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Does it matter which fund you draw from in a portfolio of unit trusts?

Reader’s questions answered.

CAPE TOWN – In this advice column Beata Carstens from Veritas Wealth answers a question from a reader who needs to draw income from a unit trust portfolio.

Q: I am invested in various funds on the Allan Gray platform, specifically the Allan Gray Balanced, Equity and Stable Funds, as well as the Coronation Strategic Income Fund, the Foord Balanced Fund and Prudential Inflation Plus Fund. My investments total R2 million in value.

I require an income of R15 000 per month but I am not sure which funds I should take the income from. Is it best to take the income across the whole spectrum of funds, or just out of one or two funds?

Your question requires a two-part answer.

The first is to understand that R15 000 a month is quite a high withdrawal rate from capital of R2 million. It equates to R180 000 a year, which is 9% of your capital.

Without knowing how much you have in each of the funds you mention, an estimated return on your investments after fees would probably be around 8% in the current market environment. In other words, from the start you would be withdrawing more than you were able to replace through investment returns.

If one presumed an inflation rate of 6% and if you increased your monthly withdrawals by that percentage every year, your money would only last about 13 years. Without knowing your age or your circumstances, it’s impossible to say whether this would be sufficient, but it’s important that you appreciate what you are facing.

If you likely to require an income for longer than that, you may have to consider reducing your monthly income requirement. You may also need to review your portfolio.

I would recommend speaking to a financial adviser who can help you with these decisions. Find one who will charge you a time-based fee for a consultation.

The second part of the answer is to address the question of which funds you should draw from. To understand why this is actually a very important consideration, I would like to take a step back and explain how an investment in unit trust works.

When you invest an amount of money in a unit trust fund, you actually buy a number of units in that fund. The amount of money you invest divided by the unit price on that day will give you the number of units you get.

That means that your asset is actually the number of units you own. The value of your investment is the number of units you own multiplied by the unit price.

When you want to withdraw a regular income from your investment, you need to sell units to make up the amount that needs to be paid to you on a monthly basis. Funds do also pay out any income they earn if you select that option, but this alone will not be enough to meet your income needs.

If you fix the income you require, the number of units sold on a monthly basis will vary according to the unit price of the fund. This is because the unit price will fluctuate as the value of the underlying investments changes.

My advice would be to start off by selling the units in the funds with the lowest volatility. Essentially that means that funds with the lowest equity exposure. By doing this you are preserving the units in the funds with the higher volatility, which are also the funds with the higher growth potential over the medium term.

You can start off by withdrawing income from the Coronation Strategic Income fund, followed by the Allan Gray Stable Fund and the Prudential Inflation Plus Fund. The balanced and equity funds can provide income at a later stage.

You may also need to change your allocations over time to move some money into funds with lower volatility as you get closer to needing it. This will guard against short term market movements that could wipe out a chunk of your money just before you are hoping to withdraw it.

By managing your withdrawals in this way, you will hopefully extend the longevity of your capital.

Beata Carstens CFP ® is the head of the Veritas Wealth Paarl office.

If you have any questions you would like answered by financial planning experts, please send them to editor@moneyweb.co.za.

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