Investors may be overlooking the benefits of taking an ‘income cost averaging’ approach to their investments, according to Premier Miton multi-asset manager David Jane.
While pound or dollar cost averaging is well understood, Jane questioned whether the industry has properly considered income cost averaging.
Jane explained his thinking in a recent commentary note. “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,” he said.
“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.”
He added that the benefit of this approach is it avoids the risk of mis-timing investments. Investors 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,” he said.
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With time in the market mattering more than timing the market, Jane considered how this can 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,” Jane continued. “This is just the same as being dependent on annuity rates at the point of retirement.”
With income and growth strategies performing relatively differently over time, Jane added that he believes 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.
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“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,” he said. “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.”
