Low Rates and Dividend Cuts: Solving the COVID Retirement Income Conundrum

COVID-19, the associated lockdowns and the government-directed attempts to ease the negative impact on economies have had a huge effect on many aspects of our lives. One, which may be easy for some to overlook, is on financial planning. This is perhaps most true of retirees. In the lockdowns’ wake, many monetary institutions (including the European Central Bank, or ECB) introduced policies that target lower interest rates. Additionally, many corporations have, either voluntarily or due to regulators’ guidance, cut dividend payments. Such moves are, we presume, well intended. Monetary institutions cut rates to try and spur lending and economic activity. Firms cut dividends to stabilise their finances. But such moves also create problems. Retirees who rely on dividends and interest to meet expenses may find their financial plan undercut. In Fisher Investments UK’s view, this may mean you need to consider another approach—one we call homegrown dividends.

In our experience, relying on income generated from securities through dividends and interest is a longstanding practice amongst investors globally. Yet it has flaws, which downturns frequently highlight. Lowering short-term interest rates is a classic monetary policy move to combat an economic contraction. In 2008, the US Federal Reserve (Fed), Bank of England (BoE) and ECB all cut interest rates dramatically to combat the downturn. They stayed low long after.

In America, the Fed cut overnight rates from 5.25% to a 0–0.25% range.ⁱ The BoE cut rates from 5.0% to 0.5%.ⁱⁱ After one hike in mid-2008 to 3.25%, the ECB cut its deposit rate to 0.25%.ⁱⁱⁱ At no point since then have rates come close to returning to pre-2008 levels. The ECB’s deposit rate is, as you may know, presently -0.5%. Even beyond this, all three institutions are currently engaged in asset-purchase programmes that lower long-term interest rates, called quantitative easing, or QE. Fixed interest yields and prices move inversely. By buying mass quantities of debt—including central-government, corporate and regional-government debt—these banks are lowering interest rates pretty much across the spectrum of assets available to retirees.

Meanwhile, the corporate world has also taken actions that could impair retirees’ ability to earn income. Headlines blared this spring when Anglo-Dutch oil firm Royal Dutch Shell cut its dividend for the first time since World War II. But it isn’t alone. In mid-June, one report noted that over 100 UK-listed firms have slashed dividends, with investors expected to suffer a 16% drop in dividend income.^iv About 10% of the US firms included in its major S&P 500 Index had cut dividends through early June.^v The ECB gave guidance to banks, typically big continental dividend-payers, to curtail payments until the COVID-19 crisis passes.

So what is an income-needing investor to do? In Fisher Investments UK’s view, the answer is simple: Change your thinking. We have long observed that many investors often think in terms of income, aiming for securities that provide dividends and interest sufficient to meet their needs. But in reality, what an investor who needs funds to meet expenses is seeking is cash flow, which could be achieved through income or selling portions of holdings. This multi-faceted approach to generating cash for withdrawal is what we refer to as homegrown dividends.

Thinking this way, in Fisher Investments UK’s opinion, allows you to see investing differently. When you are investing, it isn’t so much a security’s yield alone that matters in terms of achieving goals. It is the yield plus the price movement. This is called total return and is, in our view, by far the best way to judge a security’s return—and its ability to help you reach your financial goals.

To employ this method, you start by determining the sum you need to withdraw to meet your expenses. In doing so, it is helpful to note where you have flexibility and what is an absolute must. This can be very useful information in a downturn, when it may be wise to curtail any expenditure. From there, you simply determine how frequently you will withdraw funds, raise any necessary cash through sales and take the withdrawal.

Some will object that this is touching the principal of an investment. That is true. However, in many ways, it is a distinction without meaning, in our view. A dividend also touches principal, as £1 in dividends paid per share reduces the share price by £1. This isn’t theoretical—it is how dividends have always worked. It can sometimes be hard to see due to market volatility, but the act of getting a dividend reduces the share price—dipping into principal.

Focusing on total return and employing a homegrown-dividend strategy can help you take control of your withdrawal plan and needs, avoiding reliance on the timing and size of interest and dividend payments. You may want to consider this option if you are facing cuts from COVID-19.

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