Why equities are essential for growing retirement income

Stephen Payne gives his views on why equities are essential for growing your retirement income

The good news is we are living longer, healthier and more active lives than ever before. As a result, we will, on average, enjoy our retirement years for longer and be fit enough to be active for many of them.

Latest figures from the Office of National Statistics predict that one in six of us alive today will live to be 100. That is ten million centurions compared to less than 12,000 now - the monarch is going to be sending out an awful lot of telegrams!

While this is great news, the only issue is how are we going to pay for all these extra active years? As the Pensions Minister Steve Webb points out: "Many millions of us will be spending around a third of our lives or more in retirement in the future."

If you retire at 65 and live until 85, your pension needs to be able to fund 20 years. But if you live to 95, the number of years increases by 50%. Due to inflation, those last ten years will also be more expensive than the previous decade, which means that the amount of extra money you would need would increase even more than 50%.

Our costs in our retirement years also seem to be higher than at any point in history. One in ten people aged 70 and over are still paying to support their children, and a quarter of grandparents are paying towards the upbringing of their children's children.

It is clear we are going to need investments that can grow in value to provide a pot of money to meet this greater income need, as well as assets that continue to grow the income from our investments beyond our retirement date in order to maintain our real spending power.

With the current low interest rates and bond yields, savers must look towards the mainstream asset class that can deliver the required growth over the long term: equities.

Why invest in equities?

Fundamentally, the value in holding a share is the dividends that it pays you as an investor. These dividends are driven by and paid from the profits and cashflow that the ­company generates.

In simple terms, the sales of a company are increased by both economic growth pushing up v­olumes of units sold and also inflation pushing the price upwards of those goods sold.

This sales growth feeds through into profit growth which enables the company to pay out a growing dividend to shareholders.

Given the poor performance and volatility of equity markets over the past decade, it is not surprising that some investors have shied away from this asset class.

However, we must take a longer term perspective and look at what equities have delivered over the equivalent of a working lifetime.

We should also consider the ­possibility of equities delivering real growth ahead of inflation. The latter point is crucial. Cash is usually perceived as a risk-free asset, but over the longer term it is not.

Inflation is a risk to our wealth that cannot be ignored. It eats away at the spending power of our money over time. If inflation runs at 4% for a decade, the amount of goods and services that a cash sum would be able to buy by the end of that decade would only be two thirds of what you could have bought at the beginning.

Over a long retirement, this is unacceptable. Similarly, the income received from bonds may be higher than cash (and possibly, equities initially). But again, it will not grow over time and so its spending power will be diminished with the passing years.

By having a proportion of ­investment in equities, even into our retirement years, we can benefit from dividend growth. This will help counteract the negative impact of inflation and help us preserve the much needed spending power of our hard-earned retirement savings.

Stephen Payne is equity income fund manager at Santander Asset Management