Table Of Contents
Securing an Income Stream
In last week’s article How to Secure an Income Stream I wrote about how I developed in 1994 a Draw Down Approach to receiving an income stream which has enabled my clients to drawn an income stream of between 6% and 8% over the last three decades. The key point that I made is that there is a difference between receiving an income return from an investment and receiving a regular monthly income stream from structuring investments into what you need to draw down in the short to medium term (less than 5 years) and what you can safely invest into growth assets for the long term (more than 5 years).
Understanding this principle takes all the pressure off trying to fund your living needs in a low interest environment.
What not to do
Last week I provided a copy of an article that I wrote in the Wentworth Courier back in 2003 that advised not to chase yield in a low interest rate environment. I recalled the example of one 60-year-old gentleman (let’s call him Alan), who came and saw me in 1990. He had $3m to invest, and needed income to provide for a cost of living of $30,000 per month. I spent days documenting strategic advice that would provide him with a monthly income to meet his cost of living, while paying no tax, and growing his wealth by at least the inflation rate. Against my advice he Instead decided to place the funds into a term deposit that was paying 14% at that time. He would pay tax of approximately $194,885 each year, which would leave him with an income of nearly $19,000 a month, which he felt he could survive on. What could possibly go wrong?
Interest Rate Risk
What Alan didn’t realise was that he had ‘Interest Rate Risk’, that is the risk of interest rates being lower when his term deposit matured. I never saw Alan again, but by 1992 interest rates had fallen to 4.25%. Thus, the interest that Alan would receive on his $3,000,000 would be just $127,500 pa, with tax of $52,676, leaving $74,824 ($6,200 per month) to live off. Adjusted for inflation at that time, Alan would need at least $21,500 per month to maintain his minimum living needs. Alan would then have a shortfall of more than $180,000 pa. Alan would have had three choices:
1. Reduce his living needs from $21,500 per month to $6,200 per month;
2. Maintain his $21,500 per month living needs and start to draw on capital; or
3. find an investment paying 14% pa. I’m sure that Alan wouldn’t have been able to reduce his living needs by $15,000 per month, and if he chose to live off interest and capital he would have run out of money by age 74.
Alternative Income Choices
Around that time a company called Estate Mortgage Trust was advertising itself as "better than a bank", offering high yielding securities paying 17.5% pa with promises of being safe as it was backed by “rock-solid real estate”. In the early 1990s the trust collapsed and thousands of investors lost their life savings. I am afraid that Alan may have been one of these ‘unlucky’ retirees. There were many other high yielding offerings, that were supposedly safe, that have gone bust or frozen over recent decades. What is surprising is that many of these were offered by the big banks and large institutions. I’ll expand on this next week.
An Invitation
If you would like to discuss your financial situation with me, and look at ways to improve your income stream by utilising our Draw Down Approach, please phone or email to arrange an initial discussion with me that I will provide without cost or obligation.
Disclaimer: This informationis general advice only, & has been prepared without taking into account theobjectives, financial situation, or needs of any individual. It is not aspecific recommendation to buy, sell or hold any product or security. Readers shouldseek financial advice before making a decision & should consider the appropriatenessof this advice in light of their own objectives, financial situation, &needs.
Peter Lanham
