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| Warren Buffett has told his wife to put the majority of her retirement pot into a low-cost S&P 500 index fund |
Overlooked in his annual address, the ‘Sage of Omaha’ gave a guide to safely living off a pension pot. Richard Evans explains.
By Richard Evans
Retired savers who choose to avoid annuities and live off the income generated by their investments received help from an unlikely source last month: Warren Buffett, the world’s most successful investor.
In his annual letter to the shareholders of his company, Berkshire Hathaway, the "Sage of Omaha" published the instructions that he has left for his executors about the way they should invest the money he leaves to his wife when he dies.
In doing so, he provided an answer to the question that faces every retired person who refuses to buy an annuity at today’s depressed rates: how to invest the money in a pension pot so that it will pay a decent income that rises over time.
Or to put it another way, the legendary investor was outlining the "Warren Buffett income drawdown plan".
"Income drawdown" is the product that retired savers must use if they don’t buy an annuity. What happens is that when you retire, and after you have withdrawn a quarter of your pension savings as a tax-free lump sum, the remainder goes into a ring-fenced fund from which you can withdraw, subject to certain rules, your retirement income.
Drawdown investors face the problem of where to invest. They have a more or less free choice, encompassing cash, shares, bonds, funds and even, depending on the company that runs the plan, more unusual assets such as commercial buildings.
But when Mr Buffett described how he wanted his widow’s retirement fund to be invested, he cut through all this complexity and came up with almost the simplest investment plan possible: "My advice to the trustee could not be more simple: put 10pc of the cash in short-term government bonds and 90pc in a very low-cost S&P 500 index fund." He even tipped a particular tracker fund: "I suggest Vanguard’s."
Why did Mr Buffett recommend splitting the fund in this way and how could an equivalent arrangement work for British savers?
An index tracker clearly offers the better hope of decent long-term returns, as well a current yield of 3.6pc for the FTSE 100. But say you want more income than the yield produced by the fund, as many people will. If you hold your entire drawdown fund in the tracker fund, the only way to take extra money out is to sell units. During a bear market, to raise a particular sum requires the sale of a greater number of units – in other words, a quicker whittling away of your capital.
A simple way for drawdown savers to avoid this is to have a buffer in cash, bonds or other relatively non-volatile assets and, when share prices are low, to take any extra income needed from there. Mr Buffett said of his suggested retirement portfolio: "I believe the long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."
The funds to buy for a ‘Buffett drawdown plan’
Taking the "index fund" first, the British equivalent of an S&P 500 tracker is a fund that tracks the FTSE 100 index. These are widely available – there is even one from the company that Mr Buffett mentioned, Vanguard. As long as they are efficiently run their performance will very closely mirror that of the index itself; the only drag will be operating costs.
A FTSE 100 tracker gives investors the instant diversification of holding shares in 100 or so of Britain’s largest companies. The composition of the fund will change gradually as new firms are promoted to the blue chip index and others are relegated. But history suggests the value of these shares, and the income they pay, will rise over time, albeit with plenty of ups and downs.
The Vanguard FTSE 100 tracker is an "exchange-traded fund" (ETF) and levies total annual charges of 0.1pc.
Tracker funds exist in other forms like unit trusts (or the very similar Oeics) – HSBC has one that charges 0.17pc a year – or even an investment trust, the Aberdeen UK Tracker Trust, although this tracks the FTSE All Share index, not the FTSE 100.
Remember that on top of the fund manager’s fee you will need to pay the company that manages your drawdown pension plan or self-invested personal pension (Sipp). These charges vary; some firms charge percentage fees, others flat annual charges, while some, such as AJ Bell Youinvest, do not charge to hold shares (of which ETFs and investment trusts are specialised kinds). There is more on Sipp charges at telegraph.co.uk/sipps.
What about the bonds that Mr Buffett recommended?
British investors can buy short-term UK government bonds ("gilts") directly inside their drawdown plan, although returns are currently low – for example, gilts that are repaid in six months’ time yield just 0.4pc, according to Hargreaves Lansdown, one Sipp provider.
The advantage is that short-term gilts are about the safest asset you can buy; the British Government will not default – certainly not within the next six months – and over such a short duration the impact of inflation is small.
For large sums, these gilts are even safer than cash, which is subject to the £85,000 limit of the official savings compensation scheme.
Slightly riskier options include short-term bond funds such as Axa’s Sterling Credit Short Duration Bond fund and the Royal London Short Duration Gilt fund.
Alternatively, you can easily hold some of your drawdown fund in cash, for which you need a special "Sipp friendly" deposit account; current rates include 1.45pc for an instant-access savings account from Hanley Economic Building Society, although the minimum balance is £100,000.
A five-year bond from Punjab National Bank pays 2.75pc interest, according to Investment Sense, a specialist adviser.
Warren Buffett’s jargon-free tips for investment
Warren Buffett’s annual letters to Berkshire Hathaway shareholders are pored over every year by investors who hope that some of the master’s genius will rub off on them. The letters tend to be written in a homespun style that is as far from the jargon of City whizz-kids as is possible to imagine.
This year’s letter did not disappoint. In a section headlined "Some thoughts about investing", Mr Buffett describes two investments he made – one in a farm, one in a New York commercial building – that produced solid returns.
Several things stand out about the stories: first, Mr Buffett admitted to being no expert in either field; second, he has paid just two visits to the farm and none to the New York property; third, he is ready to invest where there is no stock-market-style ability to buy or sell whenever you want.
In both cases, Mr Buffett calculated that the properties were yielding about 10pc at the time but offered scope for rising incomes in future thanks to better productivity and higher crop prices (the farm) and rent increases after the expiry of leases (the New York property).
These are some of the lessons that Mr Buffett said investors could learn from these stories.
• You don’t need to be an expert in order to achieve satisfactory investment returns.
But if you aren’t, recognise your limitations and follow a course certain to work reasonably well. Keep things simple. When promised quick profits, respond with a quick "no".
• Focus on the future productivity of the asset you are considering.
If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.
• If you instead focus on the prospective price change of a contemplated purchase, you are speculating.
There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am sceptical of those who claim sustained success at doing so. The fact that an asset has appreciated in the recent past is never a reason to buy it.
With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.
• Forming macro[economic] opinions or listening to the macro or market predictions of others is a waste of time.
Indeed, it is dangerous because it may blur your vision of the facts that are truly important … So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.
In the 54 years we [Mr Buffett and Charlie Munger, his business partner] have worked together, we have never foregone an attractive purchase because of the political environment, or the views of other people.
In fact, these subjects never come up when we make decisions. It’s vital, however, that we recognise the perimeter of our "circle of competence" and stay inside it.
Even then, we will make mistakes. But they will not be the disasters that occur, for example, when a long-rising market induces purchases that are based on anticipated price behaviour and a desire to be where the action is.
Source Telegraph
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