ARE YOU SELLING YOUR COWS OR JUST USING THE MILK?

It has been a few months since the income solutions were launched and markets have been brutal. Investors in the new solutions may be worried, and panic when they receive a statement indicating that the investment’s market value has dropped. “How will I be able to sustain my income if my capital is losing value?” or, “Must my income be taken from my capital now that returns were negative?” These may be some of the questions keeping you up at night.

Before losing any sleep on the matter, it is important to remember why you chose the strategy in the first place. Also remember that the purpose of the income strategies is just that – producing a sustainable, predictable income stream for life. A simple way to describe the strategy is comparing it to a dairy farm. Although the value of the cows on the farm change from day to day, it doesn’t affect the milk it produces and at the end of the day, even if the milk is used, you still have the cows. The same happens in the income strategy. The property, shares and bonds that produce the income may change in value on a day to day basis, but this does not affect the income it generates.

Consider the below example of a real client who invested in one of the solutions in early June. Bear in mind that the distributions (interest from bonds, rental income from properties, dividends from equities) of the underlying funds pay out quarterly. This may mean that if you invest just after distributions were paid, you may have to sell units initially to cover the first withdrawals. However, once distributions are received, this should bring the units back into balance over time.

Mr A is 52 years old. He received an inheritance and although he only plans to retire at age 65, he needs an income from the investment until then. His ideal would be to only use the distributions generated by the investment (i.e. the milk) without having to draw the capital (sell the cows), as the capital also forms part of his retirement provision.

Let us look at his experience over the last few months up until the 12th of September.

Below is a summary of Mr A’s investment account. The initial values displayed are the number of units (i.e. cows) bought with the capital. The distributions will be paid on the number of units held, and not the market value of those units. (The litres of milk are determined by the number of cows and not the current market value of the cow.) Although there is a slight decrease in the unit balance, it must be remembered that the period illustrated is very short. Over time it is expected that the capital and income will increase and therefore one should not be worried about the slight drawdown in units.

Another way to look at the solution is to view distributions received from the funds as if it is paid into a bank account. The quarterly distributions from the 6th of June till the 12th of September were enough to cover the income withdrawal over the same time period.

Another way to look at the solution is to view distributions received from the funds as if it is paid into a bank account. The quarterly distributions from the 6th of June till the 12th of September were enough to cover the income withdrawal over the same time period.