What to do with your Income portfolios when dividend payments fall

What to do without Dividends

As at the end of May 314 companies have suspended or removed dividends worth more than £29bn. Suspending dividends allows companies to preserve cash when capital markets are weak, and it is difficult to obtain new funding. The company can resume dividend payments when economic conditions improve but what should ‘income’ portfolio holders do in the meantime? 

Go back to your checklist

First, confirm your outgoings. Many investors concentrate too much on where they are going to get their income from without giving equal consideration to where their income goes. A clear picture of your outgoings (both current and future) helps you set a target for your income goals.

Next, identify your income ‘pots’. We break these down into four headings: secure income; earned income; passive income; and drawdown of capital.

  • Secure income is money guaranteed to be paid irrespective of your own finances such as state pensions (make sure both you and your partner are fully funded where possible to take advantage of this benefit).
  • Earned income is a simple exchange of your skills and time in return for a financial remuneration. Many retired people do not appreciate the value they have in their own hands and dismiss this avenue too readily.
  • Passive income, such as dividends or rental income, is the area that has been most affected by the current crisis.
    Drawdown of capital is normally used to make up any shortfall in the above and to cover extraordinary items of expenditure. (Normally a last resort, as once spent, it loses its ability to earn passive income or benefit from future growth.)

Now we need some calculations: how long will the above be required? As no one knows how long they are going to live, this requires some estimation, normally using available data from places like the Office of National Statistics (for life expectancy etc.). Financial planners call this “cashflow forecasting” and there are some very sophisticated software programmes available to them to do it. It would be well worth asking for a cashflow forecast from a professional for a fixed fee (this fee should be based on the complexity of your situation and not on the total value of your portfolio).

The four pot plan

Once the cashflow forecast is done, you will have a clear picture of what is needed and when. With the amount of information and industry jargon in the investment world, we favour the approach of dividing the portfolio into pots and giving them names that identify their purpose.  That way you can also take into account the different time frames and risk profiles to suit each purpose, while ensuring the overall picture is not lost.

For example, you may set up a portfolio to supplement your secure income and call it your “withdrawal portfolio”. Each pot is agnostic to the types of investment vehicle or funds held within it, although once again you can take advantage of the different tax vehicles to give you an added value. We would expect to see pensions and ISAs for instance in a withdrawal portfolio.

The cashflow would only have been able to provide an estimate for how much you will need, so you may want to set aside another pot and call it “safety”. This portfolio could hold an additional percentage (say 20%) of the withdrawal portfolio so that you have that extra peace of mind for situations such as the one we are going through now.

Life is for living, so you might set up another pot – let us call it the “flexibility portfolio”. Its purpose is to take advantage of any opportunities that may arise. You use the same discipline in management as you do on the other portfolios but it does help just looking at this one in isolation when considering an extra cruise or changing the car. Making mistakes in this portfolio should not damage the overall security of the family.

Finally, you might want to consider setting up a “legacy portfolio”. Many parents want to help their children and grandchildren but equally many children want their parents to look after themselves first. By setting aside a legacy pot both parties can have confidence in any distributions that may occur. 

Do not forget that there will be items that will be with you right to the very end and in most case this involves property. We would normally include these assets, including any holiday homes, within the legacy portfolio. 

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