Defensive asset allocation is trickier than the growth side of the equation. For the latter, you can just strap on a global equity tracker for portfolio propellant and be done with it. But there isn’t a universal ‘dark times’ asset class that reliably protects your wealth from economic misfortune.
A portfolio is exposed to multiple threat vectors: inflation, deflation, stagflation, recessions, and stock market bubbles. Fending that lot off requires a multi-layered defence. If the first line fails then perhaps the next will soften the blow.
Your choice is complicated by your personal risk exposure. For instance, inflation is typically a bigger threat to retirees than young people. The young are more exposed to recessions and periods of joblessness.
It makes sense therefore to strengthen where you’re personally most vulnerable – loading up on the assets most likely to counter your own financial arch-nemesis.
Know your enemy
Here’s a quick summary of portfolio pathogens paired with their most effective treatments:
| Threat vector | Best defensive asset | Worst defensive asset | Most exposed |
| Surging inflation, stagflation | Individual index-linked gilts, commodities, gold | Long bonds | Retirees |
| Deflation, recession, stock market drawdown | Nominal government bonds, cash, gold | Commodities | Mid-career, late-stage accumulators, aggressive equity investors |
| Currency debasement, sovereign debt crisis | Gold, assets priced in foreign currency | Domestic government bonds, cash | Investors heavily tilted towards domestic assets |
Handy though the table is, it’s missing nuance, and a generous sprinkle of ‘ifs’ and ‘buts’. Fear not: they’re coming next!
Gold, for example, looks like the ultimate wealth-preserver. I’ll have six sackfuls, please! But there are reasons to doubt it, too. (See the gold section below).
Also, just so we’re crystal clear:
- No asset class is risk-free or ‘safe’. Not even cash.
- No asset class is guaranteed to work on demand.
- Unexpected circumstances can nullify any defence.
- A defensive asset may come good but not immediately, nor for the entire duration of a crisis.
- Diversification is your best friend. Possibly your only friend in the capricious world of investing.
These negatives aren’t meant to crush morale before we get started. It’s just a bald statement of fact.
Hopefully things will go well for all of us. But it’s best to have the full picture in case they do not.
The historical record and inherent uncertainty about the future both point in the same direction: use every tool in the box.
The best defensive asset classes
Defensives are asset and sub-asset classes that can fortify your portfolio when equities go down. Each of the following can play a useful role:
Nominal high-grade domestic government bonds
(Also known as gilts in the UK)
Defends against: Demand-led slumps such as economic contractions, recessions, depressions, deflation, and stock market drawdowns.
Vulnerable to: Surging inflation and fast-rising interest rates.
Younger investors
Long maturities theoretically provide the best diversification for equity-heavy portfolios. Although it doesn’t always work out that way in practice.
Older investors
Favour shorter-dated bond maturities because longer-term government bonds are highly vulnerable to inflation and fast-rising interest rates. Such shorter-dated govies may be less effective in a downturn but offer a better overall balance of risks. They’re more resistant to spiralling inflation and interest rates.
Diversification options
Global government bonds hedged to the pound
Pros: Diversification across advanced economy government debt. Choose if you’re wary of having 100% exposure to the credit risk of the UK Government. Hedge them to offset the risk of adverse currency movements that swamp your bond returns.
Cons: Higher OCFs than gilt funds. Less crash protection due to lower durations. Indices tilt towards high-debt countries such as Japan, Italy, and the US.
Pros: Often outperform gilts in a crisis because dollar-denominated assets are viewed as a safer haven.
Cons: Currency risk means they can underperform at just the wrong time. Also US political risk.
High-grade corporate bonds
Pros: Offer higher yields than government bonds.
Cons: Corporates don’t perform as well as govies during most downturns. Essentially because countries can withstand economic peril better than companies.
Individual nominal gilts
Pros: Opportunity to target particularly useful bond issues. For example, investing in specific gilts can reduce your tax burden outside of tax shelters. Extremely long maturities may be especially potent equity diversifiers. No management or platform fees.
Cons: Require more hands-on management and a good understanding of bond mechanics. Not all brokers enable you to invest online.
Useful to know
High-grade (or high-quality) refers to bonds with a credit rating of AA- and above (or Aa3 in Moody’s system). Check out our bond terms post.
Bond maturity / duration: a brief guide to risk
The following table sketches out the three term-related bond risk categories:
| Bond maturities | Volatility | Suits | Yield / expected returns |
| Short (0-5 yrs) | Lower | Older investors, lower equity allocations, higher inflation concerns | Lower, cash-like at the shortest end of scale |
| Intermediate | Middle ground | Middle ground | Middle ground |
| Long (15+ yrs) | Higher | Younger investors, higher equity allocations, lower inflation concerns | Higher, but possibly not worth the extra risk |
Longer maturities imply longer durations, though other factors are in play as well.
Duration is the key metric when judging high-grade government bond risk. Your bond’s duration number1 is an approximate guide to how big a gain or loss you can expect for every 1% move in its yield.
For example, if a bond’s duration number is 11, then it:
- Loses approximately 11% of its market value for every 1% rise in its yield.2
- Gains approximately 11% for every 1% fall in its yield.
Read our piece on rising yields to understand how bonds respond when interest rates rise.
Index-linked government bonds (high-grade, domestic)
(Also known as ‘linkers’ in the UK)
Defends against: Inflation. Index-linked bonds also generally do okay in recessions but they aren’t as effective as nominal bonds.
Vulnerable to: Fast-rising interest rates (see below). Deflation – index-linked gilts lose nominal value when the RPI index falls as they lack a ‘deflation floor’. On the other hand, they won’t lose real value in this scenario, which is what counts most.
Snag: Index-linked bond funds can be real-terms losers in inflationary periods. That happens when steep interest rate hikes cause fund prices to drop. Sometimes the resultant capital loss is so severe that it drowns out the inflation-adjusted gains of the fund’s underlying bonds. The problem is solved by investing in individual index-linked gilts.
Individual linkers hedge inflation if held to maturity. Linkers still fall in price when interest rates rise but will make good the capital loss by their maturity date. Ignore that paper loss and each linker will ultimately return RPI plus the real yield on offer when you bought in.
In contrast, bond funds routinely sell their holdings before maturity. This causes losses in rising rate conditions (and gains when rates fall). The process doesn’t doom index-linked bond funds to lose against an equivalent portfolio of individual linkers over time. But it can make them a relatively poor inflation hedge.
Beware that if you buy individual linkers on negative yields – and hold to maturity – then you’re accepting an annual loss in exchange for broader inflation protection. In this scenario, the bond’s link to RPI means its value will rise to match inflation. However, the price you’d pay here for that inflation matching would be the negative real yield at the time of purchase.
Thankfully, real yields are now positive, so you’re covered against double-digit rises in inflation and you can make a small annual profit on top.
Younger investors
Can ignore index-linked gilts on the grounds that equities outperform inflation in the long run.
Older investors
Individual index-linked gilts held to maturity are the most reliable way to hedge inflation. If you use funds to hedge inflation then choose short-dated ones because long bonds are hit harder by soaring rates.
Useful to know: Don’t get hung up on index-linked gilts lacking a deflation floor. The UK hasn’t experienced annual deflation since 1933.
Diversification options
Short-term global index-linked funds hedged to the pound
Pros: Off-the-shelf convenience. Should outperform nominal bond equivalents during bouts of unexpected inflation.
Cons: Other countries’ inflation rates won’t perfectly match the UK’s. Interest rate risk interferes with inflation-hedging capability as described above. Currency risk issues if the fund isn’t hedged to GBP.
- For options, see the Global inflation-linked bonds hedged to £ section of our low-cost index funds page.
Index-linked gilt funds
Pros: May perform when interest rate rises aren’t a major factor. Aligned with UK inflation. No currency risk.
Cons: Almost all UK index-linked gilt funds have long average maturities / durations. An exception is iShares Up to 10 Years Index Linked Gilt Index Fund. Its lower duration places it on the outer rim of the short-term choices.
Individual index-linked gilts
Pros: Specifically designed to hedge UK inflation if held to maturity. No management or platform fees.
Cons: Require more effort to manage than bond funds. Not all brokers enable you to invest online.
Physical gold
Defends against: Stock market drawdowns, surging inflation, recessions, simultaneous falls in equities and bonds.
Vulnerable to: Volatility, small changes in demand, lack of fundamental value, myth-making.
Snag: Gold’s versatility looks incredible – like the everything burger of defensive assets. Yet there are reasons to be wary.
For one thing, gold’s track record as an investible asset is relatively short. That’s because it was subject to government control until 1975.
This means that unlike with bonds and cash, we can’t see how the precious metal performed during World Wars, depressions, and multiple inflationary episodes. There’s a danger that gold’s impressive history is flattered by a small sample bias. (Gold has only racked up 50 years as an investible asset class versus more than 150 years for other defensives.)
Moreover, beware being bedazzled by gold’s recent amazing run. Dig a little deeper and you’ll see that the yellow stuff fell 78% in real terms from 1980 to 1999.
Another concern is that physical gold returns aren’t linked to intrinsic value. Equities provide a claim on the future cash flows of productive businesses. Government bond interest is paid by tax revenues. Even commodity profits can be traced back to ‘roll return’ and interest on collateral.
In contrast, your gold gains are dependent on someone deigning to offer you a higher price than you bought in for.
Thus it’s worth asking if current gold prices are sustainable? Are they being driven by fundamental sources of demand? Or are waves of performance-chasers being suckered in by a succession of all-time highs? What happens when gold’s momentum falters?
The irresolvable nature of these questions underlies my caution about gold. For a (much) deeper discussion see the excellent Understanding Gold paper by Erb and Harvey.
Younger investors
Consider a 5-10% allocation for diversification purposes.
Older investors
Consider a 5-15% allocation for diversification purposes. Remain wary of overcommitting due to the question marks hanging over gold’s short track record and its high current valuation levels.
Diversification options
Gold miners: You’d have to be insane to think of miner stocks as a defensive asset class.
Gold future ETCs: WisdomTree Gold (Ticker: BULL) invests in gold future’s contracts and has seriously underperformed its physical counterparts since inception.
Silver: Appears to be a less powerful defensive diversifier because demand is more closely tied to economic activity.
Broad commodities
Defends against: Surging inflation.
Vulnerable to: Recessionary conditions.
Snag: Commodities are highly volatile and typically a liability during economic contractions when demand evaporates for raw materials. Diversification is key so choose broad commodity ETFs not single commodity funds.
Younger investors
Can ignore commodities on the grounds that equities outperform inflation over time.
Older investors
Potentially the best portfolio diversifier against inflation. Whereas index-linked gilts match inflation by design, commodities can massively outperform by nature. Commodities are especially potent when the cause of the price shock is global supply chain shortages – as occurred after each World War and post-Covid.
Diversification options
Single commodity ETCs
Pros: None – excessive idiosyncratic risk.
Cons: Studies show that a basket of diversified commodities significantly outperforms any single commodity over the long-term.
Commodity equities
Pros: None as a defensive portfolio diversifier.
Cons: Too correlated to the stock market.
Cash
Defends against: Demand-led slumps such as economic contractions, recessions, depressions, deflation, and stock market drawdowns.
Vulnerable to: Inflation, low interest rates.
Snag: Cash has delivered the lowest historical returns of any of the defensive diversifiers on our menu. Carrying too much cash will probably hold back your portfolio over time.
Younger investors
The flight-to-quality effect means longer-dated bonds are more likely to prop up an equity-dominated portfolio in a crisis.
Older investors
Cash is a useful complement to bonds. Cash won’t spike in value during a crisis but neither will it plummet when interest rates rocket. But beware the ‘money illusion’ effect when interest rates look good but are largely wiped out by inflation.
Diversification options
Money market funds (MMFs)
Pros: Highly responsive to interest rates. There’s no need to keep on top of Best Buy tables when interest rates are rising because MMFs automatically reinvest into higher-yielding securities. The opposite is true when rates are falling.
Cons: Riskier than cash. Money market funds can struggle to meet investors’ demands for their money back under extreme conditions. MMFs aren’t covered by the FSCS bank guarantee. (Your platform may be covered by the FSCS investor compensation scheme.) Management and platform fees.
Pros: Like money market funds they are highly responsive to interest rates. Backed by the UK Government so safer than MMFs.
Cons: Must be held to maturity – usually one, three, or six-monthly terms. Not covered by the FSCS bank guarantee. (Your platform may be covered instead.) Platform fees.
Defence in depth
If you’d like to see the multi-layered defence concept in action then check out our posts on:
- The All-Weather portfolio which has demonstrably dampened some of the world’s worst stock market crashes.
- The No Cat Food portfolio – it’s regularly tracked as part of our decumulation series.
Ultimately, a simple equity/bond portfolio was shown to be too simple by the events of 2022. Just swapping nominal bonds for cash is probably not ideal either. Money market funds have been soundly beaten by bonds in the long run.
What we know for sure is that all of the defensive asset classes we’ve covered above work some of the time. But none of them work all of the time.
They each have uses and flaws. As we never know what’s coming around the corner, the answer is surely diversification.
Take it steady,
The Accumulator
- Technically, modified duration. [↩]
- Yield to maturity or YTM. You can think of YTM like the interest rate you’ll get if you hold the bond to maturity. [↩]
![Decumulation: No Cat Food retirement portfolio - Year 2 checkpoint [Members]](https://monevator.com/wp-content/uploads/2025/09/NCF-portfolio-view_Sep-2025-v2-1024x442.png "Decumulation: No Cat Food retirement portfolio - Year 2 checkpoint [Members]")
What do you think about the Golden Butterfly from portfoliocharts.com?
Looks pretty defensive to me with a nice track history.
It’s funny because former hedgefund at AHL Robert Carver would argue that global diversification would be better than relying on national bonds.
Where do “money-market” or “liquidity” funds fit in the scheme of things? My workplace defined-contribution pension’s “lifestyling” uses them in the last couple of years before the target pension date to hedge against the assumed intention to draw a 25% tax-free cash lump sum (presumably because they don’t let you hold actual interest-paying cash). I’m wondering whether I should be doing the same in my SIPP, but it seems to be a not-entirely risk-free route to a negative return at the moment.
@TA – thanks, great article. Definitely agree bonds aren’t for returns so avoid equity-like high yield/junk bonds. They’ll fall in value just like equities.
Personally, I’ve a small CS DB so that’s my inflation protection (it’ll cover food, gas & leccy and council tax, so additional spending will have to be carefully considered) and it’ll allow me to be more aggressive on equities in my SIPP (targetting 80:20). I’m fully aware that with my DB, my actual pot is the sum of both, but hard to value the DB element – at comparable annuity rates (crazy!) or, as I settled on, my target SWR.
I’m doing a “reverse glidepath” (cf. McClung, ERN) and got my cash and gold. Selling bonds for VWRL, but only if it isn’t within 3% of its top. In this stock market that’s not many buying opportunities 🙁 FOMO rules!
I was thinking if I can’t buy VWRL as it’s too near, or at, a top, maybe VHYL instead to capture some of the bull market upside and as it’s not so inflated it won’t get hammered so much in a crash, but that’s just what happened last March so maybe not! (Small sample size, admittedly.) KISS!
@ Luis – I like the Golden Butterfly but there are three major issues with it that make me dubious about using it as advertised:
Portfolio Chart’s dataset is very kind to gold as it starts circa 1971 at the beginning of a huge run-up for the yellow metal. Tyler of Portfolio Charts acknowledges this. There are many other studies that slice and dice gold’s track record over different timeframes. Long story short: gold can perform wonders when investors fear currency debasement, and it can saddle you with decades of negative returns. No way I’d hold 20% in gold given its appreciation since 2008.
Small cap value – can invest in this easily as US investor. Much harder as a UK investor.
Long term bonds – this will look great from the perspective of Portfolio Chart’s dataset, and I appreciate the strategic role of long bonds, but I haven’t got the stomach for 20% given today’s environment.
In principle I agree with the level of diversification in the Golden Butterfly. But I can’t risk 60% in bonds and gold, and I can’t properly access small cap value (that holding is meant to compensate for the relatively small total stock market allocation).
I get my short and long bonds in intermediate gilt funds, risk factor exposure through a multi-factor ETF (greater diversity and less risk than small-cap value), and plan on a smaller gold asset allocation.
@ David C – money market type funds mostly seem to be of use for institutional funds who want a cash-like instrument. Seems like a complication too far for retail investors who can hold enough cash in bank accounts etc.
@ Brod – I envy you your DB pension 😉 Do you think of your set up as more of a floor and upside with DB as the floor?
@TA – I think that’s a more succinct way of putting it, yes. 🙂
I love my DB pension, but I specifically joined the CS to get one (and an easier life, to be frank, my human capital is all but squandered on women and wine, the rest I wasted 🙂 ) I traded a much better salary and stress for future security. It was a good deal!
@Luis – as well as future low returns from the bond heavy Golden Butterfly, it has also had an amazing tail wind from interest rates falling from 15% or so in the ’80s to today’s virtual zero.
Not for me either.
Vanguard Lifestrategy from memory was fairly heavy in investment grade corporate bonds, e.g. LS60 is 5.6% explicitly corporate bond made up of
Vanguard U.K. Investment Grade Bond Index Fund GBP Acc 3.4
Vanguard U.S. Investment Grade Credit Index Fund GBP Hedged Acc 1.5
Vanguard Euro Investment Grade Bond Index Fund GBP Hedged Acc 0.7
This means over 10% over your defensive allocation is to corporate. But you do get the simplicity…
I’ve been following Tim Hale’s advise on using global short term government bonds and index-linked bonds hedged, but have added some longer dated UK gilts and index linkers in my company pension with Aegon. They are a little expensive, but have the benefit of being topped up monthly so my asset allocation doesn’t wander so much and in the event of a crash I could use to help rebalance without incurring explicit trading costs.
@Brod
If you can’t bring yourself to invest at current prices, I know how you feel, but I felt better after reading this link from last weekend’s Monevator:
https://compoundadvisors.com/2021/should-you-invest-new-money-all-at-once-over-time-or-only-after-a-bear-market
It’s US-based, but then so is VWRL (at least 60% of it is).
@TA You’re probably right about money-market funds being unnecessarily complicated for a retail investor, but I can’t hold cash in my workplace pension (as far as I can see). I suppose I could hedge against the cash lump-sum with cash savings outside the pension wrappers, but my mind slightly boggles at handling that at retirement.
@TA. This is a good piece, with one exception. You can’t put short/intermediate govt bonds in one category and long govt bonds in another. Makes no sense. There is no step function between intermediate and long bonds in risk terms.
When you buy bonds, you should think in terms of duration-weighted exposure (cash x duration), not absolute cash exposure. So if you are thinking of two bond funds, one with duration 5 and the other duration 20, and you want to invest $100k, then if you’d buy 100k of the 5-year fund, you’d only buy $25k of the 20-year fund (and keep $75k in cash). Same weighted duration.
The constraint should always be the risk you want to run in bonds, not the amount of cash you want to invest. So if you invest $100k in a 10-year duration bond fund then you need to be thinking “I have $100 per basis point of risk” not I have $100k invested in bonds. Bond yields move 5bp higher, you lose $500 etc. The risk/basis point is the input, the cash you need to achieve that risk is just an output.
@ David C – having read ZX’s comment I think I’ve found a legit use for your money market funds. BTW, I also agree with you on using one if you essentially want to park cash in a pension for a while.
@ ZX – thank you – that’s a really useful way to think about my bond allocation. Using your example, would you prefer to hold the duration 20 fund + cash over the duration 5 due to the convexity of the longer bonds?
I don’t know why we don’t seem to have variable rate debt on offer – if you owe debt personally that can be variable, so debt that you own should be able to be in theory- so your yield could change but your capital is somewhat safer.
Because “fixed income” implies we prefer the safety of the interest over the safety of the capital, and as we all know it makes duration a thing, which it wouldn’t be with variable rate debt.
In a low rate would “fixed capital” debt might be attractive?
Thanks for this @TA,
I, like @Brod and several other regular contributors have DB income (+ more to come). Unlike Brod I wish I could say the path to DB “riches 🙂 ” was a stress free one, I can assure anyone a career in education is not stress free. (the booze and other things I have squandered my human capital upon, perhaps were a symptom of this 🙂 )
The original floor and upside post here (Possibly a TI one?, apologies if not) made me re-think many parts of my exposure.
Adding to this post if you do a re-fresh in later times, with a DB floor and upside addendum might be of use to the many who have this as an asset. (It might also benefit those with property income). I think these allocations are aimed primarily at people with SIPPS and few other income streams personally, although they still make good reading as food for thought in future allocation decisions.
Thanks again
JimJim
Is not you 60% equity allocation not a bit rich for decumalators like myself?
I’ve always tried to keep to the Bogle (and other’s principle) of holding my age in bonds and the balance in a global equity fund?
FWIW, for some years now I have thought that overall asset allocation is a useful idea in accumulation; but is not really so helpful in de-accumulation – particularly for folks likely to have ‘proper’ pensions! Some related chatter is at:
https://simplelivingsomerset.wordpress.com/2021/04/16/coiled-spring-and-missing-claw/
@Matthew — You write:
Such debt does exist in the form of floating rate corporate bonds. There used to be some investment trusts available that specialized in this form of debt; I haven’t looked for a long time so not sure whether or not they’ve been squeezed out of existence / commercial appeal by yields going relentlessly down.
With interest rates rising the appeal to investors would be obvious. The snag is likely to be that companies that would issue such debt know rates are more likely to rise, and they also know they can issue debt at very low yields right now. So there’s probably not a lot of incentive to issue much floating rate debt. I imagine it’s more often issued when yields are high.
Still, I’m sure some of it is still out there, and there may be circumstances where it’s a better liability match for a company than conventional bonds.
More: https://www.investopedia.com/terms/f/floating-rate-fund.asp
@David C – thank for your link. I’m sure I’ve read that a few years ago but it’s dated June this year. Ho-hum.
Anyway, my goal is slightly different. As I want to retire, my aim is to maintain my capital. So last November ’19 I went from 90/10 equities/gold to 30/55/5/10 equities/bonds/cash/gold (in March ’20 I thought I was a market timing genius! 🙂 ). Every two months, I will sell two months living expenses of bonds and buy equities if I’m working or use the money as errrm… living expenses if I’ve pulled the trigger. My target asset allocation is 80/5/5/5 equities/bonds/cash/gold plus my DB. That 5/5/5 will give me 8 years of living expenses. But I don’t want to buy at the absolute top as Big ERN’s analysis says better returns if you only buy if greater than 3% off the top. So while I would invest as a lump sum if time was on my side, it isn’t any more.
@JimJim – oh totally, respect! Working in the NHS, Police, Social Workers or any other front line services is also incredibly stressful. I will say though, lack of challenge can also be somewhat stressful but that’s my Faustian pact, and I reckon it’s a good one over front line public services.
But please don’t think I’m rolling in DB riches. I’m not. Currently it’ll cover literally just food, utilities and council tax. Forget meals out, holidays, running the car, a new washing machine, house maintenance, expensive hobbies,etc.. That will have to come from my SIPP and small ISA until my state pension kicks in to share the burden. Which is cool and why I’m so set on preserving capital.
@Brod, I don’t know many people in my line of work who make the DB pension rich list… Neither me or Mrs JimJim (Ex NHS) will pay tax on the amount we get if that is all we are living on 🙂
It is an amount we appreciate but is only one leg of the three legged pension stool. DBs are the Dogs B…….S but take some earning.
JimJim
@JimJim – sounds like we’re in the similar boats. Let’s hope it’s not the Titanic, eh?
@Brod:
Apologies in advance if I have misunderstood/misinterpreted your numbers at #18; specifically 15% of Pot provides for 8 years. It seems to me you are probably in a pretty good place with some fifty years of living expenses plus – in due course – DB and state pensions. If this is approximately correct I can fully understand why you are “so set on preserving capital”.
@ JimJim – Mrs TA is in education too and will eventually draw a small DB pension. It’s definitely not big enough to qualify her for the floor and upside club. More likely we’ll used it to pay for her PTSD treatment after a career in education 😉
Her DB pension will be so micro that I just think of it as back-up in case my SWR strategy proves too optimistic.
I could have used it to shave a few basis points off the SWR if it was bigger, or I probably would have treated it as part of our defensive, fixed income allocation if access to it matched our retirement dates.
I did put my mum on a floor and upside strategy with State Pension and small index-linked annuity covering the essentials. The upside was 100% global equities – so far, so good.
PS – I wrote the floor and upside pieces:
https://monevator.com/the-most-important-goal-for-every-retiree/
https://monevator.com/secure-retirement-income/
@ Brod – love that women and wine gag 🙂
@ Atlantic Span – I think risk tolerance has to trump everything. I seem to be OK at that level and would rather not commit more than that to bonds given the current environment. Like Brod, I think of how many years the defensive side could fund if equities were in the dumpster. I find that to be a useful mental framing device for how long I could live with bad news.
@Al Can – oops! That should read 80/5/5/10 equities/bonds/cash/gold WITH DB pension paying out. So 20% of my pot plus DB. That’ll sustain us with a bare-bones to moderate standard of living if we get a repeat of the ’70s. If I get made redundant, the DB should pay out immediately, with no actuarial adjustment, though I need to confirm this absolutely. I’ve run the figures though portfoliocharts.com and firecalc and it looks OK. But I only need 12 years till the state pension kicks in anyways, so the last four years coming from the (worst case significantly reduced) equity portion should be OK, if rather painful. And if my wife continues working in some capacity for some/most of the next 15 years to top up her New State Pension, it’s all a bit academic. (My dirty little secret 🙂 )
@TA – thanks, though not terribly original. That costs extra.
Thank you for this article. Personally I am a little more into cash. Everything I look at seems to be near its one year high. How much of the cash is actually asset allocation and how much is dry powder would be a question I would struggle to answer. Until rising bond yields become the consensus narrative I can’t see equities tanking: money always has to be somewhere.
Will look at that IL fund, cheers.
@TA, have you looked into the Teachers Additional Pension for Mrs Accumulator? I have a couple of relatives nearing retirement who work for the NHS and I have been pointing them in the direction of the AP. The NHS AP is very generous at present compared to index linked annuities.
My relatives would not be likely to sleep well with a large equity heavy investment portfolio, so the AP is preferable for them. Might suit you as well, allowing a lower allocation to bonds.
@Brod (#23):
Thought it [#21] sounded perhaps a bit too good ….
FWIW, some DB schemes took steps to eliminate/reduce favourable terms for people being made redundant. Sounds to me like you need to dust down those rules or, possibly even better, open dialogue with your DB scheme administrator(s).
Thinking some more about hedging a planned tax-free cash lump sum from my DC workplace pension – maybe I don’t need to hold the hedge inside the pension at all. I could hold cash equivalent to 25% of my pension in, say, Cash ISAs and keep the pension invested in equities/bonds. Draw the pension lump sum by selling whatever from the pension, and simultaneously transfer the equivalent amount from the Cash ISA to a Stocks & Shares ISA investing in the same things I’d sold from the pension (maybe taking the opportunity to shift the allocation from “late accumulation” to “early drawdown”). Or am I missing something? I suppose this is only (potentially) do-able because I don’t have a huge DC pot.
Question for anyone that had/has some of their DC pension pot in “Reference Scheme Test” i.e. subject to old contracted out guarantees – do you think of that as equity or bond because of the guarantee element? One part of me thinks I might as well invest any protected element as riskily as possible as if it tanks have the guarantee to fall back on (subject to figuring out the detail of the guarantee).
@ DavidC. That strategy could work and indeed might be more efficient in overall value than leaving in inefficient money market funds in the pension wrapper. Questions would be whether more efficient to hold cash inside or outside ISA if you have a general invesment account as well given you might sacrifice tax free growth in equities plus of course whether you can crystallize GIA without capital gains biting. Of course if you were nearing LTA in pension then taking some of the heat out by rebalancing to cash within it might be the most efficient of all.
@ Naeclue – I did many moons ago but we prioritised FI. Thanks for the prompt though, I’ll take another look now FI is done.
Public sector Additional Pensions are essentially half price index linked annuities. You have to be in service to contribute though and the maximum available is capped (£5k for NHS). I would jump at the chance and fill my boots if I had the option, but as always, depends on personal circumstances.
@ Naeclue 31
At present scheme valuations it would cost about 20K per 1K of extra benefit with spousal benefits (capped at 5k income.)
As you say it depends upon personal circumstances, and is a very cheap index linked annuity.
5% indexed linked, but if it puts you into taxable income and you already have a good floor, squirreling it away into an ISA might be advantageous if you can make average gains from your portfolio.
Horses for courses as always.
JimJim
@JimJim, my relatives are not high earners and do not have a long NHS service so their pensions are not large. Early Retirement Now gives around an 80% success rate for a 5% SWR over 30 years. Right now I would rate the 80% drawdown success rate as optimistic. This is a US based result, so blessed with an above average market return history and we are at a point where stock markets are relatively highly valued and bond yields very low. In comparison, the AP has a 100% success rate at 5% and comes with longevity insurance. That strikes me as a good deal. This does mean a potentially smaller legacy, but IMHO their priority should be to themselves.
Both my relatives are single, so have opted not to have dependancy cover. That has pushed the return up to around 5.8%. Their retirement age is the state pension age, not 60 as I think it is with some public service jobs, which also makes a difference.
From my own point of view, I have no DB pension at all and would happily part with 80k (after tax relief) to secure a 4k (after tax) index linked annuity. I have not checked for a while, but I think I would need to spend about 160k, which I would not be happy with!
@Naeclue – I have at HL. Currently offering a smidge under £2k per £100k if Joint and an inflation guarantee. Which my CS pension has.
Scary.
@Brod, thanks, even worse than I thought. Index linked annuity or drawdown at 2%? I think most people would opt for the drawdown.
@Brod:
Re #26 & #34
Earlier today I read something about CS pensioners being able to ‘buy out’ actuarial reductions – not sure if this was for early retirement or redundancy though.
This may be helpful – wasn’t easy to find. Seems to be higher regularly contributions to offset the AR for retiring 1/2/3 years earlier than the NRA.
https://www.nhsbsa.nhs.uk/sites/default/files/2019-07/Early%20retirement%20reduction%20buy%20out%20%28ERRBO%29%20factsheet%20-20190711-%28V9%29%20%20%20%20%20%20%20.pdf
@Naeclue – yes, it puts me in the rather ridiculous position that my salary is less than the capital value needed if I were to purchase my accrued pension entitlement as an annuity. If that makes sense.
Who says civil servants are underpaid?
How do annuity rates compare to the rates you can get on income generating equity release schemes (Lifetime Mortgages)?
Perhaps it’s better to keep your relatively liquid and highly diversified stock portfolio, and release equity from the thing you’re going to be getting utility out of until the day you die?
@TI – I suppose if any expected interest rate rises are already priced into fixed income bonds then theoretically floating rate should be attractive to a company/government albeit from a lower rate for today’s low rates.
I suppose on the other hand a floating rate gilt is almost what cash in instant access savings is – likewise a lower rate today because it’s not pricing in future rises because it’s not fixed, although you could if course have corporate equivalent that would have features like cash/an overdraft but with default risk.
I think though this level of novelty is probably not needed for any realistic purpose, although I do like novelty in itself – but likewise we could say that corporate bonds in themselves are also novelty not needed in practice – but like all assets not ‘bad’ as such and still worth buying at the right price – ie as part of an index
@Brod & @Boltt:
Re #36:
I think this is what I skimmed yesterday:
https://www.civilservicepensionscheme.org.uk/media/255227/voluntary-redundancy-guidance-for-staff-2010-terms-v-october-2017.pdf
I am pretty certain however that CS pensions will have several layers of complexity related to for example your periods of service, job type, etc.
Does anyone have any information on the Lyxor Core Global Inflation-Linked 1-10Y Bond ETF – Monthly Hedged to GBP (GISG) mentioned in the article? I can’t see it on the Lyxor website, nor is it listed by HL.
Answering my own question (42), I can see the ETF on the Lyxor website if I declare myself to be a professional investor. This still begs the question as to how available it is on retail platforms such as Hargreaves Lansdown.
@TA – thanks for the interesting article. With regard to holding inflation-linked gilts, have you considered buying individual gilts rather than gilt funds, to only hold some of intermediate duration (so there isn’t the interest rate risk)? What I’ve done before is just buy gilts maturing in 10 and 15 years (to cover a plausible lengthy period of high inflation) and plan to sell the former and reinvest in a new batch of 15 year gilts after 5 years. It doesn’t seem that hard to do. The available linkers can be seen at pages like this one: https://www.fixedincomeinvestor.co.uk/x/bondtable.html?groupid=3530 . I’d be interested to know if you think this isn’t a good strategy for some reason.
On holding long-term bonds, whilst they can be very volatile, is there not sense in seeing them as being valuable for particular circumstances (i.e. deflationary recession)? Then other assets can be the ones to preserve capital in other challenging circumstances. This would be more a picture of holding different assets so that a portfolio does OK in a wide range of circumstances, rather than looking at the volatility of each asset in isolation.
PS The hedged global inflation-linked bond fund you suggest via your link only looks to invest in bonds with maturity dates averaging maybe ~5 years away – if high inflation lasted for a longer period than that, would you be unprotected over longer timespans (since rolling over the bonds would require buying later issues at higher prices if the surprise inflation had become expected by then)?
@ DavidV – That tends to happen a lot with Lyxor. Quite a confusing site.
Ask your platform if they’ll list it for you. It trades on the LSE so there’s no reason why they can’t. It’s still very new so it’ll take a while for the platforms to catch up. Often they’ll do so due to consumer request.
@ OxDoc – That’s a good point. I did consider a linker ladder – effectively creating my own bond fund with a lower duration than the off-the-shelf products. IIRC, it looked quite gappy given the bond issues available and ultimately I decided to save myself the cost and hassle by investing in global linkers instead.
Re: duration and linkers. Your rule of thumb doesn’t tell you anything useful about future index-linked bond prices. The relationship between linkers and duration is not as straightforward as conventional bonds. You’d need to be able to factor in changes in real yields and future inflation expectations for a start.
Still, a more intermediate duration global linker fund (hedged to £) is the Legal & General Global Inflation Linked Bond Index Fund – duration around 8 from memory.
@TA #30 – I did many moons ago but we prioritised FI. Thanks for the prompt though, I’ll take another look now FI is done.
Could you do a post about this please? (asking purely selfishly). My wife is a teacher, over a 25 year career she has a mix of full time and part time years completed. Mostly part time, so the pension is not large. I have looked into AVC’s for her, but with the public sector pension reforms (and having been through them myself), I was reluctant to commit.
The schemes are also quire confusing and all surprisingly different when you dig into the detail.
I wasn’t aware of the AP option ( thanks @Naeclue for the info), I have read the posts above and looked further into it, but TBH I still don’t really get it and am not sure I can weigh up the benefits and make an informed choice that best suits our position.
I appreciate as public sector workers we are ‘lucky’ to have these pensions, but as others have said they do come at a price and that’s not just the monthly contributions.
The public sector is a huge employer, I imagine there would be a few people interested in a post like this!
@TA Thanks. I wasn’t referring to duration in my PS by the way, but maturity date, which I think is simpler – a bond maturing in 5 years can’t protect against inflation (or expected inflation) after that can it?
Once the bond matures then it’s done but your fund (or you if you’re using a ladder) will reinvest the proceeds into a new linker which will protect you against inflation on an ongoing basis. That new bond may be more or less expensive than the original in which case you’ll make a capital gain or loss on the trade. As I understand it, the headline rate of inflation doesn’t have a linear relationship with linker prices.
I delved quite deeply into bond ladders for a while and discovered that there’s no free lunch there versus funds. I think there is a degree of comfort to be taken from ladders if you want to meet precise liabilities on a precise time horizon. But my objective has no precise endpoint i.e. I want to pay my bills until death. An intermediate or short linker fund does the job just as well. Later in life I’ll look into index-linked annuities assuming they still exist or the prices aren’t as nuts as they are now.
@ FI-Fighter – that’s a good idea. I’ll put that on my list. I looked at teacher’s AVC options too and wasn’t impressed either.
Funnily enough I did write a piece on the pension options for nurses (for a trade publication not Monevator). Took a good few thousand words to untangle and it’d be as confusing as hell for the average bear who isn’t unhealthily obsessed with finance like we are.
@TA I think I disagree with the statement that a new linker “will protect you against inflation on an ongoing basis”. This is only true as long as real yields stay at least not far below zero. This is far from guaranteed.
Suppose you buy a 5yr linker at 0% real yield with regular gilt real yields also at 0%. Then in 5 years, inflation has risen to 10% and regular gilt nominal yields to 5%, giving a -5% real yield. Would linker real yields stay near 0% in this scenario? If they were, and high inflation were expected to persist for a while, then holders of regular gilts would have strong incentive to buy linkers. This would drive down their real yields below zero, until about the point that their expected yield equals that of regular gilts (and maybe below if people feel risk averse about potential future inflation shocks). Since I think I’m right in saying that there is much more capital in regular gilts than linkers, the linker yield would be driven down to near the initial yield of gilts in this thought experiment. Then a strategy of rolling over linkers would give you no greater protection against inflation than holding regular gilts after the initial term.
Of course, there are many possibilities for how real yields would actually change. But it wouldn’t make sense for linker real yields to be predictably higher than those of nominal gilts, so it seems to me that you are only insured against inflation for the length of the term of the linkers you own before high inflation expectations set in.
Ive got a 20 year time horizon and currently hold 80% in Global equities and 20% in Intermediate global government bonds and aim to lifestyle 1% to bonds each year. At which point should I start to introduce Short global index-linked bonds? to eventually get to a 20/20 split of in my bond allocation. Im thinking about splitting it 10% global government bonds and 10% global linkers, building up the global government bonds to 20% then starting on the linkers. Or do i not need to think about linkers just yet?
At the end of the day it’s very personal but……..
After 23 yrs of retirement a 30/70 asset allocation has done it for me-so far!
Currently 35/59/6 -6=2 years living expenses in cash
3 index tracker funds only
Bond was one fund only -2022 a distant memory-nothing in life and the stockmarket is a sure thing
Suits my limited maths skills,willingness to manage complexity in my portfolio especially as I age(79)
Obviously was a defensive asset allocation from the beginning of retirement -100% success rate required but………
Perhaps I had saved enough,live frugally and bear down hard on costs
xxd09
@ZX are you day trading these bonds? Honestly trying to understand why we need the level of sophistication you are proposing or how it helps.
Why would anyone care about managing interim volatility if they are holding individual non-callable bonds, like UK gilts, to maturity ? (Like all good retail investors managing their SIPP should be.). Bond yields move 5bp higher and I lose nothing because I am holding to maturity, I don’t pay any attention to what day to day yields are.
Swapping a load of my bonds for cash just adds drag.
@Baron 53
I do believe that ZX is, in fact, a bond trader. They bring a level of sophistication to bond chats that I can barely follow, never mind implement – but I find their comments incredibly interesting and illuminating all the same. The same goes for many regular and knowledgeable commenters. My thanks to all.
Good article thanks. Any consideration of trend following strategies as a (more) defensive asset? Always feel that these are somewhat undercovered on Monevator given how much evidence there is for equity like returns with much lower drawdowns in even simple models that retail can run themselves. Perhaps seen as a bit too DIY vs set and forget for what you feel comfortable recommending?
@kamae Thanks, that makes sense now. I was wondering why my head was hurting trying to follow.
Not time to include Managed Futures yet? (since there are now various UCITS funds available now. E.g. Winton/AQR/Dunn/iMGP)
@Algernond #57: how would you rank those 4 TF funds from best to least?
I’ve bunged ~7% into Winton Trend Enhanced Global Equity (GBP hedged) for the 100/100 TF/equity overlay, but, for new infusions of cash (come 6 April), wondering now if I should diversity a bit?
Then again, any alternatives to Winton would have to offer something different.
@Mike – it’s been on my list of things to look into but I’ve never quite gotten around to it. What version would you recommend for retail investors? I can test how well it works going back to 1975 with monthly UK money market / treasury bill data.
ERE wrote a good summary using US data:
https://earlyretirementnow.com/2018/04/25/market-timing-and-risk-management-part-2-momentum/
He shows that trend following has an impressive record during some major drawdowns. But there are decades where you just get a succession of false signals.
It seems to me that this makes it a hard strategy to stick with.
@Algernond – Point me to some good evidence they’ll work and I’ll take a look.
@Delta Hedge
Yes. I’m about 9% in Winton Trend Enhanced since is the only capital efficient one that seems to be available for SIPS/ISAs (only counts 4.5% to my ‘Alts’ allocation).
I’m also ~ 9% AQR Alternative Trends. It’s not just trend, almost hedge fund like in it’s combined strategies. And can’t argue with it’s performance since inception. Have stuffed iWeb full of it, as can’t seem to get it anywhere else (maybe II with a phone call)
So they are my top 2.
The balance of my ~25% allocation to ‘Alts’ is in Montlake Dunn, iMGP, AQR managed futures (which seems can’t add to in II), BHMG, also the two AQR funds Equity market neutral + Long-short (as can’t get the AQR one’s I really want in HL).
Smallest allocation is to iMGP. Not sure about the replication technique.
Very useful @Algernond #60. Much appreciated 🙂
I’m one of the “insane” people that @TA describes who has invested into gold (and junior gold and silver) miner ETFs 😉 It’s been quite a ride!
Tbh, I’d rather get commodity and gold exposure through a professionally managed TF outfit than via a static allocation, but (before the 100% run up in the miner’s price post ETF purchases) the gold/ junior gold miners were at historic lows in terms of their combined market cap divided by the market value of their proven/ near certain below ground reserves.
Just seemed too big a gap to last.
Probably should take profits on the next rally in gold and then shift it into TF for the long run.
Commodities, for its part, has underperformed by so much for so long that maybe that’ll be next asset class to catch a break; but, in any event, I’d much rather leave allocating to it (amounts, method and timing) to an evidence based systematic model run by the likes of David Harding/ Winton than my own judgement.
I had even been thinking aling the lines that 40% Winton Enhanced and 20% WGEC ETF would give 50% leverage with 10% each left for multi factor ETFs, SCV, BHMG (or similar) and various others (including infra), with Winton then eliminating the need for gold and commodo.
@DH – definitely I won’t buy commodity funds again. Only managed futures/TF for those. And I don’t have bond funds anymore. I tell myself I don’t need to, because the managed futures/TF funds trade them.
I’m now up to ~20 % precious (~8:1 Gold:Silver). I haven’t bought for a couple of years, but find it very difficult to sell… so I keep increasing my allocation so that I don’t have to…
@TA –
@Finumus has some attempt in this fabulous post:
https://monevator.com/trend-following-is-the-trend-your-friend/
Also, here is an article from the Top Traders Unplugged website showing replacing the bonds in the 60/40 with managed futures (OK – they have higher vol that than UCITS funds, so returns are a bit super-charged):
https://www.toptradersunplugged.com/how-to-invest-with-the-best-the-case-for-increasing-allocations-towards-globally-diversified-systematic-trend-following-ctas/
ERE is talking about momentum, which isn’t really the same thing as Trend Following using futures…
“If there was a strategy that I would want to employ right now, if someone put a gun to my head, I’d say simple trend following strategies. They are not too popular today… They will probably do very well in the next 5 to 10 years.”
–Paul Tudor Jones, Market Wizard, May 3, 2022
What about, oh Accumulator, my new interest: RPI-linked annuities?
I’m interested in one without a cap on the index-linking, with a collar of 0%, and with a 100% widow’s annuity. This would let me insure against longevity risk and let us avoid the risk of 40% IHT on unspent SIPP funds.
Paying income tax would be a pest but unavoidable whatever we do with our SIPP money.
How do you see that fitting into the “portfolio” for ancients like us? With what should we balance it?
An alternative would be to draw SIPP capital, pay 40% income tax but invest in VCTs to get a 30% rebate from HMRC.
Or, if the annuity would make me a 40% taxpayer, buy enough VCT to defang the 40% tax somewhat. Actually that stream-of-consciousness idea sounds not too bad. This can’t be as good an idea as it sounds to me, can it? I mean, (relative) tax efficiency and diversification in one neat package. Hmmm.
@dearieme – yes, I’m interested in RPI-linked annuities too. The simplest strategy is the “Floor and upside” approach.
Ideally the RPI-linked annuity provides inflation-adjusted income that covers all your essentials. The remainder of your portfolio is all “upside” i.e. you can take more risk because you don’t need the money.
A straightforward upside portfolio is 100% invested in equities.
Beyond that, much depends on your attitude to risk and what you actually want from the upside portfolio.
Maybe you want a reserve of cash for known unknowns like medical procedures, the roof blowing off, a new car, or treating the grandkids. In that case, you’re gonna hold a percentage in safer assets.
But if you really decide you don’t need the cash, and you don’t anchor on your portfolio’s paper gains, then 100% equities seems viable.
The RPI-linked annuity should be covered 100% by FSCS protection for insurance policies.
I do need to write more on annuities at some stage.
@Algernond – thanks for the links! Will have a read
@DH – I don’t think it’s insane to hold gold miners 🙂 They’re just insane as a defensive asset. Maybe you can use them to lower portfolio volatility but the evidence is it’s not worth it. Seems like you’re into them more for the profit and the thrill of the chase? 🙂