Retirees tend to change their investment strategy when they reach retirement. A common practice is to adopt a dividend investing strategy (see dividend investing books on this subject) and use the growing dividend income as a supplement to their state pension income. But should you invest for income or growth during retirement? Does one strategy hold an advantage over the other?
This article is not financial advice, it is based upon the opinions of the author and journalistic research. If you need to make important decisions regarding your financial affairs and don’t feel equipped to make those judgements on your own, consider finding an independent financial adviser.
Investing for income versus growth during retirement
Investing for income is the strategy of choosing investments that will return income in the form of dividends, interest or property income. The success of an income portfolio is the annual yield. This is measured by taking the total annual cash distribution and dividing by the average market value of the portfolio during the year.
Investing for income – advantages
Income investing is a very intuitive fit for retirees. Retired investors need an income each month, and an investment portfolio will provide it. This makes income yielding investments a natural match for those living off their portfolio.
Companies that provide a healthy dividend yield can be the best companies to invest in for retirees because these tend to be mature, large-cap companies with a lower beta/risk profile. This makes them inherently cautious equity investments. However, retirees investing for an 8% income yield or another high target will find themselves investing in high-risk enterprises.
Investing for income – disadvantages
Dividend and coupon payment income streams are not evenly distributed across months of the year. You may find that February consistently results in ⅓ of the income received by your portfolio in March.
These online resources will help you find out when companies pay dividends:
Even with foresight, retirees may find that their bank account could be caught short if they’re relying upon an income portfolio to produce a steady stream of income.
A second disadvantage is that some of the best funds to invest in don’t pay dividends. An income investor who restricts their options to distributing funds or companies with high dividend yields will be missing out on a good portion of the stock market.
Google, Amazon and the other constituents of the FAANG growth companies have a poor dividend yield that makes them unattractive to income investors. However, a private investor who excluded these shares from their US equities in 2015 – 2022 would have sorely missed out on a huge source of capital gain.
A third disadvantage relates to how investments are taxed. Income is taxed at some of the highest personal tax rates of any type of gain. Capital gains, in contrast, come with a generous annual allowance which allows an investor to potentially pay no tax whatsoever on growth in the value of their investments.
If investors use a stocks & shares ISA or another tax shelter to hold their investments, then the dividends from those investments may also be free from tax. However, even the best UK stockbroker accounts don’t come with similar tax protection, which could leave income investors with a sizeable tax bill each year.
Tax rules can change and apply differently based upon your individual circumstances therefore please perform research using the latest tax rules before making any financial decisions.
Investing for growth
The growth investing strategy has enjoyed a renaissance in the last decade. The growth investing school of thought sees an investor look for companies that have a track record (long or short) of delivering high annualised growth, with good prospects for this exponential trajectory to continue into the future.
This growth might be measured by deliveries, turnover, profits or users depending on the company.
Growth companies do not necessarily need to have turned a profit, so long as the possibility for a rapidly rising outlook is on the cards.
Investing for growth – advantages
Growth investors make profits purely from the appreciation of the value of their investment portfolio.
Income can be generated for the retiree by selling investments periodically and transferring the cash to a bank account.
This process provides two clear advantages for retired investors:
The investor has total control over the size and frequency of sales, and therefore over their income.
The investor can time sales in such a way to maximise the capital gain tax annual allowance. This allowance, referred to eariler in this article, allows for the first £12,300 of any gains to attract no capital gains tax. Check the latest allowance on the HMRC website here.
When you consider that the state pensions is worth approximately £9,350 per year, a £12,300 gain in addition to this provides a ‘full’ income which may be totally sufficient for many retirees. As the state pension currently falls under the income tax personal allowance (And therefore doesn’t attract income tax), this combination of state pension and proceeds from the sale of shares could provide a tax-free income of up to £20k per year!
Investing for growth – disadvantages
Growth investors must continue to interact with their investing app or stockbroker account more frequently, and make judgements such as when is a good time to sell shares for tax or speculative reasons.
This creates more pressure upon the retiree to make good decisions and places more of the burden of responsibility upon their shoulders. In contrast, a dividend investor can sit back for the long term and simply withdraw cash from their account in a simple fashion.
Growth investing, therefore, requires a heavier active involvement which may not be feasible depending upon the mental condition of the retiree.
Also, depending on the stockbroker fees you pay in your account, you may have to pay a transaction fee each time you sell a batch of shares. Dividends, on the other hand, are distributed fee-free to investors.
Conclusion – should you invest for income or growth in retirement?
In conclusion, income and growth investing strategies are both valid ways to run a retirement portfolio.
Income investors will automatically receive cash in the form of an income stream across the year, according to dividend, bond and fund distribution dates.
Growth investors can sell lots of shares as required to provide cash to withdraw.
Income investing feels like a more intuitive fit considering the need for income, however, the income from dividends will be infrequent and lumpy.
Both approaches are equally valid ways to extract an income from a stockbroker account.