The 5% solution

It could be time to move beyond the conventional balanced portfolio, says Merryn Somerset Webb, and take a little risk.

Was 1999 the high-water mark for equity returns? In the 20 years to then, average real (post-inflation) returns from stocks (dividends plus capital gains) came in at 13.1%. The 20-year moving average has fallen every year since. Last year it was just 3.7%. The last time it was "this rotten", says Patrick Hosking in The Times, was 1983. The financial industry says that this is a medium-term phenomenon. The overvaluations of the 1990s are still working their way out of the system. Once that is done, all will be well again.

We aren't so sure and nor is Hosking. We've written here many times of our fears that the problems in the equity market are more structural than anything else that bad pay incentives are hitting investment and competition; that our biggest companies are just too big to grow; and that real growth companies have stopped listing on traditional markets. If that's true, it really matters. Morningstar recently released a study on how retirees should approach their pension fund if they want it to last for a full 30 years. The news wasn't good.

Until recently financial advisers had a straightforward way of deciding how much of a pot you could spend each year. They assumed you had it invested in a balanced portfolio of 50% bonds and 50% equities, and that you got returns on that money roughly equalling the long-term average. You took 4% of it in the first year. Then if you took the same absolute amount, adjusted for inflation every year after that, the money would run out when you were about 90. Job done.

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The problem? 4% turns out to be the wrong number for today's world. Add in costs (the study that originally produced the 4% number ignored them) and the expectation that the average returns of the past really are history, and it's more like 2.5% which makes a huge difference. If you had a £500,000 pot, you could once have assumed a safe income of £20,000 a year. Now? £12,000. It's a miserable business. But it's also hard to argue with.

You can, of course, have a go at pushing your costs down as far as you can get them down to 0.5% a year, and on Morningstar analysis maybe you can take out up to 3% a year. But if you can't get more out of the markets, you just can't push it beyond that. And it rather looks like you can't. Turn to our interview in this week's issue with economist George Magnus, for example, and you will see him forecasting another correction.

Still, we don't want to be defeatist about this. So David C Stevenson explains how to give yourself a better chance than most of getting a good return from your assets. Hetalks about what we are calling the "5% solution" the way he reckons you can get a 5% income on your capital if you are prepared to move beyond a conventional balanced portfolio and take a little risk. It's worth thinking about as is the fact that 1982/1983 marked one of history's great equity-market bottoms.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.