Should I withdraw my investments to invest in RSA retail savings bonds?

Q: I am seriously considering withdrawing the bulk of my funds invested with Allan Gray unit trusts and investing in RSA retail savings bonds for two or perhaps three years. Is there any advice you could give me – pros and cons, and so on. I need a more stable income base for my monthly pension withdrawal. I am 71 and am now struggling to live off my interest alone, without touching my capital. Perhaps you have other investment ideas that will suit my criteria.

A: At the outset, it is important to acknowledge that what you are currently feeling is to be expected and can be considered normal under the current coronavirus circumstances. As human beings we are hard-wired to survive, and that always involves escaping danger. In our minds, a poorly performing market would be a danger we would do best to avoid.

The problem with this ingrained survival instinct is that investment markets are counterintuitive. This means they present their best opportunities when the news is at its worst. Unfortunately, this is when we are the most afraid, and as a consequence seek to exit the situation, usually to our detriment.

Having dealt with the psychology behind how you are feeling, let’s examine your current dilemma. Before answering your question, it is important to have all the facts as the most appropriate decision for you will be determined by a number of personal factors such as your monthly income requirements, anticipated capital outflows, vehicle upgrades, and/or any travel goals.

It is also important to know what other sources of income such as a pension, life annuity, living annuity or rental income you receive, as these will affect your tax rate and the ultimate return from the retail bonds. Your appetite for risk, as well as the legacy you wish to leave for your loved ones, will also influence your decision.

Broadly speaking, there are four asset classes one can invest in, each with their own degree of risk and return expectations:

• Equities: inflation plus 7.3%
• Property: inflation plus 6%
• Bonds: inflation plus 2-3%
• Cash: inflation plus 1%.

Inflation is currently 4.1% and is expected to remain low at around 4.5% per annum for the next year or two. This means your gross return on a two- or three-year bond is expected to be pretty much on par with long-term expectations of inflation plus 2-3%, although bear in mind that this is before taking any tax consequences into account.

The interest earned would be subject to income tax, so this needs to be factored in as it would lower the net return you would receive from the retail bond. For example, a 6.5% return taxed at 18% would reduce the return to 5.3%, and if taxed at 45% the return would be reduced to 3.6%. So other sources of income such as rental income and/or interest earned from any cash deposits will have a material effect on your net returns.

Besides the risks you have little or no control over (rising inflation and government default), there are additional risks that should not be ignored:

1. The risk of being out of growth assets for two to three years and losing out on the returns on offer.
2. The risk of having to make the decision all over again at the end of the term of the investment. This decision may need to be made at a volatile period in the history of the markets, as is currently the case. Your appetite for making such decisions will most likely diminish as you age, and your anxiety levels may rise. You would effectively be kicking the can down the road every two to three years.

Assuming the current investments are to provide income for the rest of your life, you need to base your investment decisions with that timeframe in mind and try to ignore the short-term noise.

A point of departure would be to determine the type of return you would need to receive in order to support your lifestyle for a reasonable life expectancy. This can only be calculated by taking into account your personal expenses and your investable assets. The higher your required rate of return, the more exposure you will require to growth assets like equities and property. The lower your required returns, the more exposure to cash and bonds your investment strategy will be able to tolerate.

You may well find that your asset allocation in your current Allan Gray unit trusts is appropriate to support your long-term needs, and all that is required is patience.

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