The Rate-Sensitive Retiree
Margaret, 68, holds a £600,000 portfolio: £450,000 in a 12-year gilt ladder bought when yields were near 1%, and £150,000 in a short-duration corporate bond fund. She needs £28,000 a year of income, inflation-linked, for at least 25 years. Her adviser notes that reinvestment risk is now material: ladder rungs maturing in years 3-6 will be reinvested at unknown rates. The corporate fund has a duration of 1.8 years and a yield of 5.1%. Margaret says she cannot tolerate seeing capital fall and wants to move the whole portfolio to cash ISAs paying 4.6%. The adviser is also aware that a large gilt allocation creates concentration and that Margaret's stated risk tolerance conflicts with her 25-year horizon.
1. Assess whether moving entirely to cash satisfies Margaret's income need and objectives over her horizon.
Read the worked answer
Cash at 4.6% on £600,000 yields £27,600 - just below her £28,000 need before any inflation erosion. The rate is variable, so a fall to 3% cuts income to £18,000, a 36% shortfall. Over 25 years, reinvestment risk in cash is arguably higher than in a ladder, because every maturity reprices. Cash also has no inflation linkage, so real income declines steadily. The adviser should reframe: cash solves the symptom (volatility) but not the objective (durable real income). A partial cash buffer of 1-2 years' spending is sensible; total allocation is not.
2. Recommend how to restructure the gilt ladder and corporate fund to manage reinvestment risk while respecting her stated loss aversion.
Read the worked answer
Extend and diversify the ladder: stagger maturities out to 20+ years so only a small slice reprices each year, and consider index-linked gilts to match inflation. Use the maturing short rungs to buy longer-dated or index-linked stock rather than rolling into cash. For the corporate fund, duration of 1.8 years limits rate sensitivity but concentrates credit risk; spread across investment-grade issuers and consider a strategic bond fund for flexibility. Explain that holding gilts to maturity returns par regardless of interim price moves, addressing her capital-fall concern. Document the discussion and her informed decision.