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Weekend reading: Three graphs that boil down the retirement income conundrum

Weekend reading logo

What caught my eye this week.

These three graphs from The Retirement Café illustrate the case for a so-called ‘floor and upside’ approach to investing for an income in retirement.

Some people plan to have all their money at the mercy of the markets in retirement. They’ll then make systematic withdrawals, either by selling down capital, taking an income, or a mixture of both.

That’s a fine approach on paper – especially if you like an exciting read, because the fact is you don’t know how the story is going to end:

 

An alternative is to turn your entire pension pot into a certain income. This is the equivalent of what you used to have to do in the UK when you were compelled to buy an annuity:

The floor-and-upside approach always looks the most sensible blend to me – if you can afford it. Here you turn some of your funds into a guaranteed income, and invest the rest in volatile assets:

The lack of a scale on the first two graphs does flatter the cost of buying a secure ‘floor’, in terms of forgoing potentially superior returns. But that’s a minor gripe. Do read the whole article.

Remember that British retirees are entitled to a state pension, which provides some element of your secure income floor. See our previous articles on creating a secure retirement plan and devising your income floor.

From Monevator

Types of investing risks – Monevator

From the archive-ator: The time value of money – Monevator

News

Note: Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber.1

Three million stock indices dwarf tally of quoted companies [Search result]FT

Hammond calls for simpler inheritance tax [Search result]FT

Number of millionaire households in UK surges to 3.6 million – ThisIsMoney

Surprise rise in UK house prices as lack of homes for sale fuels lift… – Guardian

…while UK mortgage lending falls to lowest level since January 2015… – Guardian

…and interest-only borrowers are in denial, watchdog warns – ThisIsMoney

What’s a Ping Pool? A VIP lounge for dark trading – Bloomberg

Record number of Americans expect US stocks to rise – Tracy Alloway

What hedge fund managers earn (on average) to lag (on average) the market – SumZero

Products and services

Last chance to claim £1,100 Lifetime ISA bonus – Telegraph

Are the days of the trust fund numbered? [Search result]FT

M&S Bank launches top mortgages for first-time buyers – Telegraph

Personal finance apps can’t automate adulthood [US apps but relevant]BuzzFeed

Portfolio charts has been updated with new data for 2017 – Portfolio Charts

Inside the bustling comic-con of ETFs [Podcast]Bloomberg

Neil Woodford’s funds hit by exposure to Capita – ThisIsMoney

Comment and opinion

Retirement strategies: Floor-and-upside [US but relevant]The Retirement Café

It’s hard to predict how you’ll respond to risk – Morgan Housel

Taxing issues – SexHealthMoneyDeath

Can you really save for a deposit by ditching coffee and avocado toast? – Guardian

Richard Beddard: The beauty of buy and build companies – Sharescope

Larry Swedroe: Size premium persists – ETF.com

From glass half-empty to half-full, but still no euphoria – Investing Caffeine

Active risk: One fund’s 20-years of out-performance lost in four years – Servo Wealth

Economic progress doesn’t equate to stock market returns – Morningstar

Five lessons from semi-retirement – Humble Dollar

Are company spin-offs worth a look? – The Value Perspective

The best way to lose $5 billion – Of Dollars and Data

Read this before joining as employee 1 to 20 at a startup – First Round

Crypto corner

Bitcoin whipsaws investors as bubble shows signs of bursting – Bloomberg

Bitcoin is the new gold, perhaps. But it will never be a currency – Bloomberg

Brexit

Worse off under all scenarios after Brexit [Search result] – Government via leak via FT

Credit BuzzFeed for the scoop – BuzzFeed

Leaked Brexit impact report: key questions answered – Guardian

How to make sense of those pesky Brexit forecasts – BBC

Simon Jenkins: The brave Brexit speech Theresa May is afraid to give? Here it is – Guardian

Off our beat

Fitness app discloses the location of secret military bases – TechCrunch

You’re on the verge of losing everything – but you don’t understand why – BBC

Deepfakes porn has serious consequences – BBC

Grand Theft Life: Interview with Tim Urban [Podcast]Invest Like The Best

Hardcore History Episode 61: Painfotainment [Podcast]Dan Carlin

Working from home with pets [Silly pictures]Ask a Manager

And finally…

“It’s easier to hold your principles 100% of the time than it is to hold them 98% of the time.”
– Clayton M. Christensen, How Will You Measure Your Life?

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{ 44 comments… add one }
  • 1 Vanguardfan February 3, 2018, 10:47 am

    Nice topic – I’d like to see more on decumulation. Just a clarification on the ‘entitlement’ to the state pension – you need 35 years of non-contracted out NI contributions or credits to get the full state pension – ie it’s a contributory benefit rather than a universal entitlement. Working out individual entitlement can be quite complex especially if you’re within about 20 years of state pension age. of course the age at which it can be claimed is rising.

  • 2 hosimpson February 3, 2018, 11:08 am

    I see a few links to articles about house prices. So how is the flat purchase coming along?

  • 3 Richard February 3, 2018, 11:51 am

    I would think that for most couples the joint state pension of over £16k should be plenty of floor. Of course the main risk is one passing early and messing this up as £8k starts to feel a bit tight (especially if you are used to £16k plus). Maybe life insurance is a better buy than more floor income to compensate? Though the insurance money needs to be put somewhere so you are back to square one. Though at least you don’t have to tie up too much as floor income of the bat.

  • 4 The Rhino February 3, 2018, 12:22 pm

    On the Morgan Housel piece. A monumental IT failure has given me a visceral insight into my risk tolerance this week. Like bones, IT is quick to break and slow to fix..

    Now when did I do that last backup?

  • 5 John B February 3, 2018, 12:26 pm

    My suggestions for IHT sent to the Office of Tax Simplification.

    1) Roll the house allowance into the main allowance. It is complex to administer, and penalises those without children who are still passing funds within their families.

    2) Allow taper relief to apply to all gifts.

    3) Replace the complications of marriage gifts, small gifts, gifts out of income with a single number, say £10k/pa, and not taper it. Leave the living costs exemption.

    4) Include pension pots inside IHT. They are assets like any other.
    5) Remove the relief on gifts to political parties. They are not charitable.

  • 6 ian b February 3, 2018, 2:01 pm

    IHT

    Place the tax on the inheritor rather that the deceased.
    Each inheritor would be give an inheritance allowance.

  • 7 Accidental FIRE February 3, 2018, 2:10 pm

    The combination strategy is one I’ve been considering here in the U.S. I’m a public sector worker so I do have a pension, but I’m considering turning one of my other retirement assets into an annuity as well. In the end, I’ll have a pension + annuity, plus my other investments which are still substantial and which I’ll keep invested in the more volatile market.

  • 8 PC February 3, 2018, 2:34 pm

    How much income floor do you really need? Guardian article on 78 year old living pretty well on £18,000 a year in London https://www.theguardian.com/money/2018/feb/03/78-18000-income-london-pension-holidays-car-theatre-trips

  • 9 Vanguardfan February 3, 2018, 3:02 pm

    @PC would anyone argue that £18k is a fine floor for one person without a mortgage or rent to pay?
    The important things to note from that article are that she knows exactly what she has to play with, and seeks out good value for her discretionary spend. She doesn’t buy new clothes or tat for the house. I’d hazard that her main financial risk is related to house repairs and maintenance. But I imagine she’s also got some savings for that.

  • 10 PC February 3, 2018, 3:14 pm

    @VanguardFan I guess it is, but I was surprised how much she got out of it. I would have guessed she needed 1/2 as much again. But then my Dad often used to tell me that you don’t need anywhere near as much money as you did when you were working when you retire.

  • 11 Vanguardfan February 3, 2018, 3:38 pm

    @PC My dad, who is nearly 90, spends about that, and that’s including about £900 a month on care costs (so his actual floor, heat and eat, is less than about £7k a year). If he were less frail, the excess would all be available for ‘fun’. You really don’t need much once you have acquired all the ‘stuff’ you need, and most older people have no interest in updating their soft furnishings. The other instructive part of her story was the access to amazing free stuff in London, and remember also she has free travel to get to it all. It’s a bit harder if you’re out in the sticks with no bus services and not even many taxis to get you to facilities and people.

  • 12 Felice February 3, 2018, 3:53 pm

    Funnily enough, just reading up on just these sort of queries in McClung’s Living off your Money http://monevator.com/review-living-off-your-money-by-michael-mcclung/ At the risk of generalising, most of the strategies use the bond allocation to protect the equities proportion when returns are poor / negative.
    One query that has come up: do the benefits of a portfolio diversified with many funds, as opposed to a fund with built in diversification (e.g. Global Equity Fund), outweigh the additional costs of periodic re-balancing of multiple funds? As McClung assumes no charges, I won’t find the answer in his book!

  • 13 Mr Optimistic February 3, 2018, 4:09 pm

    Even in the sticks £18k gross should do it for one, as a floor.

  • 14 Learner February 3, 2018, 4:14 pm

    > How much income floor do you really need? Guardian article on 78 year old living pretty well on £18,000 a year in London

    3 pensions and a (probably) million pound house which can be downsized when she “gets round to it”, freeing up another half mil to double her income (over ~22 years). I imagine this is vastly more than most people can expect.

  • 15 Vanguardfan February 3, 2018, 4:37 pm

    Interesting to compare our 78 year old Londoner with the millennial in this article:
    https://www.theguardian.com/money/2018/jan/29/can-you-really-save-for-a-deposit-by-ditching-coffee-and-avocado-toast-i-tried-to-find-out
    I reckon that, if our older lady had to pay the same rent and travel costs as the younger one, and adding on tax and NI (assuming her £18k is net, which we aren’t told), then I think she has an income very comparable to the millennial. The approach to their lifestyles and budgeting is very different though, largely reflecting their different stage of life. But yeah, both of them really have plenty if managed well.

  • 16 Haphazard February 3, 2018, 4:53 pm

    Yes – she seems to survive partly on her late husband’s pension – so not an example of an ex-council worker getting to this stage on her own.

    Vanguardfan raises a good point about the cost of care. This is what makes me think I need more than my “minimum spend” (food, energy costs etc.) in retirement. It’s ok for the fit early-retired, but what when you lose your memory/ your sight/ your continence etc. and start needing help with basic tasks? If you want to stay out of a care home, will you have to pay a care assistant’s salary? And pay for someone to assume power of attorney? Unless your children are going to step in, of course! I think the retirement industry sell us a very rosy, “aspirational” view of things (pics of people standing astride mountain peak, etc.)

  • 17 Survivor February 3, 2018, 5:42 pm

    @ Haphazard – agreed, plan for the worst, hope for the best, given the chaos & lack of accountability in the aged care industrial complex. The likes of Carillion show that while your faculties are still sound, you have to plan very carefully indeed to not burden your loved ones, nor rely on a state backup that’s being steadily stripped away in front of us.

    Even with good advance planning, there’ll have to be some checks & balances, given the infrastructure of the ‘care’ industry for all intents & purposes has evolved into massive outsourcing specialist corporations run by global financial institutions for profit at any cost. On the ground for the little people, this equates to waiting to die in some home staffed by demoralised, sub-living wage, bottom-rung immigrants & those ‘indigenous’ who can’t game the benefits system. The parent entities will raid their own pension funds, borrow as much as they can & then collapse the house of cards by walking away from contracts they underbid to get. The Govt. of the day will say it’s nothing to do with them, that’s what they outsourced it for & the regulator will have a conflict of interest in that they’ll be using their own head as a plug.

    So, the wise will have to raise their game by thinking unconventionally – off the top of my head, I know a few Western Europeans on very modest pensions who’d be struggling at home costs, living in villages in countries like Bulgaria. They can live comfortably by renting a nice house with all the help they need, access equivalent medical care & are no more socially isolated by the cultural differences than they would have been by being poor back at home. Others risk more if they’re adventurous & still quite healthy, by living somewhere like Thailand which costs a lot less, but has first world amenities they can now afford as their pensions buy more there.

  • 18 Tyro February 3, 2018, 5:49 pm

    @ Haphazard:
    “she seems to survive partly on her late husband’s pension – so not an example of an ex-council worker getting to this stage on her own”

    Yes, but remember women of her generation typically spent very few years in the *paid* labour market, because social norms were such that they spent all or most of their time doing the (unpaid) labour of running the home and looking after children etc. If I remember rightly in that piece she says both that she only worked for a short period (Council and NHS), and that she has a four-bedroomed house, which suggests that her life followed that course. Things are very different now; the experience of that generation of women is not being replicated by later cohorts, at least not those in the age range likely to be reading blogs about future retirement. So from here on in nearly everybody should have at least the state pension + (given auto-enrolment) a bit of occupational pension too.

    I am an early retiree many years away from getting the state pension. My annual income at present is substantially higher than £18,000, but looking at the last couple of years’ spreadsheets I see my annual spending is under £12,000 (!) This includes, over the period, 5 foreign holidays (none of which involved staying with friends or relatives, and one of which was 3 weeks+, long-haul), numerous trips to theatres, cinemas, National Trust properties and the like, lots of train trips within the UK to visit friends and relatives or have days out, gym membership, meals out (though not as many as six or seven a month like the woman in The Guardian – probably half that) and other social activities involving beverages, gifts, clothes, and stuff for the home (none of it from charity shops in my case), and frequent shopping in Waitrose. And, of course, all the basics – council tax, broadband, mobile phone, TV licence, home insurance, gas and electricity, and transport (I’m not old enough to get free bus rides, but don’t at the moment own a car). So yes, it can quite easily be done! I’m still saving into a pension and ISA but tell myself this is irrational and I should try and boost the spending instead …… FWIW I think a single person can live on two-thirds of what a couple can live on, or to reverse it, a couple needs 1.5 times what a single person needs.

  • 19 Haphazard February 3, 2018, 7:01 pm

    @Tyro – a very fair point. Thanks for the correction.
    Though I’m not sure whether bringing up children is to be regarded (just) as unpaid labour… I hope some parents see more in it than that!

  • 20 tom February 3, 2018, 7:08 pm

    That ’20-years of out-performance lost in four years’ article is a wind-up. You can’t comment on a fund’s long-term performance if it has different managers (as FPA Capital has had). As soon as a new manager comes along, it’s a new fund.

    Bob Rodriguez (the former manager) is one of the greats and a classic example of how Active management with carefully chosen managers is preferable to Passive.

  • 21 Neverland February 3, 2018, 8:01 pm

    First Round article is unintentionally hilarious

    Sitting at a computer writing code as superheroism

    Really?

    … dotcom bubble v1.2

  • 22 Brod February 3, 2018, 11:10 pm

    I too was worried about how I’d meet the essentials so I moved from the private sector to the public. The pay is less (about a third) but I did the math around the pension and thought it was worth it. Especially working in IT in your early 50s is very precarious.

    When I retire (about 3 years hopefully) I’ve set my floor at £15k (state pension £8k and my civil service pension £7k). And that’s not far off what we spend now as a family of four excluding mortgages payments which will be paid off in 18 months or so. Happy day 🙂

    My private pension will allow us some luxuries and be passed to my wife. I hope.

  • 23 The Borderer February 4, 2018, 1:15 am

    @Neverland – re: the First Round article.

    Do people really communicate with words like “triage your time ” and “cathartic documentation”?

    … dotcom bubble v1.2? More like Birtspeak 2.0

  • 24 Tyro February 4, 2018, 3:10 pm

    First Round article – yes, I thought it was a hoot too. Somebody, please, send it to Private Eye’s ‘Pseuds Corner’. As a public service I offer my translation from Silicon Valley Millennial-speak: prioritize, focus, define timescales, write stuff down, streamline, know what you want before you hire it, reflect on mistakes.

  • 25 Neverland February 4, 2018, 3:46 pm

    @Tyro

    Portentous articles about an industry usually precede a deep brutal shake-out

    Plenty of dead unicorns littering Silicon roundabout already: the latest Dan Wagner car crash; Vevo; Moshe monsters

    If I tried I could come up with a big list pretty easy

  • 26 Factor February 4, 2018, 8:13 pm

    Remember to allow for the likely tax hit on any occupational pension income.

  • 27 The Rhino February 4, 2018, 9:44 pm

    I was in silicon fen this week. Didn’t bump into anyone like matey in the first round article. Bit of a shame, she sounded like a wise head on young shoulders?

  • 28 Learner February 4, 2018, 11:26 pm

    @Brod, how long ago did you switch? Probably wise; 40+ is rare enough, 50+ almost unheard of. Remains to be seen if there will be a demographic ramp moving though due to the industry expanding in the 90s, but I somehow doubt it.

  • 29 Gally February 5, 2018, 12:52 am

    My dilemina at 71 with quite a lot of gains is do I stay invested or withdraw them. If this bubble bursts will I have time to wait for recovery.

    The 4% drawdown rule and 60/40 or investing in retirement does not help assessing when to capitalise gains and enjoy.

    Is holding onto gains a wise decision?

  • 30 dearieme February 5, 2018, 3:48 am

    @Factor:”the likely tax hit on any occupational pension income” – what do you have in mind?

  • 31 Neverland February 5, 2018, 7:57 am

    @Rhino

    Methinks you are trolling matey 😉

  • 32 The Rhino February 5, 2018, 9:02 am

    @NL – haha, did i say ‘wise head’? Meant to say ‘mad as cheese’..

  • 33 Vanguardfan February 5, 2018, 9:25 am

    @gally. It’s at this point I feel it’s useful to have a written investment plan, which includes your personal target asset allocation and rules for rebalancing (and if appropriate, rules for making withdrawals). I’ve yet to be invested through a major correction, but I am fully expecting it to feel bad! So I will take out my plan, read it, put it away and sit on my hands.
    My questions for you are: what’s your asset allocation and does it correctly match your risk tolerance and capacity? Do you have an adequate cash buffer (or guaranteed floor income) to be able to reduce your need to sell when the market is down? In short, what’s your plan for responding to these (entirely normal and predictable) market conditions?

  • 34 The Rhino February 5, 2018, 12:14 pm

    I wonder whether sentiment has just turned and ‘now’ marks the beginning of the next bear market?

  • 35 Factor February 5, 2018, 1:53 pm

    @dearieme (30)

    Nothing sinister or clairvoyant but merely the surprising extent to which some people, when calculating their anticipated retirement income, seem blissfully unaware that PAYE applies to occupational pensions income, and occasionally even unaware that the state pension is also taxable.

  • 36 Gally February 5, 2018, 3:55 pm

    Thanks Vanguard for your response. The point I wanted to have advice was the general issue of age related risk tolerance and portfolio design.

    I have a fully diversified Vanguard portfolio that meets my risk tolerance and needs. However as one gets older needs change and risk tolerance may change. For example at 71 male life expectancy is 14yrs reducing to 9yrs at 78. One might therefore suggest that portfolios need revising in later years.

    I might not have chosen to do this at 71 but sitting on a pile of gains might be an opportune time as any recovery period will eat into life expectancy.

    I know it is against the hold forever theory but there is obviously some experience or rules of thumb out there that offer insight to the norms if there are any. Bearing in mind cash spending needs decline with Age excepting paying for care fees.

    Although I don’t need the cash my first thought was if its available now why not take it.

    A difficult decision to take hence what are the collective thoughts and issues to consider.

  • 37 Vanguardfan February 5, 2018, 4:34 pm

    @gally – yes, very important point that investment plans should be reviewed and changed if necessary as time goes on and circumstances change. But the principles are the same – is your plan what you want now, does it meet your objectives? Is the asset allocation right? How would you feel if the market crashed 50% and took years to recover? On the other hand, if you decided to take some risk off the table, what would you do with the cash?
    Yes there are ‘rules of thumb’ about eg bond allocations, and much discussion about glide paths and de-risking portfolios with age, and a whole range of different conclusions reached, depending on personal circumstances and preferences. Your conclusion only has to suit you. And, if you don’t need the cash, then you’re in the happy position that whatever you decide, will be fine.

  • 38 Gally February 5, 2018, 6:09 pm

    After looking at the options and listening to everybody I whatever we decide could be right or wrong in the long term, so my wife and I have decided to take half of our profits on the basis that will only ever be half right or wrong in the long term and we can enjoy spending the cash while we have the time, health and energy.

    Thanks

  • 39 Brod February 5, 2018, 10:54 pm

    @ Gally, excellent reasoning! 🙂

    @Learner, I was 48 but I do look a little younger. But I also have a young family and agreed with my wife she’d concentrate on her career and I’d be the one to drop things for the kids if needed. Civil Service great for that. Unfortunately, the fall in the price of oil has put paid to that…

  • 40 dearieme February 5, 2018, 11:37 pm

    @Brod: “The pay is less (about a third) ” – about a third less or about two-thirds less?

  • 41 Brod February 6, 2018, 6:56 pm

    @Dearime – about a third less.

    Add in the pension, take away the share save schemes and add in the 50ish job market (I’ve learnt to ask what a ZX80 is) and I’m ahead. Especially with this market volatility 🙂

  • 42 Hospitaller February 10, 2018, 4:57 pm

    @ The Rhino “I wonder whether sentiment has just turned and ‘now’ marks the beginning of the next bear market?”

    In essence yes I think this is the beginning although there might be a few more upticks before winter sets in. The reason I say that is that US govt 10 year bond yields reaching towards the magic 3% number (2.8% now) fundamentally affects the attractiveness of equities.

  • 43 Mathmo February 11, 2018, 12:25 pm

    @TI – I hope all ok with you. I appreciate I haven’t read last weekend’s weekly reading yet and it’s been on my to-read list all week and I was looking forward to it — but I didn’t realise my failure to do so meant another wasn’t published… 😉

  • 44 The Investor February 11, 2018, 1:48 pm

    @Mathmo — Cheers! 🙂 Have been caught up in moving etc and have no Internet at new place. Have dropped into an Internet zone to write a quick update but long/short no links this weekend alas.

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