By Bill Storie
This is the 3rd in the weekly Series called Retirement Happiness. In this Series we discuss the issues and concerns about money, and how its various components are so inter-twined that sometimes we cannot see a solution to our constant fear of running out of money as we get older.
Part 3 – Investment Income (Stocks)
Generally speaking there are three types of standard investment for your pension fund :-
1. Stocks and shares
2. Fixed income securities
3. Mutual Funds
This Part will discuss the first, #1 – Stocks and Shares and relates to the investments made by your private pension fund, as opposed to an independent investment portfolio you may additionally own. Usually the private pension fund will have professional investment managers administering your share ownerships, as opposed to you personally making the buy/sell decisions.
Simply, this category relates to the buying of shares in public companies i.e. companies whose shares are listed/quoted on the major stock exchanges around the world (e.g. New York, London, Tokyo, etc). The shares can be ordinary shares or preference shares.
An ordinary share will have a value i.e. the price you paid for it and the subsequent increase or decrease in its value. Also, in the majority (but not all) cases, the ordinary share will pay an annual dividend (either quarterly or in 2 instalments per annum). This is referred to as a “dividend-paying share). The company decided annually whether it has to financial capability to pay the dividend and on occasion, in lesser times, the company may decide to cancel its dividend in any given year(s).
A preference share will carry a pre-determined annual dividend, and only in unforeseen, bad conditions would it not pay its preference dividend. The value of the preference share, while it can fluctuate, general trades in a narrow band around its issuing price.
Thus ordinary shares are bought for both value purposes (price goes up) and/or dividend-paying ability, whereas the preference share is typically only bought for its dividend-paying. Both types of share have their merit in being part of the pension portfolio.
While neither share should be bought on the belief that its value will grow and grow year over year, nonetheless for purposes of this discussion we will assume a modest annual increase in value for the ordinary share and a static value for the preference share, both over the year.
If the ordinary share is bought at say $100 and it pays an annual dividend of 4% then you will receive $4 dividend income for the year. Additionally if it grows in value by say 5% per annum then the value of the share will be $105 at year-end. Therefore your total income for the year is $9 ($4+$5).
If the preference share is bought at $100 and pays a 5% dividend (and no value increase) then your total income for the year is $5.
Stocks go up, but stocks also come down. So, if you are jittery about the ordinary share losing value then the preference share, by and large, may actually be the better choice as it is more “guaranteed”.
You should be able to instruct your pension provider, and in turn, the investment manager of your pension fund, what tolerance level you have for your investment decisions, ranging from “conservative” to “aggressive”. It is not an easy decision to make, especially to get it consistently right, so every appropriate financial advice must be taken. This is a broad overview and by no means can be classified as solid advice in your case. Be careful.