My wife and I have just sold our house in Bermuda and are now resident in the UK. We have £650,000 cash and want to generate an income of some £1,400 net a month. We are very risk-averse and want capital protection. How can we achieve this income?
Why not just retain your money in a cash account earning interest? There are two risks you will face. The first is inflation as, over time, the real value of your money will be eroded.
The second risk to consider is institutional risk. What if the bank goes bust? You can protect against the worst of this by spreading your money across a number of institutions and taking advantage of the protection available under the Financial Services Compensation Scheme.
A net of £1,400 is equivalent to a net interest rate of about 2.6 per cent. If either you or your wife are basic-rate income taxpayers, then that is equivalent to 3.25 per cent gross. Such a rate is readily achievable currently even with historically low interest rates. You may need to defer taking any income from the interest earned for one full year in order to achieve your income goal and avoid capital erosion.
If you are unhappy with the inflationary risk, you may need to consider exposing some of your capital to assets with the prospect of capital growth but which are likely to fluctuate in value, so you may have to accept some volatility to achieve your goals. You need to consider your overall financial situation and see if you have any tolerance at all for loss.
There is a difference between volatility and loss. The former is a quite normal part of investing outside of cash and the latter occurs if you decide to encash an investment after it has fallen in value. Do not invest in anything other than cash if you are really risk-averse.
The accessibility to valuations of investment portfolios really does unsettle some people. As financial planners, we love transparency but some clients find it difficult to deal with. In the old days, when a client only received a once a year statement it was less unsettling for some than being able to see values move on a 24/7 basis.
Even a low-risk portfolio is going to contain some assets that might fall in value, such as fixed-interest securities, so do not mix up low risk and no risk. They are two different things. When people think they are getting low returns on their cash accounts they can be inclined to invest in a portfolio, hoping this might generate better income returns than cash.
If you talk to your bank about the best return available, watch out for any attempt they may take to sell you structured products. These are usually unsuitable for cautious investors, have some hidden risks and are difficult for the typical investor to understand. Never invest in something you do not understand. In your case, stick to cash.
Nick Bamford is chief executive of Informed Choice