Under the new pension rules, retirees can now choose to draw an ongoing income from their pension fund after retirement, without having to cash in their investments and buy an annuity.
I reckon this is fantastic news — as long as you understand the risks involved.
The key question, of course, is which investments should you choose to fund your retirement?
Should you invest £1,000 in Diageo right now?
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In this article, I’ll explain why I believe you only need to choose one investment — the FTSE 100.
Why the FTSE?
You might think that you can earn more by investing in individual stocks — and you might.
However, doing this means facing the very real risk that a chunk of your portfolio will be invested in a firm that runs into problems, or that your selections will underperform the market.
That’s not necessarily a problem when you’re young, but if this happens after you’ve retired, you could really feel the pinch.
Concentrating the majority of your pension fund in a FTSE 100 tracker fund protects you from being too exposed to troubled stocks such as Tesco, where the final dividend has been suspended, and the shares have fallen by 30% since the start of 2014.
Robust and diversified
According to the latest Capita Dividend Monitor report, the FTSE 100 currently offers a prospective yield of 3.9%, and payouts are expected to rise by 3.6% this year.
That looks pretty attractive, especially when you consider that a more traditional retirement choice, 10-year UK government bonds, currently offer a yield of just 1.8% — barely enough to keep pace with inflation.
Although the income from bonds is safer than that from individual stocks, I believe the diversity provided by the FTSE 100 overcomes this risk.
After all, even just the fifteen largest companies in the index include global telecoms, banking, oil, mining, pharmaceutical, alcohol, tobacco, consumer goods and utility businesses.
Except in exceptional circumstances, such as the global financial crisis in 2008/9, I wouldn’t ever expect a major cut in dividend income from the FTSE 100.
Two weaknesses
My FTSE 100-based approach does have two slight weaknesses.
Firstly, the FTSE 100 is diversified, but it isn’t evenly diversified. Big financial firms and commodity stocks tend to account for a disproportionate share of the index, and thus of its dividend payouts.
Secondly, investing in the FTSE 100 means you won’t ever outperform the market — your investment is the market.
