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Defensive asset allocation and model portfolios

Defensive asset allocation and model portfolios post image

What should your defensive asset allocation look like? How do the fixed income asset classes and bond sub-asset classes fit together?

We often hear from readers who’d like help with this aspect of portfolio construction. So let’s talk through the best defensives and table some asset allocation suggestions.

Let’s also acknowledge that many people are nervous about holding bonds right now and wonder whether they still have a role to play. If that’s you, then first read up on why we think bonds are a good investment.

What’s on the defensive asset allocation menu?

Defensives are asset and sub-asset classes that can fortify your portfolio. Here are the ones you need to know about.

Index-linked bonds

Best for: Keeping pace with very high inflation – one of the most frightening risks investors face.

Downside: High demand for index-linked bonds means they currently pay negative yields.

They also typically underperform conventional bonds in a standard, deflationary recession. 

Look for: Investment grade, developed world, government index-linked bond funds/ETFs. Index-linked gilt funds are theoretically ideal. However that market is potentially distorted

The alternative is global index-linked bond funds hedged to the pound. These may include some (less desirable) corporate bonds. But if the majority of the fund’s holdings are index-linked government bonds (issued by advanced nations) then put them on your shortlist.

Index-linked bond funds often use the term ‘inflation-linked’ in their name.

Short-dated government bonds

Best for: Short bonds mature quickly. They are less vulnerable to rising interest rates than longer maturity bonds.

Their lack of volatility makes short bonds useful for decumulators who want to pay their bills without worrying about sudden changes in capital values.

Downside: Short bonds offer flimsy refuge in a stock market crash, compared to longer dated bonds.

Look for: Bond funds holding investment grade government bonds with maturities of 0 to 5 years. Gilt funds and global government bond funds hedged to the pound fit the bill.

Intermediate government bonds

Best for: A reasonable compromise between short and long bond vehicles. Intermediates offer better crash protection than short bond funds without the egregious interest rate risk of 100% long bonds.

Downside: Intermediates suffer more in a rising rate environment than short bonds, and can’t compete with long bonds in a recession. Like a superhero, their very strength is their weakness. Ultimately, you must decide where you want to be on the risk / reward curve.

Look for: Investment grade government bond funds that offer a spectrum of maturities from 1 year to 15 years or more. Check the duration metric on your bond fund’s webpage. An intermediate fund will sit somewhere between 7 and 14.

Gilt funds are good, and global government bonds hedged to the pound are fine, too.

Global government bonds hedged to the pound

Best for: An alternative to gilts for British investors. Choose if you’re wary of 100% exposure to the credit risk of the UK Government.

Hedging offsets the risk of adverse currency movements swamping your bond returns, which would add unwelcome volatility to the defensive side of your portfolio.

Intermediate global bond funds generally have shorter durations than their gilt cousins. 

Downside: Global government bond funds tend to offer less crash protection than UK counterparts. That’s due to their lower durations. You’ll also pay more in management fees versus gilt funds.

Look for: Funds that explicitly say they’re hedged to the pound. The right funds for defensive purposes hold investment grade, developed world, government bonds. They don’t hold emerging market bonds.

Most global bond funds hedged to the pound own some corporate bonds and are called aggregate bond funds. Holding riskier corporate bonds means you can expect a bit more yield overall. However they offer less shock absorption in a downturn.

Cash

Best for: Convenience, liquidity, and reducing interest rate risk.

Downside: Cash doesn’t have the capacity to spike in value like intermediate and long-dated bonds.

Look for: Accounts paying interest rates that beat the yield-to-maturity (YTM) of bond alternatives.

Gold

Best for: Rocketing when other assets crater.

Downside: Gold has performed incredibly during a handful of recessions. But it’s been about as useful as a deckchair on a submarine at other times. The case is marginally positive overall.

Look for: A low-cost Gold ETC (Exchange Traded Commodity fund).

Off the menu: these are not defensive

From the perspective of your defensive allocation, you should avoid:

Sub-investment grade bonds (also known as junk bonds) sport tempting yields. Here you’re exposed to the default risk of dodgy debtors.

Such risk typically materialises at the worst possible time, sending junk bonds diving just when you want your defensives to stabilise your portfolio. The weak go under, and defaults batter those yields that lured you in like an anglerfish’s light. (Or at least the market fears as much, and so marks down their value.)

Long bonds, which could deliver equity-scale gains or losses, depending on the interest rate dice.

Unhedged global bonds. These require you to bet on the wild horses of the world’s currency markets. Great sport when it pays off but advocates go quiet when they back the wrong nag.

Investment grade corporate bonds aren’t needed. They’re unlikely to perform as well as government bonds in a recession (companies go bust, governments less so) yet are outpaced by equities over the long-term. 

Broad commodities wrap up low returns with high volatility in a Scotch egg of grimness.

Equity sub-asset classes touted as defensives prove to be anything but when they domino in line with the broad market. So take a bow tumble:

  • Infrastructure
  • Energy
  • REITs
  • Timber and farmland
  • Low volatility
  • Dividend aristocrats

There’s nothing wrong with investing in any of the above. But they belong in the growth side of your asset allocation, not in your defensive bastion.

Model defensive asset allocations

The following asset allocations are starting points keyed to different investing milestones. No size fits everyone. Always adapt model portfolio ideas to your personal situation and risk tolerance.

Because we’re in defensive mode today, I’ll leave the growth side as a global equities percentage without drilling any deeper.

Young accumulators

Asset class Allocation (%)
Global equities 80
Intermediate government bonds (Gilts) 20

You’re young, you’re starting out, and you have at least a decade of investing ahead of you. Your main risk is a market crash that exceeds your risk tolerance and puts you off equities for life.

Your best defence is high-quality (developed world/investment grade) conventional government bonds.

Older accumulators / lower risk tolerance

Asset class Allocation (%)
Global equities 60
Intermediate government bonds (Gilts) 20
Global index-linked bonds 20

As the sands drain from the top chamber of your personal hourglass into a peak of wealth below, you will increasingly think about protecting what you have.

That means increasing your allocation to bonds generally, and increasing your defence against inflation specifically. Use a wedge of index-linked bonds to hold the money munching monster at bay.

Check out our piece on managing your portfolio through accumulation. 

Decumulators – simple

Asset class Allocation (%)
Global equities 60
Intermediate government bonds (Gilts) 15
Global index-linked bonds 15
Cash and/or short government bonds (Gilts) 10

Spending down your wealth is trickier than accumulating it because your portfolio must meet a variety of needs:

  • The need to be certain you can pay the bills for the next few years – hence you’ll hold cash and/or short dated bonds
  • The ever-present risk of a crash – which is why you own intermediate bonds
  • The long-term risk of high inflation impairing your spending power – prompting the 15% slug in index-linked bonds

Decumulators – max diversification

Asset class Allocation (%)
Global equities 60
Intermediate government bonds (Gilts) 10
Global index-linked bonds 10
Cash and/or short government bonds (Gilts) 10
Gold 10

This portfolio adds gold to an armoury of strategic diversifiers that have proven useful against threats from depression to stagflation.

This suggested split should also allay the fears of people who believe that bonds are tapped out by low interest rates and looming inflation.

There’s no need to bet all for or against one possible future. Instead you can diversify against a spectrum of risks, using a modest proportion of your wealth to defang each danger.

On the defensive

Okay readers, have-at-ye! Asset allocation is as much art as science so I’m looking forward to a hearty debate in the comments.

For anyone who’d like some more background:

  • Investigate the best bond funds that can man the ramparts of your defensive allocations. We’ve also covered important bond metrics like duration and yield-to-maturity in this one. 
  • Discover how to build your own asset allocation from first principles.
  • See more model portfolios.

Take it steady,

The Accumulator

P.S. Shout out to Monevator reader John who tipped us off about a new shorter-dated global linker fund that neatly fills a gap in the market. It’s very new, but if you’re interested: Lyxor Core Global Inflation-Linked 1-10Y Bond ETF – Monthly Hedged to GBP (GISG).

{ 50 comments… add one }
  • 1 Luis June 16, 2021, 1:55 pm

    What do you think about the Golden Butterfly from portfoliocharts.com?

    Looks pretty defensive to me with a nice track history.

  • 2 Sergio June 16, 2021, 2:06 pm

    It’s funny because former hedgefund at AHL Robert Carver would argue that global diversification would be better than relying on national bonds.

  • 3 David C June 16, 2021, 3:16 pm

    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.

  • 4 Brod June 16, 2021, 3:42 pm

    @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!

  • 5 The Accumulator June 16, 2021, 4:03 pm

    @ 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.

  • 6 The Accumulator June 16, 2021, 4:06 pm

    @ 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?

  • 7 Brod June 16, 2021, 4:42 pm

    @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!

  • 8 Brod June 16, 2021, 4:45 pm

    @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.

  • 9 Fremantle June 16, 2021, 4:46 pm

    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.

  • 10 David C June 16, 2021, 5:26 pm

    @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.

  • 11 ZXSpectrum48k June 16, 2021, 5:42 pm

    @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.

  • 12 The Accumulator June 16, 2021, 6:41 pm

    @ 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?

  • 13 Matthew June 16, 2021, 9:35 pm

    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?

  • 14 JimJim June 17, 2021, 6:26 am

    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

  • 15 AtlanticSpan June 17, 2021, 9:02 am

    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?

  • 16 Al Cam June 17, 2021, 9:24 am

    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/

  • 17 The Investor June 17, 2021, 9:36 am

    @Matthew — You write:

    “I don’t know why we don’t seem to have variable rate debt on offer.”

    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

  • 18 Brod June 17, 2021, 9:48 am

    @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.

  • 19 JimJim June 17, 2021, 10:35 am

    @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

  • 20 Brod June 17, 2021, 11:12 am

    @JimJim – sounds like we’re in the similar boats. Let’s hope it’s not the Titanic, eh?

  • 21 Al Cam June 17, 2021, 11:47 am

    @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”.

  • 22 The Accumulator June 17, 2021, 11:57 am

    @ 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.

  • 23 Brod June 17, 2021, 12:31 pm

    @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.

  • 24 MrOptimistic June 17, 2021, 1:05 pm

    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.

  • 25 Naeclue June 17, 2021, 2:48 pm

    @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.

  • 26 Al Cam June 17, 2021, 4:15 pm

    @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).

  • 27 David C June 17, 2021, 5:38 pm

    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.

  • 28 Bobbins June 17, 2021, 6:13 pm

    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).

  • 29 Bobbins June 17, 2021, 6:20 pm

    @ 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.

  • 30 The Accumulator June 17, 2021, 7:01 pm

    @ Naeclue – I did many moons ago but we prioritised FI. Thanks for the prompt though, I’ll take another look now FI is done.

  • 31 Naeclue June 17, 2021, 10:54 pm

    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.

  • 32 JimJim June 18, 2021, 7:11 am

    @ 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

  • 33 Naeclue June 18, 2021, 12:03 pm

    @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!

  • 34 Brod June 18, 2021, 12:18 pm

    @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.

  • 35 Naeclue June 18, 2021, 12:32 pm

    @Brod, thanks, even worse than I thought. Index linked annuity or drawdown at 2%? I think most people would opt for the drawdown.

  • 36 Al Cam June 18, 2021, 2:36 pm

    @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.

  • 37 Boltt June 18, 2021, 3:11 pm

    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

  • 38 Brod June 18, 2021, 4:14 pm

    @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?

  • 39 Andrew Nelless June 18, 2021, 5:32 pm

    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?

  • 40 Matthew June 18, 2021, 10:56 pm

    @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

  • 41 Al Cam June 19, 2021, 1:05 pm

    @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.

  • 42 DavidV June 19, 2021, 9:07 pm

    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.

  • 43 DavidV June 19, 2021, 10:04 pm

    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.

  • 44 OxDoc June 19, 2021, 10:08 pm

    @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.

  • 45 OxDoc June 19, 2021, 10:19 pm

    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)?

  • 46 The Accumulator June 20, 2021, 12:23 pm

    @ 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.

  • 47 FI-FireFighter June 20, 2021, 5:19 pm

    @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!

  • 48 OxDoc June 20, 2021, 7:29 pm

    @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?

  • 49 The Accumulator June 21, 2021, 12:16 pm

    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.

  • 50 OxDoc June 23, 2021, 8:14 am

    @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.

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