Thinkpiece

01 Oct Thinkpiece

Are you using your portfolio like a bank account?

In this update:

• Why your portfolio should not be treated like a bank account.

Is your Investment Portfolio a Piggy Bank? Think Again!

It’s a scenario many of us dream of – checking your investment portfolio and seeing a significant sum, perhaps even enough to make you feel like you’ve won the lottery. The temptation to dip into that pot for a new car, a lavish holiday, or to cover an unexpected expense can be overwhelming. But treating your investment portfolio like an ad-hoc bank account is a surefire way to jeopardise your financial future.

The Illusion of Abundance

That healthy balance in your portfolio isn’t necessarily a windfall to be spent freely. It represents capital that is working for you, compounding over time to build your wealth. Each time you make a large, unscheduled withdrawal, you’re not just taking out a sum of money, you’re removing the potential for that money to grow and generate future returns. It’s like harvesting a tree for its fruit but then cutting down the tree itself – there won’t be any more fruit next season.

The Peril of Market Downturns

This destructive habit becomes even more damaging during negative market cycles, which are a perfectly normal part of the market cycle. When markets fall, as they naturally do from time to time, the value of your investments naturally decreases. If you withdraw capital at this point, you’re crystallising losses and selling assets at a lower price than you might otherwise. This means you need to sell more units from your investment to get the same amount of cash, leaving even less capital in your portfolio to recover when the market eventually bounces back. It’s a double hit that significantly hinders your portfolio’s potential for long-term growth.

The first rule of compounding: Never interrupt it unnecessarily.

Charlie Munger

Sustainable Income: The Smarter Approach

Instead of eyeing the total capital, consider your portfolio’s natural income. Many investment portfolios, particularly those with a focus on income-generating assets like dividend-paying stocks or bonds, can provide a sustainable stream of income each year. This is the “fruit” of your investment tree.

The key is to budget for and live off this natural income, much like you would a salary or a pension. This allows your core capital to remain invested and continue to grow and compound over the long term. If your portfolio is designed to provide, say, a 3% or 4% income yield per year, then that’s the figure to focus on for your spending. Any withdrawals beyond this “natural income” are essentially eating into your future.

Why Portfolios Don’t Like Large Withdrawals

Investment portfolios are not designed for large, arbitrary capital withdrawals. They are built for long-term growth and stability, and large capital reductions can severely disrupt this. Imagine a finely tuned engine – suddenly removing a significant part will throw it out of balance and reduce its efficiency.

For those who are serious about planning for their long-term financial goals, it’s crucial to understand this distinction. A well-structured investment plan should involve calculating a sustainable withdrawal rate based on the income your portfolio generates, rather than dipping into the capital whenever the urge strikes.

The intelligent investor is a realist who sells to optimists and buys from pessimists.

Benjamin Graham

In Summary: 

• Don’t treat your portfolio like a bank account. It’s a growth engine, not a spending pot.
• Focus on natural income. Budget for and live off the sustainable income your portfolio provides.
• Avoid large capital withdrawals, especially in negative markets. This destroys future growth potential.
• Plan for the long term. Sustainable investing is about building and maintaining wealth, not quick spending.

Your opportunity

If you’ve not yet put in place a sound financial plan and you’d like to know more, please feel free to contact us on 01626 305318 or via email here.

The value of investments can go down as well as up. You may end up with less back than you have paid in. Past performance is no guarantee of future returns.

The views expressed are not to be taken as financial advice. Professional advice should be sought before proceeding.