The problem for many investors adopting this strategy, of matching a cash buffer with a mixed investment portfolio, is lack of attention or lack of discipline. Either we become caught up and distracted with other things and do not take gains when we should, or we simply see gains building, and become too enamoured – or seduced – by the progress and take no action.
The simple answer is to apply an intelligent and formulaic approach to managing this process. If one is looking for a ‘yield’ of 4 per cent from one’s investible assets, research suggests that one might consider placing 20 per cent into cash or near-cash reserves from which one draws the 4 per cent a year on a regular basis – probably by standing order. The remaining 80 per cent is invested as one chooses, according to one’s risk appetite, and gently managed going forwards. The discipline comes from a regular review of how things are going.
At each review one can value the overall portfolio – cash reserves and investment portfolio. If the total is greater than the initial sum invested then it is time to take some profits and re-balance the portfolio back to the 20 per cent/80 per cent ratio.
Clearly this restarts the strategy from a neutral but re-based position. The advantage is that if the reviewed total valuation is higher than the original combination, then one can increase the drawing level to 4 per cent of the new total.
There need be no further hard and fast rules as to what is sold; that is a matter of judgment. The important discipline is the review itself and the decision to take an appropriate level of gains – if the review shows an overall increase. Of course, gains will also be taken and reinvested, when appropriate, quite separate to the regular, ‘re-balancing’ reviews. Many of those gains will either be tax-free (within the annual allowance) or taxable at modest rates. Meanwhile the drawings are drawings of cash which attract no tax.
Such a strategy has been shown to be effective through much of all historical investment cycles as long as it is followed over the medium to long term. It clearly receives a boost during periods of high interest rates when the cash buffer is enhanced by accumulating net interest, but this must be viewed as a bonus.
Paul Wilcox is executive chairman and managing director of Way Group
Key points
The real problem for many investors and savers is that they do not wish to put their capital at risk but they do need a better return.
Most reasonably wealthy investors tend not to have a singular approach to supporting their lifestyles.
