Page 34 - DIY INVESTOR MAGAZINE - NOVEMBER 2018
P. 34

OPTIONS FOR TAKING SUSTAINABLE INCOME FROM YOUR PORTFOLIO
Taking a sustainable income from your portfolio could be more complicated than accumulating it in the first place. Dominique Riedl of just ETF explores your options.
    You’ve finally got enough in your ETF portfolio to start taking an income from it; how do you sustain that income over many years, especially if it’s your sole source of funding? Firstly:
• How much income can I take?
• How long will my portfolio last at that rate of income?
Inevitably, the more income you take, the faster your portfolio is likely to be depleted; how can you maximise your income while ensuring that your pot lasts as long as you need it.
SUSTAINABLE INCOME
A popular rule of thumb is the 4% rule’; conceived by William Bengen based on US equity and bond returns since 1926, historical data tells us that you could have withdrawn an inflation-adjusted 4% from your portfolio annually, over any of the studied 30-year periods, without completely exhausting your assets.
30 years when all capital is spent and the portfolio is exhausted.
Monthly incomes over time assuming a 5% annual portfolio return.
HOW FLEXIBLE ARE YOUR INCOME NEEDS?
A major consideration is whether you need your portfolio to provide a steady income i.e. the same amount every year, adjusted for inflation.
The 4% rule and some of its variants are calibrated on this premise; e.g. 4% of a £1 million portfolio means equates to £40,000 income in year 1.
However, you don’t take 4% of whatever is left in your portfolio in year 2, you adjust your year 1 income by inflation. For example, if inflation at the end of year 1 is 2%, then year 2 income is £40,000 x 1.02 = £40,800.
You take £40,800 from your portfolio in year 2, regardless of how much your portfolio is worth, maintaining a steady income over time.
That’s important if your annual expenses are fixed and there’s no way to reduce them. However, few people are that inflexible in practice and there is a risk of running down your portfolio too quickly if you’re unlucky enough to suffer years of poor asset returns.
If equities fall by 50% then you’d need to sell twice as many ETF shares to take the same level of income as
    justETF Tip: The 4% rule can also be used to estimate how big a portfolio you need; e.g. if you want an annual income
of £30,000, multiply your income number by 25. That tells us we need a portfolio worth £750,000 before we can sustainably withdraw a £30,000 annual income
This simple table gives a rough idea of how much monthly income a portfolio can provide over different time periods although it doesn’t account for taxes, costs, inflation or asset return volatility.
Assuming a 5% annual investment return, a £300,000 portfolio could sustain a £1,583 monthly income for
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