The power of com­pound­ing

Shares - - TALKING POINT -

In 2015, Par­lia­ment passed the new Pen­sion Schemes Act which al­lowed greater free­dom to with­draw lump sums from per­sonal pen­sions, al­beit with a de­duc­tion for tax. The con­cern of some pun­dits was that ill-in­formed pen­sion­ers would cashin their pen­sion pots and blow the lot on a Lam­borgh­ini. As­sum­ing that the vast ma­jor­ity of pen­sion­ers were not suf­fer­ing from a col­lec­tive “mid”-life cri­sis, there are some more ‘sen­si­ble’ op­tions avail­able. Let’s roll the clock back a few years to back­test var­i­ous op­tions. As­sum­ing the same free­doms were avail­able 20 years ago, one could have purchased a Lam­borgh­ini Di­ablo for £165,000. The same car (as­sum­ing it was well looked after) would be worth c. £200,000 to­day. Al­ter­na­tively, for the price of the Di­ablo, a 65 year-old re­tiree could have purchased an an­nu­ity in 1997 which, due to el­e­vated rates at the time, would have paid c. £16,500 per an­num for life (or £330,000 as­sum­ing our in­vestor sur­vived for twenty years). Cur­rent an­nu­ity rates would pro­vide ap­prox­i­mately half that level of in­come for the same cap­i­tal out­lay to­day. Bonds are an­other op­tion but, with in­ter­est rates at historic lows (and with many gov­ern­ment bonds yield­ing less than in­fla­tion), re­tirees risk be­com­ing poorer in in­come terms dur­ing retirement. What about eq­ui­ties? Here, we use the track record of Wi­tan In­vest­ment Trust (a global eq­uity in­vest­ment trust) as an ex­am­ple. The cal­cu­la­tions in­clude stam­p­duty but not other trans­ac­tion costs (which may vary). In 1997, the same £165,000 could be used to pur­chase 51,386 Wi­tan shares. First year in­come of £3,751 equated to a yield of 2.3% but this rose to £10,534 (or a 6.4% yield on the ini­tial out­lay) in 2017. In to­tal, over the twenty year pe­riod, our fic­tional in­vestor would have en­joyed an in­come of £115,310. In cap­i­tal terms this in­vest­ment would have grown to £554,457. But please bear in mind that in­vest­ments in eq­ui­ties are in­her­ently riskier than gov­ern­ment bonds and it is pos­si­ble that you may not get back the amount orig­i­nally in­vested.

Div­i­dend re-in­vest­ment over the long-term helps pro­duce even bet­ter fu­ture cash flows (please note the risk warn­ing be­low). For ex­am­ple, if our fu­ture re­tiree ac­cu­mu­lated a “Lam­borgh­ini” fund at age 55, and rein­vested the div­i­dends the num­bers are quite dif­fer­ent. Let’s wind the clock back again, this time to 1987, when many school­boys had a poster of the Lam­borgh­ini Coun­tach on their bed­room walls. The real thing cost £80,000 (£220,000 in to­day’s money). Let’s as­sume that our fic­tional 55 year-old in­vestor purchased 78,813 Wi­tan shares in­stead of that Lam­borgh­ini Coun­tach. Rein­vest­ing, rather than spend­ing, the div­i­dends for the first 10 years un­til retirement in 1997, would re­sult in a hold­ing of 104,111 Wi­tan shares. Upon retirement, our fic­tional in­vestor chooses to stop re-in­vest­ing

so that the in­come re­ceived from these shares over the sub­se­quent 20 years is £233,626. The ini­tial in­come was £7,636 per an­num (a yield of over 9% on the £80,000 1987 in­vest­ment) and grew to £21,342 per an­num in 2017 (an aver­age in­come of £11,681 per an­num over 20 years) while the cap­i­tal value now sur­passes £1,123,000. It should be em­pha­sised that these cap­i­tal val­ues and div­i­dend growth are historic and cer­tainly not guar­an­teed. Wi­tan has man­aged to in­crease its div­i­dend for 43 con­sec­u­tive years at an an­nu­alised rate of 9.8%, in ad­di­tion to cap­i­tal growth over the long-term but fu­ture re­turns are sub­ject to many long term caveats and risks. Our re­tiree in this il­lus­tra­tion could have ac­cu­mu­lated a very sig­nif­i­cant as­set pro­vided they were com­fort­able with the risk in­volved in eq­uity in­vest­ment and adopted a long term in­vest­ment view.

Clearly, a pen­sion fund the size of a su­per­car (to­day’s flag­ship model costs c. £275,000) is out of reach for many but is not far short of the £300,000 pos­tu­lated as nec­es­sary by re­cent re­search for the aver­age re­tiree to main­tain their cur­rent lifestyles, based on cur­rent an­nu­ity and state pen­sion rates. After some pru­dent in­vest­ing, our fic­tional 1987 in­vestor could buy that 1987 Lam­borgh­ini Coun­tach after all, while re­tain­ing a sig­nif­i­cant pen­sion pot. These 30 year-old clas­sics change hands for c. £350,000 to­day, which is com­fort­ably ahead of in­fla­tion over the pe­riod and per­haps a lit­tle more fun than own­ing Wi­tan shares. How­ever even an iconic Lam­borgh­ini has not matched the power of grow­ing div­i­dends in com­pound­ing in­vest­ment re­turns over a long pe­riod.

JAMES HART, IN­VEST­MENT DI­REC­TOR OF WI­TAN IN­VEST­MENT SER­VICES.

Please re­mem­ber that past per­for­mance is not a guide to fu­ture per­for­mance. Wi­tan In­vest­ment Trust is an eq­uity in­vest­ment. The value of an in­vest­ment and the in­come from it can fall as well as rise as a re­sult of cur­rency and mar­ket fluc­tu­a­tions and you may not get back the amount orig­i­nally in­vested. Fur­ther, div­i­dend pay­ments and div­i­dend growth are not guar­an­teed.

This ma­te­rial is a mar­ket­ing com­mu­ni­ca­tion is­sued and ap­proved by Wi­tan In­vest­ment Ser­vices Lim­ited for in­for­ma­tional pur­poses only and does not con­sti­tute a so­lic­i­ta­tion or a per­sonal rec­om­men­da­tion in any ju­ris­dic­tion. Opin­ions ex­pressed are cur­rent opin­ions as of the date of ap­pear­ing in this ma­te­rial. No re­liance may be placed for any pur­pose on the in­for­ma­tion and opin­ions con­tained in this doc­u­ment or their ac­cu­racy or com­plete­ness. No part of this ma­te­rial may be copied, pho­to­copied or du­pli­cated in any form or dis­trib­uted to any per­son that is not an em­ployee, of­fi­cer, di­rec­tor or au­tho­rized agent of the re­cip­i­ent, with­out Wi­tan In­vest­ment Ser­vices Lim­ited’s prior per­mis­sion. This does not con­sti­tute in­vest­ment ad­vice and it is rec­om­mended that you seek in­vest­ment ad­vice be­fore mak­ing an in­vest­ment de­ci­sion.

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