburgh Investment Trust, an income focused fund, and Royal London Stirling Income, a commercial bond fund, giving me 867 shares in Edinburgh IT and 4366.5 units in Royal London.

The value of my portfolio didn't really move much, drifting slightly upwards towards the year end.  Then, along with pretty much everything else, it dropped dramatically due to Covid-19 and has subsequently partially recovered.  The graph below tracks the portfolio over the past 12 months:

It is worth noting that because I'm just plotting the month end valuations, a lot of market volatility has been removed.  Specifically, you cannot see the high point in January or the low point in March.

There's been some further recovery in June and right now it looks like this:

Overall, in terms of capital preservation, I'm down 13%, but given the circumstances I'm OK with that.

The other aspect to consider is income.  The portfolio as described above delivered £5,140.77 in dividends in the twelve months: 1st June 2019 to 31st May 2020.  This was £291.83 more than predicted a year ago.  The increase was driven by two things: 1) increased payouts from the two Vanguard funds, Phoenix and Merchants; 2) effect of the closing BMO after having received 3 out of 4 dividend payments for the year and buying investments that had only made 2 out of 4 payments for the year so far.

Looking ahead, if all seven investments were to pay the same dividends in the next year, as they did last year, the income would be £5,042.16.  However, this is not going to happen.  Both the Vanguard funds are tracker funds and the dividends are a direct reflection of the payments received from the funds investments.  I know that many companies are in trouble and have stopped dividend payments.  This will, for sure, impact the payments I receive from these two funds.  I have absolutely no idea by how much, I will only know when the dividends come in.  Phoenix Group looks pretty secure to me and I'm confident that won't be cut.  Hendersons, Merchants and Edinburgh are all investment trusts with very long records of not having cut their dividends, even through previous stock market crashes and recessions.  They have reserves which they build up during good years, which can be used to maintain the dividend during bad years.  This is going to be a bad year, so the question is - will their reserves be enough?  I don't know the answer to that - but if there is a cut, hopefully it will be a small one.   Finally Royal London Stirling Bond fund - again, I don't really know the impact.  The fund is invested in company bonds, so if those companies go bust the fund looses capital and income.  I wouldn't be surprised if there's some impact to the dividend, but I wouldn't expect it to be too dramatic.  A company can choose to stop paying dividends, but it still has to pay interest on the money it's borrowed.

What ever happens, the year ahead will certainly be interesting from an investing perspective.  Will my investments perform well enough for me to continue in the manner to which I've grown accustomed or will I, next year, be looking for part time work at my local supermarket?  I'll let you know.

Chickens and Investing

As an investor, investing for long term income, I find comparisons to a chicken farmer helpful in explaining my investment philosophy.

As a chicken farmer, I'm interested in eggs.  The eggs are what I can eat and what I can sell.  As long as I'm getting a steady stream of eggs from my chickens, I'm happy.  And if I have excess eggs, I can use some to make new chickens and thus provide even more eggs in the future.

When I buy some shares in a company, I like to think of them as chickens in my growing flock.  Instead of eggs, they provide me with dividends.

As a chicken farmer, I'm not too much bothered by the day to day fluctuations in the price of the birds.  As long as the birds I have are giving me eggs, the price fluctuations are irrelevant.  Of course, if chickens became particularly cheap, I can always buy some more and that's goodness, not something to worry about.

Long term investing is similar - the daily price fluctuations of shares is not a worry.  As long as dividends continue to flow, then I can sleep peacefully at night.

Of course, in the same way that I'd want to make sure I had healthy chickens, I want to ensure that the companies I invest in are healthy too.  I'm not looking for small start ups that might be the next big thing and triple my investment, but rather steady investments with a solid record and good prospects for being around over the coming decades.  Profitable businesses that pay shareholders a good dividend.  And in the same way that I could hold back some eggs to grow more chickens, I can ensure that I hold back some of the dividends I receive to buy more shares.

But what about an unexpected disaster?  Chicken fever? A fox?  There will always be things you can't foresee.  For example, the Deepwater Horizon oil spill that hit BP in 2010, which so far has cost BP over $65 billion.  So it's critical to diversify - maybe buy different breeds of chickens or even some ducks and geese.  I try and cover a wide range of different industrial sectors as well as investing in a broad range of geographical economic areas.  If the UK gets "Boris'ed", then that's OK, because the overseas investments should keep me going.

To ensure I keep going forever, then what happens if one year the chickens don't do so well and lay fewer eggs?  Well I don't panic and sell some chickens to make up the shortfall.  Instead, I tighten my belt and have two eggs in my omelette instead of three.  I maintain the flock so that things can hopefully get better in the future.  And every time I can spare an egg or two, I'll pop them in the incubator to make my flock a little larger.

Just remember, it's all about the eggs...

Further Pension Musings

(This is a follow on post from: So how is this pension thing going to work...?)

Last week, while I was away walking the South Downs, my 25% tax free lump sum came through and was credited to my account.  So this week, I've had to actually decide how to allocate the funds from my IBM pension pot, to investments that I'm confident will see me through the next few decades.

First, where's the money?

I've got four distinct pots within which I hold investments.  The largest is a SIPP, which now contains the IBM pension money plus various investments that I'd also built up in the SIPP outside of the IBM plan.  I'd already consolidated two other plans into this SIPP that had been started before I'd joined the IBM scheme.  Then I have an ISA, which I've been building up over the past decade.  I also have some funds invested in VCTs.  And finally I have some shares that are not in any kind of investment wrapper at all.

Snapshot at retirement start

The Cunning Plan

Ideally, I'd like to just put all the investments I have into the ISA pot - then I'd have no restrictions on what I can do with the money and all the income would be tax free.  However two things prevent that.  First, I'm limited on how much I can put in an ISA each year.  Second, I get taxed on what I take out of the SIPP - so too much in one year and I'm giving 40% or more to HMRC.

So the plan is to move the funds from the SIPP and the Other pot, into the ISA over time - putting off actually drawing any income from the ISA as long as possible, hoping that by the time I've emptied the SIPP, the ISA will be big enough to take over.

Therefore, I've decided to draw down from the SIPP as much as I can each year without hitting the 40% tax bracket, live on what I need to live and add what's left over into the ISA.  I will also transfer the shares in the Other pot into the ISA - as I can, up to the annual ISA limit.

At the moment, the only income I have that is taxable is what I draw down from the SIPP - VCT and ISA income is tax free and the dividend income from the Other shares is below the current dividend income threshold for tax.

If the cunning plan works, then eventually, the amount I have invested should stay constant (or even better - go up) and I will have all my investments in the ISA and be living off the dividends, tax free.

The Investments Bought

The IBM Pension cash has been split between six investments.  Together, these six investments make up the largest proportion of my retirement pot and I regard it as my core portfolio.  This is what I've gone for:

Investment Name	%	Ticker	Comments
Vanguard FTSE All World High Div. Inc. ETF	30%	VHYL	An ETF, tracking a world index of high dividend paying shares. Good international diversification.
Vanguard FTSE UK Equity Inc.	30%	VVUKEI	A low cost fund, tracking the index of UK dividend paying shares
Phoenix Group	10%	PHNX	Closed book, life insurance consolidator.  Reliable, solid, multi year income projection available.
Henderson Far East Inc.	10%	HFEL	A regional investment trust, focusing on dividend paying shares in the Far East region.  Multi year record of growing dividend.
Merchants Trust	10%	MRCH	A UK focused Investment Trust, focusing on generating income.  Has been running for over a century with 30+ years record of increasing dividend
BMO MSCI UK Inc. Leaders	10%	ZILK	A UK focused ETF, tracking dividend paying companies, with algorithmic filter to exclude potential poor performers.

To help visualise this, I've created a virtual portfolio, which I can track.  So with a £100K spend, it would look like this:

Spending the cash 30%, 30%, 10%, 10%, 10%, 10%

Now because I can't stand money sitting around, not working for me - that £23.34 left over can get me two extra Phoenix shares and one each of Henderson and Merchants:

Final investments for virtual portfolio (Prices from 12/07/2019)

I'll review this portfolio regularly to see how it's performing.  Obviously I hope that over time the income will gradually increase and I will see an increasing valuation.  We will see.

My core portfolio represents about 85% of my SIPP, the remainder being a mix of high yield individual company shares and high yield bond funds.  It is those that I plan to sell first as I start to draw down income from the SIPP.  It is my intent that as I sell investments in the SIPP, I will be able to buy equivalent value investments in the ISA - so as to not erode overall capital value.

Within the ISA and Other shares, there are a mixture of over thirty different funds and individual company shares, all paying dividends (except one - but that's a story for another post) and covering a diverse range of industries (I wont invest in tobacco or gambling stocks).  The largest holding is less than 8% of the total, most are about 3%.  I'll post about the other companies I've invested in, later this year.

Overall my income from investments looks like this:

Significantly better than I could get from an annuity - but will it prove to be as safe?

So how is this pension thing going to work...?

My savings over the past ten years

My last earned income was paid into my bank account on the 6th May 2019.  From this point on I'm relying on the money saved in my pension pot (the red line in the graph above) and my other savings (the gap between the red line and the blue line).

So what is my cunning plan to ensure I don't run out of money over the next few years?  Many people go for the annuity option, buying a guaranteed income for life, but I've decided against that for a couple of reasons.

• One, as a 55 year old, the rates are pretty poor in my opinion.  If I go for a flat annuity until I die, I can get about 4.24%.  If I want it to increase over time, so that I can maybe keep my income in line with inflation, then I'd get 2.48% to start and a small increase each year.  If I want Linda to have some continuing payment after I'm gone, then the payment drops even further - and she'll only get 50% of what I received. 
• Reason two is that with an annuity, OK you get the certainty of income until you die, but once you're gone, that's it, nothing left.

Well I think I can do better than buying annuities.  I think I can get a higher initial income, that will keep pace with inflation and will be available for Linda, should I die before her.

In simple terms, I believe that I will be able to buy a selection of shares that pay dividends and live off those dividends, without having to sell the shares.  In theory, that should provide an income for life, it should have the potential to increase over time and there should be no decrease in income if I should die before Linda.

Of course, there is no guarantee that there wont be a stock market crash, but I believe I can invest in a diverse range of stocks that should significant mitigate any downside risks.

My current position is that 72% of my retirement fund is held within a pension wrapper and 28% is held in other investments (mostly shares in an ISA). I'm happy with what the non-pension investments are doing - but I do need to make up my mind about the pension wrapped savings.  At the point of leaving IBM, about 20% of my pension was in a SIPP, with the rest contained in IBM's money purchase scheme.  Unfortunately, actually getting any money is not a fast process.  Because I want to use "flexible draw down" rather than buy an annuity, I have to transfer my pension out of the IBM scheme into an alternative that will support flexible draw down.  I completed the forms required for this and sent them off to the pension company before I left IBM - however, they wont process any instructions for a transfer out until they get confirmation from IBM that I have actually left IBM.  I could see that things were moving on the 11th June, as the funds in my IBM pension were sold and the money transferred out.  Six day's later, the money arrived on June 17th and was credited to my SIPP account.

I now have to decide how to invest that money and also go through the process of requesting the 25% tax free lump sum that I'm able to claim upon retiring.  So far I've completed the initial "I want my money" form and submitted it on Tuesday 18th.  This resulted in a questionnaire being sent to me on the 20th which needs to be completed before I can proceed any further.  I've completed that and returned it - so now I wait....

At the moment my pension fund is about 80% cash - I've decided to leave it that way until I've got my 25% out.  Once that occurs, I'll post on what I've decided to invest in and what my plan will be to draw down the remaining funds in the pension wrapper.