How can I invest R1.5m for income and capital growth?

A bucket approach where income and growth assets are split into various sections may be an option.

Shortly I will have ±R1 500 000/R1 600 000 to invest. I am going to retire, so I need to get the very best interest available as I need an income and still need to cater for capital growth. I am 66 years old.

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Dear reader,

Before we start, I think it’s essential for you to ask yourself a few simple questions. How much do I need to withdraw each month? What is the investment period? Am I willing to take more risk in order to achieve higher returns?

As an investor, you typically don’t want to withdraw anything more than 4-5% per annum of your portfolio value. At a 5% per annum drawdown, you will be able to withdraw R75 000 per annum and R6 250 per month. The basic principle around capital depreciation is that growth needs to exceed the drawdown. If you require a 5% drawdown, your capital needs to grow at 5%. If you require a consumer price indix (CPI) increase, your fund will need to grow at 5% plus CPI to be able to absorb the increase. If you require a yearly increase the amount of risk you would need to take will drastically change from an income that requires no yearly increase.

When people think of interest, they usually refer to money market funds or notice deposits with a bank.

The average managed money market fund provided 6.14% interest over the past five years. If you had invested in a money market fund over the past five years, with inflation averaging 4.34% over this period you would’ve made a mere 1.8% real return.

Money markets aim to provide capital protection while generating a sound level of income, however you need to understand that these funds do not aim to provide long-term capital growth. Money market unit trusts are a good tool to use for money in transition or for short-term savings or as an emergency fund, but not for long-term investing.

When constructing an income drawdown portfolio, you should make full use of diversification by introducing money market, fixed income, and local and offshore assets to provide sustainable long-term growth.

I personally like to use a bucket approach where income and growth assets are split into various sections as they have different functions. The income bucket would typically be a fixed-income or money market instrument, and this will purely be for income purposes. The other portion is split into growth assets which aim to provide capital growth over the long term and replenish the income bucket after a certain number of years.

Below are one-year, three-year, five-year and 10-year performances from the same investment house, but different funds.

The funds shown are money market (light grey), SA balanced (red), SA equity (black) and global equity fund (grey).

One-year performance

You will find that the money market provided the most stable returns compared to the other three funds. The global equity fund struggled to most over the past year and was the worst performer. The balanced and SA equity fund provided positive returns in excess of inflation and higher than the money market fund. If you were invested in the global fund, you would’ve been the loser over the past year.

Three-year performance

You will find that the money market again provided the most stable returns compared to the other three. The global equity fund outperformed the other three funds quite comfortably. The balanced and SA equity fund provided positive returns in excess of inflation and higher than the money market fund. If you were invested in the money market fund over this period, you would’ve been the loser over the past three years.

Five-year performance

Again, you will find that the money market provided the most stable returns compared to the other three funds and managed to provide close to the same returns as the SA balanced and SA equity funds over a five-year period. The global equity fund outperformed the other three funds and provided a 16% excess return over that of the money market fund. If you were invested in the money market fund you almost would’ve received the same growth as the SA equity and SA balanced funds.

10-year performance

This is where you start to see the difference in growth come through and risk is rewarded. The higher-risk funds are able to go through various market cycles and provide real returns. The global fund provided 367%, SA equity 162%, SA balanced 158%, and the money market fund 85% growth …

In conclusion

Even though past performance isn’t a predictor of future performance, the fundamental investment principle remains the same.

Short-term funds will provide steady, low returns.

Long-term funds will be volatile, there will (definitely) be downward movements in the fund, but given enough time they will provide real returns. You must be able to stomach these short-term movements in order to enjoy the long-term returns.

Know what your income needs are and speak to a professional who will be able to give you the right advice and manage your expectations. Know the difference between your risk appetite and your risk capacity. Your capacity to take risk may be different from your risk appetite and this could cause some stress. A professional advisor will be able to balance your portfolio and find a happy medium.

You are always welcome to contact me.

Enjoy your retirement!

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