Before we get into the sexy sounding business of dynamic asset allocation, a quick mid-series recap.
You’ll remember from my previous post that I’m on the eve of early retirement and I have my decumulation plan in place.
Please go read that article if you’ve not done so already.
Do you think there are risks to my strategy?
Yeah, me too.
Some risk is inevitable. As The Investor once wrote:
“Investing risk cannot be created or destroyed. It can only be transformed from one form of risk to another.”
With that admitted, I have back-up plans. We’ll get to those in the final installment of this series, so please don’t protest too loudly before you’ve caught them all.
Now let’s get into how exactly we’ll get money out of the portfolio.
What is dynamic asset allocation?
With a dynamic asset allocation strategy, you don’t automatically rebalance your equities and bonds to a favoured allocation, such as 60:40.
Instead you use a system that mitigates against selling equities when they’re down, or rebalancing back into them when they’re still dropping like a lift with a snapped cable.
Research indicates that a well-designed dynamic asset allocation strategy outperforms fixed allocations in most decumulation scenarios.
The trade-off is you could find yourself 100% in equities if the market doesn’t recover for many years.
That could happen deep into your dotage. Not a time traditionally associated with voluntary risk-taking.
Still, some octogenarians love motorbikes. Your appetite for risk in retirement is likely to depend on your own personality more than time-of-life stereotypes.
Prime directive
I’m going to use a dynamic asset allocation strategy called Prime Harvesting.
Prime harvesting was devised by Michael McClung. It is fully explained in his book, Living Off Your Money.
The main rules are:
- Sell bonds once a year to fund your annual expenses.
- Sell equities to fund your expenses if you’ve run out of bonds.
- Rebalance into bonds only after a significant run-up in the value of your equities. For example: 20% beyond an inflation-adjusted baseline.
- You don’t rebalance into equities, although your equity allocation (as a proportion of your portfolio) will rise as bonds are sold.
Otherwise, you rebalance between asset sub-classes as you normally would.
For example, you’d rebalance annually to maintain your ratio of linkers to conventional bonds.
McClung’s historical backtesting showed that an initial 50:50 equity:bond portfolio veered from 30% to 70% equities on average.
Commentators such as Early Retirement Now, EREVN, and The Bogleheads have all independently tested Prime Harvesting. They also found it fared well historically.
You can read more about Prime Harvesting via a free sample from Living Off Your Money.
McClung provides full details on how to use it in his book. He has also provided a spreadsheet to handle the calculation for you.
In my portfolio, Prime Harvesting would also mean I’d sell down cash and gold before equities to fund my expenses.
I’ll annually rebalance between my preferred defensive asset allocations as if they were all bonds in McClung’s system.
The risks of withdrawing on auto-pilot
A major cause of portfolio death in decumulation is jacking up spending by inflation every year, regardless of market conditions.
A combination of portfolio losses, equity sales, inflation, and escalating withdrawals over a few years can quickly take a toll.
For example, let’s say you withdraw 4% from a £1,000,000 portfolio for an income of £40,000 at the start of Year One.
Then imagine that – thanks to weak markets – your portfolio falls further to £672,000 by year-end.
Year Two’s mandated withdrawal is £41,200, after 3% inflation. Your withdrawal rate is now over 6%.
The portfolio then goes down to £536,180 by Year Two end, after a 15% loss. Unlucky.
Year Three’s withdrawal is £42,848 after 4% inflation. The withdrawal rate is now 8% and the portfolio balance has plunged more than 50% to £493,332 inside two years.
Just a few more years of bad luck and your withdrawal rate could be well into double figures. You need equities to bounce back – but that won’t happen if you sell too many.
Gulp.
Dynamic withdrawal rate
This is where a dynamic withdrawal rate can show its strengths.
- Dynamic withdrawal rates are responsive to the amount of fuel left in your wealth tank.
- They’ll ease your pedal off the money accelerator when the equity gauge flashes red.
- That can mean living on less, for a time, so your portfolio doesn’t run out of road.
- But dynamic withdrawal rates can signal that you can spend more, too.
If market conditions indicate full-speed ahead, then a dynamic withdrawal rate sends you up the gears, so you can live life in a faster lane.
This deals with a little-discussed drawback of conservative Safe Withdrawal Rate (SWR) strategies, which is that most people do not live through a nightmare scenario.
You could easily die with piles of loot unspent if you stick to rules calibrated to avoid the worst case. A worst case scenario that rarely happens.
In contrast, sophisticated dynamic withdrawal rates take into account market valuations and/or mortality.
The downside of dynamic withdrawal is your income may be curtailed for years if your sequence of returns proves ugly.
But the upside is you can choose a higher initial SWR – because your financial bungee cord prevents you from spending your portfolio off a cliff.
Dynamic withdrawal rate: which one?
There a number of dynamic withdrawal methods that are well-documented and designed for DIY decumulators.
They include:
- The Bogleheads Variable Percentage Withdrawal (VPW) method.
- Early Retirement Now’s CAPE-based withdrawal formula.
- Michael McClung’s Extended Mortality Updating Percentage Failure (EM) rules. See his book: Living Off Your Money or read my review.
Which is the best? None of them, really.
I eventually realised that I was searching for the perfect system. One which let me spend like my wallet was on fire, but also saved me from Armageddon.
That system doesn’t exist.
You always face the same compromises:
- Spending more upfront, risks cutting back more later.
- Saving your portfolio from a financial face-plant may mean cutting expenditure.
- Different systems outperform at different times, but you can’t know what conditions you will face.
How to decide between them? Here’s my own dynamic withdrawal rate criteria:
- The system should account for market valuations. We live in an era of high valuations, which I believe signals subdued returns ahead.
- The system shouldn’t front-load with an overly optimistic SWR, only to risk a severe spending cutback later.
- Mortality is recognised so you can up the spending ante as your candle burns low.
- There should be evidence that the system works during the historic nightmare situations that we all fear.
- The author(s) are open about the trade-offs.
- I need to be able to live with it. In other words, I need to understand how the system works, make the necessary calculations, and know what demands it could make if we’re unlucky.
Ideally the system comes with resources such as an active community – or at least a book’s worth of backtesting (including non-US scenarios), use cases, and advice on how and when to bend the rules.
McClung is the man
I could easily live with ERN’s or The Boglehead’s systems, but McClung’s Extended Mortality (EM) withdrawal rate formula ticks the most boxes for me.
Not least because he’s tested EM against historical returns for the UK and Japan, and because he considers the global portfolio, not just US.
Whichever system you choose, make sure you are comfortable flexing your spending down. (I guess we’re all comfortable flexing up.)
Mrs D. Accumulator and I could drop spending 15% and live happily.
We could drop 25% and still cover our bare essentials.
Dynamic duo
Dynamic asset allocation and dynamic withdrawal are additive, SWR-optimising partners.
They’re not panaceas but both tip the odds further in your favour.
I only have to make the calculations once a year and McClung has provided a spreadsheet to do the hard work for me.
I will have to stick to more complex rules under pressure, which is a risk, as is cognitive decline.
If that sets in then I’ll switch to Vanguard LifeStrategy and annuities.
So what is my SWR?
Taking into account our life expectancy, ‘failure’ tolerance, asset allocation, and high market valuations, McClung’s formula awarded us an SWR of 4%.
Or a real SWR of 3.8% after investment fees.
That’s much less than the 4.7% I previously got using Michael Kitces ‘layer cake’ SWR improvement method.
I backtested the 4.7% SWR using the brilliant Timeline SWR tool that uses historic global investment returns.
4.7% passed the test of history with a 99% success rate, although it cut spending drastically in 10% of scenarios.
Nevertheless I’m happy with a 3.8% SWR.
It was actually 4% (after investment fees) when I ran the numbers two years ago. Higher market valuations today have cost us two pips but rising share prices have also buoyed our portfolio in the accumulation phase. We’re better off overall, but it’s still a warning to beware of trouble ahead.
That’s why I’m not buying into the 4.7% that I can coax out of Kitces and Timeline.
No, 3.8% it is for us.
State Pension SWR bonus
Although a younger version of me would never have believed it, one day we’ll be drawing our State Pension. That will add fresh horses to the portfolio in a couple of decades.
The State Pension reinforcements bump up our SWR by 0.64% (along with Mrs A’s DB pension), according to Early Retirement Now’s superb Social Security and Pensions formula.
Note: UK investors should only use Early Retirement Now’s pessimistic Minimum Value table. His wider work is underpinned by those world-beating US historical returns.
Fortunately, we don’t need to front-load our SWR in order to live, so I’ll leave the State Pension bonus in reserve.
I prefer to think of the State Pension as the cavalry, ready to charge in to save us if our portfolio is battered by our late sixties.
Whether it will arrive resplendent as heavily-armoured cuirassiers or more like a few starving peasants on nags is debatable.
I’m relatively sanguine about it. If you’re not, bear in mind it’s only one of our decumulation back-up plans.
To get a gander at our belts and braces in full – and to conclude this mini-series of decumulation posts – tune in to the third installment.
Working title: Decumulation: A Better Finale than the Return of The Jedi.
Subscribe to make sure you see it.
Take it steady,
The Accumulator
Comments on this entry are closed.
Another nice post – I am sure it will prompt lots of quality chatter.
Just to be clear; is this the plan from the outset or are you going to use a cash bridge until you can “crack open your SIPP” as described in: https://monevator.com/should-you-use-cash-to-bridge-the-gap-between-your-isas-and-your-pension/
Many thanks for this – a really useful post.
If I could ask a question – why don’t you include the State Pension as part of your Plan A – rather than as a backup plan? Too much political risk?
Thanks TA… I’m so enjoying reading through your deacumulation plans, its so helpful. I kinda got my SWR of 3.5%
I’m 55 ,my equity, cash, index linked bond portfolio remains currently untouched as I live off rental income ( which covers my floor expenses) and part time work which I CHOOSE to do , dont HAVE to do. Big difference!
Rental income is different cos your not eating into your capital the same so it FEELS safer . But it comes with different anxieties to deal with. Fortunately I have a good tennant who is there till death. Like you ,i do wonder ,as I’ve no children to look after my money, how I’ll cope with mental and physical decline, like you say annuities and LS.
Looking forward to reading your next part.
@Dawn:
Re: “I’m 55 ,my equity, cash, …..”
If I have understood you correctly, this is an interesting scenario. Also, I assume (in due course) you will draw a state pension too?
Does this mean you may still actually be accumulating, ie your net assets are still growing?
If this is the case, may I ask how do you handle any surplus?
I ask because all decumulation models don’t really cover this scenario.
Many thanks for this – looks very sensible and similar to what I might consider when the time comes.
My only question was, given the extensive reading you have clearly done around the subject, what made you decide not to include any kind of trend-following approach? From what I have read trend following (eg selling equities when 12 month trailing momentum turns negative) appears to deal very well with sequence of returns risk in decumulation, but for some reason I also struggle to commit to it despite the evidence – perhaps a relic of being a buy and hold investor for a long time? Or concern about behaviourally sticking to it? Grateful for any thoughts from you or others that have considered.
Another great one in the series. Many thanks.
The length of time before the state pension kicks in and gives you a handsome pay rise seems to be the big reason for your conservatism and a plethora of back up plans perhaps? I like that as it has the same belt and braces approach that I take.
Our time at planned retirement (total retirement if we want it) to state pension hike is half(partner) at year 5 – and half(me) at year 9, I view these as milestones and have designed our draw down of assets to cover the shortfall from our two DB schemes accordingly. This, by it’s nature, has a slightly high SWR for a few years, but a lower one if necessary later after yr5 and 9. Worst possible scenario is work or downsizing/equity release, which we are reluctant to do as we quite like the house and so does our singular offspring who has her eye on it 🙂
The idea of a dynamic approach to managing the assets in draw down will give me a little further reading to do I have read some but your references tell me I should read further. Idealy I want to be done with thinking too hard about money by the time I’m 70.
JimJim
The explanation is really interesting. Even though we live in different countries, there are many common points useful also in mine. Could you develop more the part where you mention Life Strategy? I mean: are we really sure that the only possibility, in that case, is the standard SWR rule? Usually LS is kept combined with an Inflation Linked Etf, often global: could we assume there is a dynamic strategy able to pull out the best from this portfolio? Just your opinion (and other readers’ one, obviously). Thanks and ciao.
Happy to see Part 2 of your @TA’s master decumulation plan. McClung is indeed the Man ! and the backtesting looks compelling. Personally being very much a buy and hold investor, and migrating years ago to having around 80% of portfolio in Vanguard LS funds, i dont feel like switching to separate Bond and Equity holdings to implement McClungs dynamic asset allocation model is for me. Rather i will use the 3 years baseline cash that i hold for living expenses, and top it up by selling equities when annual portfolio returns are circa 5% or more up. This may well not squeeze out as much return as the dynamic allocation method but its simpler to operate, am i missing anything ??
Re Dynamic Withdrawals: Agree totally on being able to flex spending down from baseline SWR and have significant room to do that. My plan is to look at all 3 measures (base SWR (3.5%) + inflation, McClungs xls, bogle heads VPW xls) each year to come up with a “budget” amount for the following year which will be somewhere between the 3 measures based on how we feel about mr Market and what plans we have for spending/travel in the following 12 months – its a kind of sitting on the fence approach cos for a 30+ year retirement i dont feel i want to commit religiously to any one single method – Again thoughts what am i missing ??
again really looking forward to following the debate and comments on this post its supper helpful thanks @TA and everyone else for sharing !
I’m sure that this strategy is well- modelled and thoroughly sound, but intuitively it worries me that if deaccumulation ‘day zero’ coincides with equities being very high and possibly heading for a prolonged dip, then holding grimly onto those equities until they have increased in value risks ultimately being obliged to sell them at a lower valuation and missing out on the gains achieved during accumulation.
Interesting. Let’s say (for whatever reason) you decided to just use Lifestrategy 60 for your drawdown. Would you aim to take 4% a year withdrawal – lump sum? (keeping 2 or 3 years as a cash reserve – as a backup). Does anyone do this? Simplicity seems very attractive at times. Oh what to do…
@hal using LS60 with annual withdrawals is pretty much what i plan to do see post #8 the actual amount withdrawn will vary probably between 2.5% floor and 6% ceiling although i will look to McClung and Bogleheads VPW spreadsheets for some guidance at the start of every year, having updated values based on previous year performance (up or down). For me simpicity will be key for sleeping soundly and cognitive aging gracefully 😉
Loving this mini-series. It’s just interesting to compare what we’ve been doing with how you are thinking about it all.
I have to admit, I tend to think ‘systems’ are over-rated to some extent. To a large degree, it’s just common sense? Don’t be forced into selling something when you don’t want to. Create enough diversity & flexibility in your portfolio to adapt as needed.
Same way on the budget front, as you mention. We ended up with way more flexibility on that front than expected, largely due to our travel plans being much cheaper than we thought. Slow travel is very different to holidays!
So yep, you need a plan/approach – but the biggest thing by far is being able to adapt as needed. And have plenty of back up plans – which I look forwards to reading about in part 3 🙂
Great article by The Adventurer before he sails off into the sunset on the good ship SWR. Looking forward to part three already!
I downloaded the McClung spreadsheet and will give it a run. The more different resources you have to compare the better. I feel so far 3.5% should be OK, maybe an extra 0.5% as I’m confident the SP will come thundering over the hill like the Charge of the Light Brigade… oh… But seriously, too many of us oldies to mess with. It’d be political suicide. “Temporarily” freezing the triple lock though, and just having inflation rises, that’s another matter.
Always have to be careful about the siren calls from other, flashier SWRs, but I’ll see what I end up with.
@A1Cam
I hit my FI number 2 years ago so decided to drop to partime work. Yes, and let my untouched portfolio keep growing . I dont have the same surplus cash available to invest now on a partime income but I’m finding I’ve still got money over spare at my year end.! Once a saver, always a saver. So i tend to reinvest it in SS isa, cash or premium bonds. Last year i spent some on a small cosmetic surgery job. But if I’ve none spare at end of year its OK. I’ve done my grafting and saving. I did think about spending going on more holidays too as I’ve got more time now and I’m fit and healthy.. Yes, i expect to get full state pension in 12 / 13 years time which will be a fantastic boost @8k but I’m a tad nervous it may be cut or means tested so carnt rely 100% on that boat coming in, that’s why I decided my SWR would be 3.5%. On my portfolio. I’m currently getting a 4.7% return on my rental property. After I’ve put aside repairs maintenance money.
Dear TA,
I have been trying to access Timeline for ages,but found it only accessible to Advisors. Are you able to share how you have managed to access it, and more importantly can I ! ?
@TA – Excellent article as always, thanks!
I’m also considering going for McClung’s prime harvesting but I am tempted to choose a more conservative safe withdrawal rate at least in the first couple of years: (1/PE) * percentage of stocks + 1% * percentage of safe assets – 2%. This 2% is a rough estimate of the average inflation rate l would expect in the near future. My portfolio has a net Equities PE between 16 and 17. I end up with a safe withdrawal rate of about 2%. If all goes well for the first couple of years (or for the first 5 years perhaps), my plan is to increase this SWR to about 3% and use McClung’s Extended Mortality dynamic withdrawal method.
@Brod. “But seriously, too many of us oldies to mess with. It’d be political suicide. ”
This idea that the status quo is underpinned by elderly interest groups may be comforting but it isn’t supported by the numbers. Millenials and Gen Z will outnumber Boomers and Gen X by the end of this decade. What was political suicide could become political opportunity. All those big, fat, juicy (totally unaffordable) DB pensions will be the low-hanging fruit for a bit of intergenerational rebalancing.
@ ZXSpectrum – “Millenials and Gen Z will outnumber Boomers and Gen X by the end of this decade.”
Couldn’t agree more with your point, and this is also why I think the state pension should not be relied on too much even if you are only about a decade away from receiving it.
I wasn’t sure about this part:
Mortality is recognised so you can up the spending ante as your candle burns low
What are you likely to be wanting to spend money on as you get very old/infirm? I’d have thought you want to have the bulk of your funds spent while you’re relatively young and healthy, before you get too old to be bothered with international travel etc.
@ZXSpectrum48K (17) I do hope you are wrong, (And you are right about so much) – But, our demographic is still top fat with life expediencies static or improving depending on who you read (Improving especially for the wealthier end of society) – also remembering that in ten years time millennials will be thinking about their own pension schemes and voting to cut that effects them too – also people vote more the more they feel enfranchised by the state, again, the wealthier end of society… Could it happen – yes, undoubtedly – but as we do not stack up well against many other developed countries for state benefits in retirement and the political will has been to rectify this for some time now, I think the risk is small… Not that I don’t have a plan to mitigate that small risk 🙂 As for DB schemes, they have been eroded for many years now in the public sector and I can see this being the method of reduction into the future rather than going back on a promise to pay or abandoning them altogether. DB schemes in the private sector are now like gold dust.
JimJim
Good article. Comments on Vanguard LS above miss the point that these equity bond strategies don’t sit well with such blended funds. I am curious as to how you address the uncertainties of inflation ( and taxes) on future expenditure.
@MrOptimistic i am quite aware that blended LS funds dont suit McClung or other decumulation strategies that require separate Bonds/Equities to operate, they do however offer simplicity which may be something myself and others value, admittedly at the cost of future returns if McClung is correct
@MrOptimistic The point is > Vanguard LS 60 is the strategy . Easy peasy . Less stress and more free time. There’s nothing wrong with that.
@Dawn:
Thanks for your detailed response.
I suspect that this ‘problem’ is possibly more wide spread than people may at first assume.
I summarised my situation in a comment to the first Part of this series as “I am some four years plus into ……….. and have found that I have been quite reluctant to push any surplus (vs planned spend) directly back into equities.
What I have done instead is up the equities exposure of my upside Pot. However, this can only continue for so long.”
I am currently not sure which is the best way to proceed in the mid/longer term, but it surely must rank as one of the better problems to have.
Fantastic post! This is really helping me to round out my decumulation strategy. I think that you are 100% correct in that its ok to take on some risk. As long as you are willing to make adjustments and have a backup plan. That is where I have landed.
There’s no perfect strategy, but gotta create a plan and try to execute that plan as best as you can, and make adjustments as you go along.
I have yet to read the free chapters from McClung (note to self (again!) as I downloaded some time ago) but after reading your 4 bullet-point precis I have an itch that I am hoping you or one of the readers can scratch. (Hopefully it is covered in the book.)
Bonds are sold for annual expenses, rebalancing is from equities to bonds only provided there has been sufficient growth, and if bonds run out then equities are sold to fund annual expenses.
My itch is a scenario where equity growth is weaker than the rebalancing threshold, all the bonds are sold off from year to year, and then horror of horrors, equities crash just when you start to sell them. Perhaps I am overly pessimistic but does McClung consider this possibility? And what is his ‘Plan B’?
I am aware that you have your ‘plans in depth’ (https://monevator.com/how-to-protect-your-portfolio-in-a-crisis/) and I am looking forward to seeing Part 3 and your plans.
As others have said @TA another great article, looking forward to the last part. A few observations/ comments:
– with regards to dynamic asset allocation, did you consider a reverse equity glide path? I think this approach has merit as it mitigates against sequence of return risk in the early years of retirement, when you are most vulnerable to it? Sure if equity market booms you loose out, but if that happens at start you will have already ‘won’?
– how will you modify McClungs rules to allow for your additional Defensive assets e.g. will you spend bonds first then cash then gold? Or cash first, then bonds?
– re dynamic withdrawal rates did you consider the annual PMT Excel calculation described by Wade Pfau? Similar to @Cigano99 I’m intending to monitor other approaches, in addition to the one I settle on and a simple annual PMT test seems a useful benchmark, especially as it can easily incorporate changes to longevity expectation and expected return
Re state pension I hope it will not disappear totally, but I think it’s likely to at least be tinkered with and it’s value reduce, so I agree it’s best not to plan on it
@ZX…interesting point ab out the direction of population dynamics…how might HMG have a go at rebalancing against the DB brigade ? As many more in a few years hence will no longer be contributing to them , ie deferred or in receipt.
@Ash – rather assumes some of us want to do the travel thing. I’ve done plenty with work!
Having some money when you are old/infirm might be spent on better care and/or medical interventions to avoid becoming infirm – even if old. I strongly suspect the boomers will create a massive market in all kinds of aged related interventions.
It is interesting to see the concern about the future of the state pension here as, in the comments to part 1 in this series, everyone (IIRC) appeared to be in favour of buying extra years and/or ensuring maximum state pension payout but there seems to be less positivity on these comments.
Apologies, re my previous comment, I meant everyone who contributed re the state pension, not that every person who left a comment on the article was in favour of maxing out the state pension….
@MarkR #26
The whole point of a withdrawal strategy is that plan A should work well, and you don’t need to change strategy half-way through? The scenario you describe is difficult for any strategy, and with most strategies you would have had to sell stocks even earlier. Or do you have any alternative in mind?
McClung himself says for example: “Prime Harvesting can sometimes have a seemingly undesirable side effect: during long periods of low stock returns, bond levels can go below their preferred limits […]. However, Prime Harvesting has a strong counterbalance to these occasional low bond levels – these periods correspond to attractive stock valuations. […] [A]ttractive stock valuations substantially reduce exposure to known risk. It’s important to understand that growing stock percentages using Prime Harvesting is not an anomaly, but a response to the market, trying to minimize overall risk.”
Basically bonds are for decumulation and unless you’re going to take the lot in one go then it makes sense to always maintain the most risk you can stomach. On this basis draw state pensions and DBs asap to spare your equities, consider using debt to cover down periods or spend strategically (holidays/home improvements in the good times), borrowing personal debt is analagous to selling bonds anyway, just in yourself
I do think though that to some degree a baseline level of spending needs exists that is not really negotiable and might increase with inflation (food, council tax, service charges, etc) – And you cant always suddenly find more to buy just because your portfolio is doing well – but i suppose at least the state covers basic needs – ultimately people do live on it
@Mark C
I’m more sanguine about the State Pension continuing to exist than some some others in this thread. But nothing in this life being certain, topping up your contributions might best be seen as just another way of diversifying your portfolio and spreading risk.
A few comments in the two articles suggest that as you age you don’t spend so much so you might as well blow some more now. To an extent this may be true but there is also a danger of wishful thinking. It is also difficult to estimate what that future saving may be as you wont really know until the time comes.
While it is true that you shouldn’t have mortgage payments, university fees, outfits for work, commuting costs, etc. experience shows we personally still spend a high percentage of previous outgoings. However, as everyone is different, there is no general rule. I’m 76 and we travel much more and, in more normal times, eat out a lot because we can and now have the time. We spend over 25% of our income on others again because we can and are so grateful that we are able to do so. Also, we set aside a large amount to cover private health treatment if needed in our final years and £60k per person per year for private nursing homes, say £250k for two. Nobody reading Monevator is likely to have the miniscule net assets needed to qualify for free care.
TP2
Living the Deaccumulation!
Retired at 57 -17 years ago-now nearly 75
Got McClung plus as many others as I could read-still reading but it’s now getting late and course set seems to have worked
Used Bogleheads Dynamic withdrawal method-very simple
I enjoy finance but I do have other things to do!
Withdrew much the same amounts that gave me equivalence to to my working salary
This turned out to be right as wife and I travelled a lot -more free time
A set Asset Allocation 40/60/5 equities bonds cash- 3-3.5% Withdrawal rate
Quicken 2004 has small Portfolio rebalancer program which tells you how much required from equities and bonds to retain Asset Allocation integrity
One withdrawal per annum to top up the 2 years expenses cash float
Now at 30/65/5 -time to start increasing equities again ?-if I can raise the enthusiasm
3 index tracker funds only
Simple cheap and easy to follow
So far so good!
xxd09
PS I meant to say portfolio many thousands more than when I started out
However we haven’t stinted ourselves but maybe it was good investment times
Going forward who knows?
xxd09
There are times in history (for example 2000 to 2010) where racking up debt to avoid selling equities would have made a bad situation even worse – albeit probably not definitively catastrophic – depending on how you were positioned with your debt for the financial crisis at the end of that decade.
People in drawdown have stopped earning an income and need to manage their wealth. The idea isn’t to die an early death through stress by repeated double or quits bets.
This is why the cash and bonds are there. If things are so bad that you blow through them and have to start selling equities, and that was what your strategy mandated when you set out, then selling equities is almost certainly a better idea than getting debt from whoever is going to give it to you as a non-earner (potentially dodgy or at high rates).
All in all an *entirely* different posture and risk/reward set-up to say a 30-something choosing to invest in a SIPP rather than overpay their mortgage.
Great thread, and I’ve only got time for a quick comment at the mo:
I don’t include the State Pension in my Plan A calculations, not because of my views on the political risk, but as part of the strategic flexibility that enables me to respond if any number of factors go against me:
Inflation
Tax
Health / other personal calamities
Historically bad sequence of returns
Insert decumulation bogeyman here
Naturally it’s possible that one or more of these factors could swamp my SWR boat in extreme weather.
But, to mix my metaphors, like an engineer builds a bridge to withstand forces stronger than might be expected, my plan allows for a fair amount of stress.
State Pension in reserve
For sale sign on the house
Spending less
The SWR itself being predicated on historical bad case scenarios
Diversified assets including ones that don’t have the greatest growth prospects right now
Even working a little!
Weaving the raft (it’s a raft now!) from these different materials will hopefully reduce the stress of navigating life’s squalls.
I’ll be back! Accursed employment.
@TI – a retiree wouldn’t be a non earner because of sipp and state pension income, so might have access to conventional finance like 0% cards, interest only mortgage, maybe offset mortgage, even equity release, etc, and they might carry forward these facilities from pre retirement. I wouldn’t touch margin loans and I regard standard unsecured loans as mostly pointless with a 5 year term.
Just mean that selling down other people’s bonds has similarities to issuing your own. 0% cards are generally good because you can (usually) keep kicking the can down the road although they won’t cover your expenses for long
There could indeed be times when taking on debt to preserve equities was bad but assuming a similar interest rate I imagine they’d be the same times when dynamic drawdown wouldn’t work (ie bonds outperforming equities)outperform
But yes, peace of mind important. In reality I dont need much and could afford to live off the state if I had to. I have trouble finding things that I actually want to buy (happy with old banger, prefer hone over holidays, dont apprentice posh nosh, etc)
Another good piece, thanks @TA, and the comments are equally as interesting to read (well, I think so!). Good luck to you and thanks for sharing your insights. The real-life examples are motivation for us further down the line for sure. Still very much at an early stage, but I prefer the simple approach, with my focus on the Vanguard LS 80, plus other property and small-cap indexes, and some individual shares and investment trusts that I feel aren’t covered by LS80. Just a question of keeping going!
If I may, a question to the floor on the subject voluntary NI contributions (I don’t know if this comes under ‘advice’ or merely comments or may or may not be suitable or answerable here, but this website is fantastic resource and full of informed types). Basically about a year ago, when looking around for my tax code information on the UK Gov website, I discovered gaps in my NI contribution, from a period out of work when I went travelling a couple of years ago, and also from only working part-time after uni, and also a period out of work when I didn’t sign on about 12 years ago, to the tune of around £1000 or so, which is spread out over three of the years I wasn’t in full-time employment. The Gov websites says I have until 2023 to pay half the shortfall and to 2025 the other half.
Trying to set 30% income aside to invest/save now for eventual FI at 55/60, but don’t know if it’s worth paying this now or just leaving it as a gap and continuing to focus on building the investments. As many mentioned in the comments above, I’m probably not planning on relying on the state pension as part of my long term FI planning, seeing it more of a bonus if/when I reach that age and I assume at some point the state pension will be changed/reduced/whatever. (it’s accessible at 67 now, which is only likely to rise, and I’m still at least 32 years away from that and currently have 15 years full contributions, rising to 18 if I make up the shortfall) but won’t get another chance to fill this down the line by the look, once the deadline passes. I think it’s one of those things where there isn’t a right or wrong answer, potentially. Thanks.
@TP2, have you set aside a “care home fund” from the beginning? Our thought was that our initial extra expenditure on travel etc (when permitted) would start to reduce and allow us to increase the emergency cash fund for that purpose. Or just stay in investments that are reasonably liquid.
And those extra costs you mention do still exist. Yes we paid off the morgage when I retired, but we have a daughter at university who needs parental contributions. And no doubt at some point, unless property prices change dramatically, she is likely to require parental help if she is to get on the housing ladder.
Phworr TA, you’ve outdone yourself with this one. I think this post article is about to break into my top ten most useful retirement articles and I might have more to say and read once I’ve achieved today’s gardening objectives! Mrs Nearlyrich isn’t too happy with you as she already thinks I spend too much time on retirement research 🙂
For now I would add:
a. https://monevator.com/the-most-important-goal-for-every-retiree/
and its twin a week later are imho a useful compliment to this mini-series.
b. I expect spending to be ‘U’ shaped. 60s Spending big on holidays and a new kitchen, 70s spending small (ovaltine and early nights), 80s high cost health and accommodation care. The latter two have the state pension to help so I think we all need to be bold in our 60s.
FWIW I use a high-annuity based income floor and then a 5.5% fixed percentage withdrawal (no guiderails) but in 5 years I’ve not got near it especially in 2020 and it has been coincidentally 3.8% (annualised). I like to rebalance on 5% thresholds mainly because of the volatile gold and equities in my portfolio and because I like to use my ‘free’ II trades.
Looking forward to the final instalment. NR
@JDW:
This is not a direct answer to your NI question but might help with your thinking.
I am still under 60 and pulled the plug a handful of years ago. Due to being contracted out, I am currently short of the ‘years’ needed for full SP. I need to fund a few more ‘years’ before I turn 67 to get full SP.
N.B. part ‘years’ are not a purchasing option although they are a pay-out possibility, see more at point d) below.
My current plan is to wait until nearer 67 before parting with these funds, because:
a) I paid for an extra ‘year’ under the old scheme – which then counted for precisely zilch when the system/rules changed,
b) I might (stress might!!) do some paid work between now and turning 67,
c) there is no longer any survivor benefit under the new scheme, and
d) I may not buy my final missing ‘year’ as whilst it costs the full amount it will only provide me with part of a ‘years’ state pension pay-out
However, things do change so I keep the situation under review and am fully prepared to change course if necessary.
IMO such a degree of flexibility is probably necessary to successfully navigate de-accumulation too. That is, whatever system you currently plan to follow, at best, it can only provide near-term guidance and must regularly be reviewed and revised as events unfold.
@JDW I was in a very similar boat to you last week. I had 16 years of full contributions and 1 year where I could make up the shortfall. I spoke with the DWP and they confirmed I would get an additional £5 per week to my pension forecast if I were to pay the outstanding contribution of £120. For such a small amount I thought it was worth the risk that the rules change again. My plan is to retire within the next 10 years, so I will hopefully finish work before contributing to the required number of years’ NI payments. If you’re planning to work until 55, are you likely to have made enough years’ contributions by then anyway? Another thing to note is that DWP told me the top up amount would increase past Apr 5th so I thought I’d bite the bullet now.
@Al cam, re your final year missing year, Ive just discovered Im in a similar boat – Im short one year, but at a (current) cost of £795 I believe, I would only get an additional £28.40, which is what I’m short of the full NSP. I assume this irregularity/small shortfall cane about because of the calculations to take account of being contracted-out some years ago. Glad I checked with the pension service.
@Al cam, re your final missing year, Ive just discovered Im in a similar boat – Im short one year, but at a (current) cost of £795 I believe, I would only get an additional £28.40, which is what I’m short of the full NSP. I assume this irregularity/small shortfall came about because of the calculations to take account of being contracted-out some years ago. Glad I checked with the pension service.
I think this series will join the ‘how much do I need to put in my SIPP and ISA’ from early 2020 as a must read. Thank you!
Like @Al cam, I’m interested in how to combine this with an ISA bridge. I’m likely to have a 12 year bridge and was thinking of a 40-60 stock bond allocation, rebalanced annually. I read Wade Pfau’s ‘How much can I spend in retirement’ which has a handy table showing the SWRs for different asset allocations and time periods (I think it was 8.2% for 12 years). So, I was just going to use that
I suppose there is no reason why you couldn’t use prime harvesting for the bridge and then the dynamic asset allocations and withdrawals once you can access pensions.
@JP:
Yes that is correct. All the required information is in the pension forecast – but it would be very easy to overlook this “feature”.
This, of course, assumes that the contracted out calculation is correct – see e.g. comments #104 & #108 at Part 1 at: https://monevator.com/decumulation-a-real-life-plan/
I should also point out that for years where you have already paid in some NI contributions – e.g. you left paid work part-way through that tax year – it is possible to make this up to a qualifying year by making a partial payment.
This might be the scenario that LALILULELO describes at #45 above.
As I might have mentioned once or twice before: NI can be fiendishly complicated!
@JP:
Just to be clear did you mean £28.40 per annum or per week or what precisely?
Context a 30 or 40 year pension drawdown – the McClung book is *very* much worth the price of admission. It’s a tough read though. Covers a lot of ground and presents a lot of data in support of the arguments made. Suits people who need to know *why* and want to poke the argument and data with a stick before accepting it. Valuable even if you pick one of the other (simpler) methods examined as good enough – for your use.
Valuable both for the recommendations he makes and the alternatives he tests with multiple separate data sets US, International. And for the shortlist he uses a “stress test” worse than all historic markets. It is a helpful book in a several ways whether or not you adopt his “best of the selections” arguments. He can’t tell us that the future is like the past but he can and does present a thorough test of the main options and arguments and useful achieved backtested ranges for variable incomes on a range of market conditions and portfolio selections. To known market risk (history) and something worse. Very helpful.
The guaranteed income implementation sections of the book are US focused but the drawdown alongside GI logic presented is fine. The portfolio selection part of the book is less developed than the rest but still contains some very useful content.
Importantly he demonstrates the magnitude of the marginal gains to be had by different techniques of fiddling with the drawdown admin plan and the impact on “squeezing the balloon in one spot” on others. Techniques he doesn’t ultimately pick are very usefully placed in context as to how they behave differently (less well but perhaps not enough to matter – in some circumstances). A lot of course depends upon how hard you are working a given pot size to achieve an income goal for how long a retirement.
He does not fully complete the implementation journey for any country US or UK or otherwise. Though he comes a lot closer than many writers on this subject.
Extended Mortality does indeed come out well in the testing as a variable income technique and would be a not too difficult choice for implementing DC drawdown with variable income and a floor (and if you choose a cap).
Local country tax planning may of course get in the way of any purist approach. Issues such as BCE5A (Age 75 2nd LTA test of nominal growth to already crystallised value, SA taxation and IHT) to consider alongside pure WR mechanics from the DC pension pot itself
@TA
Another great article. I bought McClung’s book last year after reading your review, it’s very comprehensive and insightful. I like the Prime Harvesting concept and McClung does a good job of demolishing some of the alternatives.
I get the point made in your comment that there are multiple redundancies built in to your approach, and I expect you got comfortable on that basis. But like a couple of other commenters I was wondering if you had considered a more direct way of attacking the sequence risk problem. I’ve spent a bit of time looking into trend following (as mentioned by Mike at comment 5), which does seem like an interesting way of potentially reducing volatility without harming returns too much. There is a little favourable research on this (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2764933) but generally it doesn’t seem to have received much attention in the retirement context.
Of course it seems like anathema to us buy ‘n hold types, and as it would need (at least) monthly checking of asset values against 200 day SMAs or whatever, perhaps it’s just too much trouble for a retiree – even an early retiree.
There are even funkier possibilities, like tail risk hedging, that I haven’t looked into in any detail. I do think that there must be more focused ways of dealing with the sequence risk problem than just relying on a stocks and bonds portfolio, even if tied to a variable withdrawal/asset allocation strategy. Perhaps in time the investment & pensions industry will make some sensible options available to the consumer, though their record on retail structured products is… not good.
Doris #34 – thanks for your response.
JDW #41 LALILULELO #45 – I read earlier that the class 3 NI contributions will only increase by 10p per week next tax year so, depending on your personal situation, you may want to leave paying the voluntary contributions until nearer the deadline.
Great series so far and already looking forward to the final episode…
I’m 5 years into retirement now, though nearer a traditional retiree (I was 60) than a RE type. Like TA I’m most keen on the glidepath decumulation strategy outlined in Michael McClung’s book, but moderated by EarlyRetirementNow’s critique which identified a couple of very odd boundary behaviours of the raw prime harvesting method. In my reading of ERN’s modelling it seems a consistently increasing glidepath up to 100% equities is as effective or better than PH. I get lost on how this glidepath idea applies to retirees though, as ERN is dealing with the run up to and through retirement, despite going head to head with McClung. ERN says post-retirement things are different and you need chunk of cash and/or bonds for long term security and the ability to sleep at night as much as anything.
Now in practice what has happened is I’ve followed the McClung PH method alongside ERNs models (he also has a free spreadsheet you can tinker with) AND an annual actuarial-based view from howmuchcaniaffordtospendinretirement.blogspot.com/ – they provide an ABC spreadsheet. I changed the level of equities I was happy with (from about 63% to currently 73%) so that has thrown the PH spreadsheet up in the air – I’ll have to figure out how to restart it or otherwise muddle through. I changed from an annual drawdown into a high interest easy access account to a monthly one (that’s ERN for you), but draw down the CAPE-based estimate (but ‘mentally’ account for the extra I could have drawn down by adding the difference with that to the plain version (about 10% more) and ‘save;’ it in a daft expenses account for holidays and such like, so I will feel less bad if I do some of that). I keep an eye on the ABC actuarial valuations (usually MORE generous than the ERN CAPE based ones, but my assumptions are maybe different between the cases).
And so on. It’s human instinct to try to divine the tea-leaves and agonise about stuff that is inscrutable, and sadly I’m only human.
My real safety cushion is I have a good DB pension and have just paid off a few extra years of NI – my state pension kicks in in October. Three-quarters of my income needs are going to come out of these resources. On reflection if I had to fund the lot out of a portfolio in freetrade I’d probably be somewhat less sanguine about how much to put in equities – really TBH I can’t see why I don’t just go 100% equities. You don’t often see commentary about how to modify drawdown scenarios for pensions and annuities – ERN’s spreadsheet does this though as does the ABC spreadsheet. I think perhaps if I got to 60 and had virtually no pension but just a big sack of cash, say from selling a business, I’d be tempted to cover my core expenses with an annuity, despite the epochally low rates, just for peace of mind, simplicity and security against longevity risk. I think this is the kind of approach Wade Pfau might advocate. And with the Grim Reaper and all that round the corner one has to face up to simplification and the security of ones finances earlier rather than later. https://monevator.com/death-infirmity-investing/
Probably past time we heard from the Greybeard again. Hope he’s OK.
@c-strong
I’ve read the papers from Andrew Clare’s group and the results do look convincing. A key claim is that trend following is a good defence against sequence of returns risk with little impact on the upside of portfolio returns. I’ve not seen any critique of this in FIRE blogs so far, but some may come. After some thought for my own case I guessed the tax implications of doing this (converting 100% periodically to cash and back) would be too disadvantageous as I’ve got quite a lot in unsheltered accounts. If you had all your portfolio in ISAs and SIPPS it would be OK I guess, but I’ve no data to offer either way.
@Al Cam, yes, should have made that clearer – £28.40 per year. A very small shortfall.
@JP:
Good, I was pretty sure that was what you meant – but thought it best to check as it is very easy to misunderstand these things.
Thanks for sharing this information as it is a great real-world example of the point I was trying to make!
At c. 55p / week it is even more ludicrous than my own scenario. I wonder if any other reader has a similarly silly example?
@ Al Cam & Ray – I will be using a cash bridge for over 6 years but that doesn’t exclude running the rest of the decumulation plan. I think of cash as part of my asset allocation, not a beast apart. McClung’s method calls for me to use cash / bonds for living expenses. Equities rebalance into bonds after breaching the 20% inflation-adjusted increase. I’ll follow that system once decumulation starts.
@ Dawn – it sounds like you’re nicely set up. As you illustrate, every solution comes with trade-offs.
@ Mike & c-strong – I have similar thoughts to you about trend following. Plenty of evidence in its favour but it does require you to stick with it through hell and high water. And there seems to be plenty of high water. You can lag the market for years before making it big. Given my own psychology, I decided to get exposure to momentum via the multi-factor allocation where it has a low to negative correlation with value.
@ SirRik – my mention of Vanguard LifeStrategy in connection with cognitive decline also means buying an annuity. The annuity would be the ‘bond’ side of the allocation in that scenario.
My assumption is that this could happen when I’m much older. Annuitise as much of the portfolio as necessary to provide a solid floor in an index-linked product. The remainder of the portfolio goes into Vanguard LifeStrategy 100 – but only if that money isn’t really needed. You live on the annuity while the equity side of the portfolio is free to grow and is essentially on a rising glidepath.
It’s a very simple approach that I’ve seen work wonders for a close relative. The annuity takes away day-to-day stress but equity upside is still a possibility. They’re not interested in anything more complicated than that.
@ Cigano99 and Hal – holding a set number of years of cash is a bucket strategy. There’s been lots of research into it, and that typically shows that a baseline level of cash proves to be a drag over the years and doesn’t offer any more safety. That said, I think it’s far more important to be comfortable with your system than optimising everything to death and experiencing on-going, low-level stress about it.
@ Doris – what’s the alternative to one day selling your equities? I think it’s important not to anchor on any given equity valuation. As long as the portfolio funds a long and happy life then that will do.
@ John Tickner – I signed up for the free trial here:
https://app.timelineapp.co/registrations/new
@ Tom-Baker – The lower your SWR the safer you’ll be. I’m too impatient to wait any longer
@ Ash – that reference is meant to highlight that mortality-sensitive systems recognise that you aren’t going to live forever. In other words, if you knew you were going to live one more year then your annual withdrawal could be 100%. Vanilla SWR rules only allow for a standard inflation-adjusted increase even if you’re 110. They don’t take into account your attenuating lifeline.
That said, I don’t buy into this idea of declining spend as you age. Even if the research is right on average I’m not banking on it applying to me. That’s just another of my conservative assumptions.
As an aside, we talk a lot about care homes, cognitive decline, failing health etc on these threads. I intend to kick against this outcome as much as I possibly can.
@ MarkR – Choosing a conservative SWR is the central brace against such a fate. You’re setting your withdrawal rate low enough to not exhaust your portfolio based on how those scenarios have played out in the past. McClung models a number of Plan Bs such as back-up portfolios.
@ Whettam – I did consider a rising equity glidepath or bond tent. I like it. Ultimately I decided that the dynamic withdrawal rate is more flexible, and achieves much the same objective re: safety. Only history will tell whether I made the right choice.
I’ll maintain the asset allocation outlined last episode between bonds, cash and gold. The caveat is that gold gets spent down and never replaced in a crisis when bonds and equities are tumbling off the Reichenbach Falls together.
Re: Pfau and PMT – yes, I’ve read about it. Pfau is a great academic and I’ve found his work invaluable, especially on international SWRs and annuities. But in my experience, he’s never really offered a fully-featured, practical solution for DIY decumulators who can’t afford safety first. Are you considering PMT for your system?
@ Nearlyrich – cheers!
@ GMO – that’s a great review. The ’squeezing the balloon’ metaphor is a great way to visualise the problem.
@ IanH – thank you for your insight. It sounds like you really enjoy the process of being hands on, and the cushion is an important part of enabling you to experiment.
My reading of the research on rising glidepaths is that they ultimately perform best in a narrower range of market conditions than dynamic withdrawal rates. Much depends on your inputs and ultimate objectives though of course.
If you had to choose a system which one would you go for, or would you still create your own hybrid?
@TA:
A feature of the McClung system you propose to follow is that by definition it never allows you to buy any more equities! It assumes from the outset that you do actually de-accumulate. As @Dawn (and others e.g. xxd09 I assume) can attest, this may not actually turn out to be the case. Personally, I would use the early years (of your bridge) to establish what is really going on before seemingly locking myself out of anything!
As I said at #44 above, any plan can only really provide near-term guidance and must regularly be reviewed and revised as events unfold.
Re Pfau:
Are you familiar with the Stanford Spend Safely in Retirement Strategy (SSiRS) which is really a hybrid approach that uses US Social Security as a partial Floor, see for example: https://longevity.stanford.edu/wp-content/uploads/2019/07/Viability%20SSiRS%20Final%20SCL.pdf
Pfau is one of the three authors. Whilst this study is aimed primarily at a US audience it is intended to be “a fully-featured, practical solution for DIY decumulators” to borrow your phrase. There are lots of detailed documents available about the SSiRS approach – but the one I linked to concentrates on “various design and implementation details”.
@TA:
And it turns out that in the real world Ian H (#54) discovered that feature of McClung (#59) and decided – IMO eminently sensibly – to be pragmatic!
@Ian H:
Sounds to me like it might be helpful (and much simpler) to reframe your approach along Floor and Upside lines.
Are you familiar with Zwecher’s book Retirement Portfolios and the late great Dirk Cottons website: the Retirement Cafe?
@ Al Cam – I will be decumulating. But, this doesn’t seem like a problem to me either way. The decumulation strategy allows for the fact that the portfolio can increase in value. If that happened to be with new money then I could just buy the same asset allocation in proportion.
Or I could use it as a back-up portfolio – some people call this a fuse portfolio. McClung describes different variants. Or I could invest in a ladder of index-linked bonds, or annuities.
The SSiRS is new to me. Thank you for the link. Do you intend to use it? How do you rate it?
@TA:
Re: McC
Personally I think that all, so-called, SWR systems are designed with at least an eye to programmability – otherwise they are hard to back-test, etc.
Fundamentally, they cannot provide “the answer” because the future is unknown and unknowable.
Re: SSiRS
IMO it has been well considered and has been thoroughly bench-tested – using a whole host of different “measures of goodness”. It is very US-centric – but IMO there is some read-across to the UK. However, like all such systems it can never be the answer either – because ….
Even pure safety first approaches are not 100% bomb proof. Just look at all the chatter above about the SP.
My own take is that ultimately you have to take a view and be comfortable with your choices bearing in mind that as we all get older we will become less able (but beware: probably no less willing to try) to make good financial decisions. Thus, attributes like reversibility, optionality, simplicity, and flexibility are probably more important than so-called SWR’s and other modern myths like failure rates. But, of course, this is just my view.
@ Al Cam – You’ve put your finger on an important sub-text of every comment thread on this topic.
If the ‘answer’ is to bombproof then there is no answer because there is no bombproof. We can up the Armageddon ante all day long.
If the ‘answer’ is a system that you’re comfortable with, understand, can operate and considers the variables you believe to be relevant to your situation then there is an answer. But it probably isn’t one single system. It’s a blend of considerations bent around your personal circumstances.
All systems have their shortcomings. It’s important to know what they are. It’s also useful to know where people are coming from.
If someone is getting 80% of their income from a DB pension and doesn’t care about leaving a legacy then their system may not contain many answers for someone relying on a defined contribution portfolio and for whom leaving something for the kids is mission critical.
Similarly, I can totally buy into the ‘keeping it simple’ argument.
I don’t think you can take a single factor like an SWR and say, ‘that’s it folks, nothing else to think about.’ Although it’s simplicity that’s the allure of the 4% rule and why it’s famous.
Can you outline what your solution will be? You’ve obviously thought deeply on the topic.
@TA:
I think it may be better to wait until after you publish your Part 3 before I try to answer your Q “can you outline …”
What I would say at this juncture is that the de-accumulation issue is one of many similar imponderables in that puzzle we call life!
@TA
I suspect that my thinking on this is too simplistic, but isn’t it true that in the limiting case where equity prices fall monotonically from your day of retiral until your demise then the earlier those equities are sold the better? From my understanding, the proposed strategy would lead to the tail end of the portfolio being 100% devalued equities. I appreciate that no strategy is risk free, but if you’re in the camp that sees global equities as being currently very overvalued, might this not be a bad time to set the ‘base value’ for equities below which they won’t be sold?
Hi,
I have long been a follower of these articles but first time to have commented.
Excellent series and very informative.
I am currently in my early 50’s and plan to retire in about 6-7 years time.
Going slightly off on a tangent, I don’t know if anyone can help me.
Having transferred the value of my DB scheme to my SIPP I had hoped to reach my lifetime allowance around the same time as my retirement age. However, with the chancellor’s freeze on the LTA yesterday I may reach my LTA a year or two earlier. Can anybody tell me, if I crystallise my pension before I reach my LTA would I incur additional taxes if my pension subsequently rises above the LTA? Also if I only take from my tax free lump sum can I still pay into the pension (above the £4000)? Thanks in anticipation for any help.
@ TA Thank you again, for all the answers. I agree that Pfau does place a large emphasis on safety first for the income floor and this is not affordable for most and / or younger retirees. I have not decided my own system yet, which is one of the reasons I’m finding this series so interesting.
I ‘m attracted to the simplicity of the Excel PMT calculation for variable withdrawals. I think it has a number of advantages, including its simplicity, my wife has very little interest in all this stuff, I also like the way it includes current portfolio value explicitly in the calculation and incorporates changing estimates of mortality and expected returns. Ultimately I think I’m more likely to initially choose something like EM, but I will still calculate PMT as a “shadow” benchmark each year.
Thank you (again) @A1Cam for the SSiRS paper, I had not seen that either something else to read, along with re-reading McClung.
Although I’m totally convinced by Dynamic Asset Allocation, I do struggle a bit with the Prime Harvesting idea that you never buy more equities. Which is why I asked @TA about your thoughts on equity glide paths. Maybe it’s a behavioural / confirmation bias, I need to get over, but I have spent 20 odd years interested in Accumulation investing thinking about asset allocation / re-balancing. I think I’m likely to try and combine the equity glide path, partly based on a timeframe, but also some market valuation using CAPE. Then when I have reached max equities, then switch to McClung.
I know that this will be too active for some, but although my portfolio is operated on a total return basis. My system is likely to differentiate between selling equities for income and taking the dividend from equities as income and reinvesting dividends.
Re: McClung and ERN’s work, what I took away is that consuming your bonds before your Equities gives a nice little boost. Almost as good as the glide paths. That’s basically my approach because a) it’s simple; and b) I need to rebalance towards equities in the medium term. If I stay employed, it’s a glide path buying into equities, if I retire I’ll spend the bond portion first.
Though the markets seem to be doing that for me today anyway 🙁
@Cruncher Hi I’m a similar age and similar issue. I ‘m now certain to exceed the LTA, although I plan to only crystallise up to the LTA initially, to delay the charge.
You should verify this (maybe speak with pension wise?). However my understanding, is you can crystallise part of your pension, as soon as you are 55, put the pension into flexible access drawdown and take tax free cash. When you do this, you can still pay into the part you have not crystallised, I don’t think you can pay into a pension in FAD so you would need to keep at least two accounts (which may incur more fees). My understanding is that, you don’t trigger the Money Purchase Annual Allowance £4k limit, until you actually withdraw funds out of your FAD account.
For all funds in FAD, there is then a second test against the LTA at age 75. I think this second LTA test is maybe a target for future chancellors, maybe to limit the value of SIPPs as an IHT dodge?
@Cruncher, “if I crystallise my pension before I reach my LTA would I incur additional taxes if my pension subsequently rises above the LTA?”
Short answer, probably not. Longer answer, there is another BCE test carried out at age 75. In that test they look at the growth of the SIPP since you crystallised. Any growth will consume part of your LTA and if you exceed the LTA a charge will be made on the excess. Note that this test only happens when you are 75, so you can exceed the LTA prior to that, but if you draw it down (or the value drops) so that you do not exceed the LTA on your 75th birthday you will be ok. In your situation you should definitely try to fully crystallise before you exceed the LTA otherwise 2 unpleasant things happen. The first is an LTA charge. The second is that your 25% tax free pension commencement lump (PCLS) sum is reduced as it is capped at 25% of the LTA.
“Also if I only take from my tax free lump sum can I still pay into the pension (above the £4000)?”. Yes, but make sure you it is ONLY from your PCLS. Take any income and you will be restricted to £4k per year.
If you do take tax free cash, be careful not to break the lump sum recycling rules:
https://www.pensionsadvisoryservice.org.uk/about-pensions/saving-into-a-pension/pensions-and-tax/pension-lump-sum-recycling
This problem is avoidable, just be cognisant of the rules so you don’t accidentally slip up.
@TA, are you following the full McClung Prime Harvesting, or a modified version?
There were 2 aspects of PH I did not like and have changed. The first is that he reinvests all dividends. The only rationale I can find in his book for doing that is that it made modelling easier. I prefer to add them to the cash pot for spending.
The second thing I did not like was on selling 20% when the value of the equity investments rose by 20% real. 20% is a large amount to suddenly dispose of and my preference is to sell the excess over 20% instead of knocking the whole thing back down again. ERN included this “slice off the excess” option in his review of Prime Harvesting and found it performed slightly better than McClung’s PH.
@Cruncher (#67):
FWIW, I entirely agree with Naeclue’s (#71) analysis and suggestion re your situation! Personally, I then took further LTA mitigation steps – but they are not suitable/appropriate for all.
I similarly agree with Whettam’s (#70) view too.
@ Whettam – I think the idea that you never buy equities under Prime Harvesting is a misnomer. You sell bonds to fund annual withdrawals. Over time, you could end up 100% in equities. This is most likely to happen when equity valuations are low. The system is geared to preserve your equities from sale and allow them time to recover. As a proportion of your wealth, your equity allocation increases in similar circumstances as if you rebalanced into them. It’s just a different mechanism that’s meant to help you avoid catching a falling knife.
@ Naeclue – it’s hard to argue with ERN. But ERN wrote one article on Prime Harvesting. McClung wrote a book. And tested it against non-US historical returns. Therefore I’m likely to stick to the original.
@ Doris – I fear that you’re not planning on me living as long as I hope to 😉
On the face of it, what you’re suggesting is that we can use a signal to know that equities are going to crash and then stay down until death do us part.
If you had a system which told you that equities were going to lose value and never recover then, yes, you should sell up now and put everything into whatever asset will perform best for that entire period.
But we don’t have that foresight. What you’re asking for is the ultimate in market-timing and the scenario you fear isn’t very likely – though it could happen.
I’m not sure what you mean by a baseline for equities below which they won’t be sold. The equities will be sold at whatever value, *if* they’re the only way to carry on funding my retirement.
Often people worry about how it can be that someone could retire today on an SWR of 4% and withdraw £40,000 from a £1,000,000 portfolio. Whereas someone who retires tomorrow after a crash gets to withdraw say £30,000 from a smaller portfolio.
The reality is that after the crash, valuations fall and that correlates with higher historical SWRs. A valuation based system makes that link explicit – I use a higher withdrawal rate when valuations are low, and a lower withdrawal rate when valuations are high.
I’ve ended up with a higher income on a larger portfolio at a lower withdrawal rate than I was expecting a couple of years ago.
I’m not sure if I’ve really answered your question, but let’s continue to kick it about if that’s helpful.
Another point that becomes obvious once reading McClung’s methods comparison is that fiddling with any of the methods/parameters – even a little – will not give exactly the same results in backtesting i.e. it may behave differently for some sequences and starting conditions + sometimes more than you would expect. The stress testing chapters show this well where methods/parameters are pressurised and their “linear range” breaksdown somewhat. What looked good – ends up less attractive in more stressed markets.
*If* a parameter change increases sensitivity to particular sequencing then the results may be *materially* worse than expected (if that sequencing turns up again). Whether the magnitude of the change actually matters is a whole other discussion. The examples in his stress test chapters (on prolonged low variable income / failure definitions arguably do qualify as mattering.
The implication is that once you fiddle with the parameters then you really should rerun your own tests. You are no longer riding on McClung or ERN’s backtesting coat tails. As is his wont and indeed right ERN tests what *he* likes (and not necessarily an author’s exact intent or original setup). Where he errs occasionally is in characterising his test as a valid debunking of something he has himself adjusted. He did the same with GuytonKlinger. You don’t reproduce or invalidate anything by testing something which is *similar* but not identical. You may think your fiddling is immaterial or an improvement and it may or may not be true. ERN is great in the sheer volume of drawdown topics and myth busting he has covered. His drawdown series is a great resource.
Like some other commenters – I also find the prime harvesting tuned asset class sales/rebalancing thresholds counterintuitive and arbitrary seeming. McClung’s great help is his testing of what he proposes with more than one geographic data set so you are not seeing a tuned for historic US only story. For me the out of band testing is the extra contribution he makes over most other books.
This counterintuitive magic formula numbers point comes up a lot in machine learning. When you train a mathematical approximation for complex inputs to generate a predictive output against a data set – the somewhat predictive magic parameters appear in the trained “formula” which are not readily understandable to the lay person. This traceability of decision making being one of the remaining hard issues with the socially acceptable application of datascience/ML/AI more generally.
Thank you @TA I get that your equity allocation can still increase, as I said I’ll just need to reset my brain when the time comes, I’m too used to rebalancing. So the idea of never buying more equities seems weird. My with profits policy is also something specific to my circumstances, I consider it a bond, but it would not work in PH.
I’m 52 so still have a few years, not yet at target and definitely need to access pensions. But I will definitely be re-reading McClung, I was intending to anyway, but the series has persuaded me to start define plan now.
@TA
One last attempt to refine my thoughts, then I’ll leave it to those who actually know what they are talking about.
Your fourth rule is
‘Rebalance into bonds only after a significant run-up in the value of your equities.’
I suppose my question boils down to run up from what? Is it the equity valuation on the day you retire or from some temporal average of their value leading up to retirement? If it’s the former, is their any sensitivity over the next say 25 years to whether someone retired pre covid in February 2020 or a month later in the depths of the March 2020 trough? It feels like that could affect how many equities are being held further down the line.
@al cam
“Sounds to me like it might be helpful (and much simpler) to reframe your approach along Floor and Upside lines.
Are you familiar with Zwecher’s book Retirement Portfolios and the late great Dirk Cottons website: the Retirement Cafe?”
Thanks for reminding me about Retirement Cafe, but I’m not familiar with Zwecher’s work. I’ll check it out. Floor / upside was among the first ideas I heard about when researching decumulation strategies years ago but it didn’t appeal at the time – no idea now why not. Insufficiently complex and baffling I guess. I’ll definitely chase up Zwecher’s book – thanks.
@Ian H:
Zwecher’s book is written for the US market. Having said that, it is not too tricky to do read-across to the UK where applicable. IMO, the book, although at times not the easiest of reads, is far and away the most comprehensive exploration of Floor and Upside.
@ Doris – if you read the free sample and then the book it will become much clearer. Moreover, you can see many tables that detail how withdrawal rates move over time, depending on your start date.
Bear in mind that accumulation and decumulation are linked. If valuations are high then your system may require you to make a lower withdrawal rate but from a bigger pot.
If you wait until valuations drop then you’ll likely be withdrawing from a smaller pot.
If you’re worried about the effect of somehow sealing your fate because you pick the ‘wrong time’ to retire then check out ERN’s piece on the power of one-more-year:
https://earlyretirementnow.com/2021/01/13/one-more-year-swr-series-part-42/
@ GMO – that’s very interesting. Thank you. When you see a formula that says do X when Y hits Z – how do you deal with it? As in, do you treat it as a rule of thumb? Or do you to run your own tests like you mention?
Given the sensitivity of retirement research to inputs I’ve come to disbelieve that there’s a magic formula I can pick and the rest will take care of itself.
I now try to think of it more as an environment to navigate. I set the course, I have a rough map of the terrain, but I can still fall into a crevasse, so I need to be equipped to climb out if that happens.
It’s interesting that although lots of researchers have covered the ‘dividend fallacy’, ‘why dividends are a bonkers retirement strategy”, etc. I don’t believe any have looked at total return strategy, but treating the dividends differently to the capital, when looking at withdrawals.
Very simplistically if a retiree has a horrid sequence of return early in retirement and spends their bonds first, these will last for X years. But if their equities are a producing 1-2% dividend and this was withdrawn as income, rather than re-invested, it would make the bonds last for longer. I’m surprised no-one seems to have investigated the value of the extra time vs. loosing out on the re-invested dividends.
@gmo I’m a data scientist (I confess I mainly manage these days) and I agree with your comments about traceability, but for me traceability of data and the ultimate decision is a must have requirement, for anyone in my team implementing ML Models within decisions. I think the harder issue is explainability of ML models to lay people and that’s why a lot of production models are based on well understood techniques like regression / credit scorecards. A lot of data scientists are not very good at explaining more complex methods and lay people are usually not great at stats! There are lots of new methods that can assist with this, but some people still argue about the Monty Hall problem or the Birthday paradox, because we humans are full of cognitive biases 🙂
However I don’t think this is the issue with retirement research, we are not talking complex models, as @TA says “given the sensitivity of retirement research to inputs”. This for me is the real issue if you use historic data and want a 45 year planning window, then you do not have many time periods to look at and the world has fundamentally changed since the data used in some of the research. Three points don’t make a trend.
@Whettam, “Very simplistically if a retiree has a horrid sequence of return early in retirement and spends their bonds first, these will last for X years. But if their equities are a producing 1-2% dividend and this was withdrawn as income, rather than re-invested, it would make the bonds last for longer. I’m surprised no-one seems to have investigated the value of the extra time vs. loosing out on the re-invested dividends.”
I think there are 2 main reasons for this. The first is a practical one, the lack of reliable dividend data. Published indices are typically ex-dividend, or accumulating/TR. Index providers clearly must have dividend information, but they don’t publish it. Dividend streams have to be inferred from the ex-div and TR indices. Perfectly possible, but an extra step in the process.
The second and more important difficulty is that dividend policies change with time. For example, the proportion of company profits going into share buy backs compared to dividends has markedly increased over time for US shares. This variable dividend policy aspect renders historic dividend research somewhat pointless.
FWIW our drawdown strategy does rely on dividend payments. We don’t invest in bonds any more, just cash deposits and we keep less cash, currently 6 years spending, than we otherwise would if we fully followed the McClung approach and reinvested dividends. Dividends from the equity portfolio are added to the cash deposits and we spend from the deposits.
@TA – I agree that seeking precision is misguided. We can’t predict the future, merely horizon scan for potential problems and try to mitigate any adverse outcomes. “Am I about right?” is as good as it can get.
Personally, I think we might be about to enter the Great Stagnation. Asset prices have been boosted to the max (it’s like a drug Govts can’t kick – “got some nice Stamp Duty holiday here. Very pure.”) and Governments have very little ammo left – maxed out on borrowing and interest rates lowest in 300 years where is there to go? Added to that, increased protectionism seems everywhere a risk, inflation may pick up and unemployment has been delayed by massive Government borrowing.
But I know nothing. Ho-hum.
@Whettam, Naeclue – and additionally, if you’re spending your 1-2% dividends you are effectively selling 1-2% of you equities as if you accumulated instead, your fund value would increase by the size of the dividend.
@Brod, etc
To quote Carveth Read, see e.g. https://en.wikipedia.org/wiki/Carveth_Read,
“It is better to be vaguely right than exactly wrong”
This quote, or some subtle variant thereof, is often attributed (incorrectly, I now believe – thanks to a previous chat on this subject at Monevator) to Keynes.
@TA
Thanks for taking the time to write a full reply. As an aside, it makes me wonder how many people believe that they are following a carefully thought through (by someone else) investment or retirement strategy, but are actually screwing up the details.
@Naeclue Your approach is interesting thank you. I agree it’s harder to research, but it seems to me such a fundamental factor with equities I’m surprised that someone has not tried.
@Brod I agree with principal that spending the dividend is like ‘selling’. But in practice dividends have not been as historically volatile as equity prices, so spending just the dividend and hanging on to the capital, will have a fundamentally different outcome from a deaccumulation performance perspective. If we take a fairly standard Dev World ETF like HMWO:
https://www2.trustnet.com/Tools/Equities/FactsheetPDF.aspx?code=HMWO
Its Dividend has fluctuated quite a bit since 2013, starting at 30.26 cents, rising to 39.11 in 2017 and only 28.14 last year. But if someone smoothed this income volatility by spending from cash or bonds, they would still have their equity capital and maybe this would be better than having to have sold HMWO last March when it was down 25% in a month?
@Brod, ” and additionally, if you’re spending your 1-2% dividends you are effectively selling 1-2% of you equities as if you accumulated instead, your fund value would increase by the size of the dividend.”
Agreed. I am not arguing about some mystical properties that dividends might have and certainly not for overweighting high yielding shares or dividend “Aristocrats”. However, dividends do not march in lock step with share prices and dividends are less volatile than share prices. They also arrive at zero cost and zero effort. I could reinvest them (at cost), but then I would be selling more frequently as well, at cost. Where is the logic in that?
Agree completely about seeking precision. There are big dangers with overfitting leading to a false sense of security as well. Also, one aspect that McClung and the others do not address, as it is impossible to backtest, is the need/desire to vary spending throughout retirement. Not just anticipating spending less or more as we age, but to adjust for life changing events.
A conventional drawdown strategy might say you have X to spend this year, does not mean you have to spend X. We have never lived like that and don’t intend to start now. As part of an annual review we intend to take into account how we think our spending might change over the next 5 year.
As we are less than 1 year into our new strategy, we have not had another review yet and see no point doing that until next January as it has been such an exceptional period, but this part of the review is by far the most difficult part of our drawdown strategy.
@Whettam – I’d agree GENERALLY not as volatile as asset prices (sorry for shouting) though the figures you quote show an (exceptional?) fall in dividends of about 25% 😉
But I would hope/plan to have 20%-30% or so in bonds to sell instead. At (puts finger in air) 3.5% WR that 6-8 years or so with no real return on bonds. I hope that any share price recovery should be under way by then though a 1966 scenario gives me the creeps. As that begins to run out, can I reduce spending? Stack shelves for 10 hours a week? (Actually, my SP should kick in in 12 years so I’d have an adequate floor.)
@Whettam, I agree it might be interesting to compare. I might have a look for some dividend history. I think there is some publicly available S&P 500 dividend history, which would be a good start. There will clearly be some cases when reinvesting dividends led to bad outcomes and some that led to good outcomes. Hard to know without looking at the data which gives the route that is likely to be better, but what I do know is that there are costs associated with reinvesting dividends and with subsequently disinvesting. Minimising trading minimises trading costs. Costs in terms of dealer fees, spreads, additional taxes and the risk of someone front running your trades, etc. I would need to see any benefit from reinvesting dividends outweigh the costs and risks.
@Brod I did not give every years data, but yes the dividend of HMWO dropped 25% over three years, the share price did the same in a month 😉
I wanted a passive example for a Monevator comment 🙂 but I could have picked lots of other active Investment Trusts e.g. Bankers in share price performance terms a closet all world tracker, but 21 years of dividend growth, no drops since 2000 or BlackRock Smaller Co’s 13 years of dividend growth.
I’m NOT (sorry 🙂 saying Dividends are the total solution, but I think their unique characteristics, make them worthy considering for deaccumulation.
@Whettam – I guess we’ll have to agree to disagree. I don’t think you’re proposing to select funds/companies based on dividends, but I merely think of dividends as distributed capital. And are the dividend’s back up?
Oh, and I think IT’s etc, are merely holding cash reserves or selling assets themselves to give you that increasing dividend. You’re paying someone else to manage the decisions for you. Blackrock I don’t know.
Sorry, I’ve done this to death now so I’ll stay stum.
@Al Cam
re Zwecher’s book – £61.75 for a Kindle copy? No thanks! I’ll see if the library can source it for me otherwise I’ll rely on Retirement Cafre et al. Cheers anyway :=)
@IanH:
I agree that does seem a tad expensive.
Public library sounds like a good idea.
The ISBN from my copy is 978-0-470-55681-8 (cloth)
Apparently, you can get a digital download – whatever that is, PDF? – for £25.65, see:
https://www.amazon.co.uk/Retirement-Portfolios-Construction-Management-Finance/dp/0470556811/ref=tmm_hrd_swatch_0?_encoding=UTF8&qid=1614955639&sr=8-3
I bought mine (hardback) years ago and I do not not recall it being exceptionally expensive – but I might have forgotten. In any case, it is my go to for a lot of things and has given me very good service.
@Whettam (#88)
Re @Naeclues approach:
I agree with you and IIRC @Naeclue and I discussed it at some length a few months back on Monevator as it was emerging. It has probably matured a bit since then but what I particularly liked was:
a) it did not rely on bonds;
b) it’s elegance; and
c) that it ticks the boxes (reversibility, etc) that I mentioned at #63 above.
If I reinvest those dividends while equities are cheap, as I’m running the bonds dry, then I’ll be in a better position, hopefully, when equities bounce back?
Meanwhile, I’m selling bonds high, because people are running scared of equities: ‘shares are dead’ etc.
What am I missing? Besides equities never coming back, or divis reinvested into equities that eventually go down 90% – Great Depression style.
@ Doris – haha. You’re describing my recurring nightmare 😉
@TA:
I may well be wrong, but IIRC @Naeclue has quite a lot of un-sheltered holdings, and in such accounts holding INC units make more sense than ACC units, see: https://monevator.com/income-tax-on-accumulation-unit/
Then, as he says, why bother paying to re-invest the dividends and then pay again to sell some units to furnish an income.
I am sure @Naeclue will correct this if I have it all wrong.
@TA, if you make a return on reinvested dividends above the cost of trading those dividends + the return on cash, then you are winning. That may well be the case if you don’t run out of bonds as you will always be selling shares for more than you paid.
The difficulty is if you run out of bonds. Then you become a forced seller of shares and more likely to lose out on the dividend trading.
Spending the dividends clearly reduces the risk of running out of bonds. Alternatively, that means you can take the same risk of running out, but with fewer bonds, ie you can up the initial equity allocation. Upping the initial equity allocation increases the expected growth.
Without doing a lot of work, which may not produce a satisfactory answer, it is not obvious to me whether reinvesting dividends is likely to be better or not. I would not feel comfortable holding 6 years of bonds/cash (I started with 5) if I was not also prepared to spend the dividends.
What we do know is that, all else being equal, trading increases costs, so in the absence of further evidence, it seems better to me not to reinvest the dividends.
I agree it’s a very interesting approach and I’d love to see some research on it.
I take it we’re talking about shares not funds? As there’s no additional trading cost for reinvesting in ACC funds.
@ Al – what’s the tax advantage you’re looking to, it’s escaping me. Also, I’ve noticed a few cheeky ACC funds don’t declare any kind of dividend you could even report…
@Al Cam, yes I do have unsheltered holdings and none are accumulating funds, but that would not sway my decision on whether to reinvest dividends or not. There are still costs involved with dividend reinvestment in accumulating funds.
@ Naeclue – what’s the dividend reinvestment cost with acc funds? I’m trying to work out what I’m overlooking. Are you thinking that the trading costs would show up in tracking difference?
@TA (#101):
Assuming this Q was to me; I was not looking at any tax advantage, just eliminating two sets of explicit fees to generate income (via the re-investment by the individual route) when income would be available with no associated need to pay fees (via the spend dividends by the individual route).
However, as @Naeclue points out at #102 this may be a misunderstanding on my side as presumably similar [what I assume must be implicit] costs are associated with reinvesting via ACC units.
I must admit though that I am struggling to believe that the costs (explicit vs implicit) of the two routes (re-investment by an individual vs re-investment by the fund) are actually that similar due to the relative scale of the two operations.
@Doris,
ERN’s latest post may be of some interest to you too, see:
https://earlyretirementnow.com/2021/03/02/pre-retirement-glidepaths-swr-series-part-43/#more-63105
@TA, dividends in accumulating funds and ETFs have to be reinvested by the fund managers. They will pay fees, duties and potentially suffer from a spread, all admittedly at lower cost than retail investors, but there is still a cost. When taking money out there may also be costs, such as dealing fees, spreads or swing pricing with OEICs.
@ Naeclue – yes. If the cost differential was significant then it would show up in the tracking difference of the inc and acc sub-classes of the same fund. Have you compared between inc and acc variants of the funds you own? I must admit I haven’t. Though I’ve checked various share classes of funds before.
You’d think that if there was an inherent inc fund advantage to be had then that knowledge would have escaped into the wild and we’d all be giving acc funds a wide berth.
Still, worth checking out.
The trouble with changing strategy when you have cognitive decline, is that as your cognitive decline takes hold you actually get more confident that you know what your doing, not less! so you will never realise your going to end up with nothing! what a typically human dilemma ♂️
@adam (#108):
IMO, you are basically correct. Getting older is not without issues!
I suspect some might phrase your “more confident” clause with something along the lines of “no less confident” though.
There is academic evidence to back this up too.
See for example: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4662381/
IMO this paper is defo worth a read – if only to see the survey questions used!
@TA, you will not see any tracking difference between income and accumulation units of the same fund. The reason is that the calculation of the total return from income units assumes identical reinvestment to that of the accumulation units. In practice there may be differences due to timing of reinvestment and extra costs payable on reinvestment. For example, some brokers charge to reinvest dividends.
If you are going to be reinvesting dividends then ACC units make perfect sense as reinvestment is likely to be done at the lowest possible cost.
If you are drawing an income, INC units make more sense as you then have to sell a lower value and so lose a smaller amount in the selling. For large index funds and ETFs, we are probably talking about tiny amounts though. Differences in timing are likely to swamp any observable difference.
I see the main benefit of spending dividends as being able to hold more in risk assets than would be the case if dividends were reinvested. If you are paid a dividend it becomes part of the defensive portfolio. Reinvesting the dividend puts it at risk again.
Consider your 60:40 portfolio and 3.8% SWR. At constant SWR and assuming the defensive portfolio kept track with inflation, it would take about 10.5 years to exhaust the pot. If instead you went for a 70:30 pot and you averaged 2% in dividends from the growth portfolio, it would take 12.5 years to exhaust the defensive pot. Even if you only averaged 1%, it would still take 10.7 years to exhaust the pot. There are of course drawbacks. It is clearly going to take longer for the growth portfolio to grow by 20% if you are spending instead of reinvesting the dividends, so defensive pot top-ups can be expected to be less frequent.
@TA, sorry got my sums wrong. Spending 1% dividends for a 70:30 portfolio would last 9.7 years, not 10.7.
@Whettam (#70), @Naeclue (#71), @AlCam (#73).
Sorry for the late reply. Unfortunately still have to do the day job! Thank you very much for your insights.
Just to clarify. Does this mean that if on my 55th birthday for example I have £1million in my pension and I decide to crystallise £200K into a separate pot, I can still pay into the other £800K pension (employer contributions to avoid being classed as recycling) as long as I only take from the tax free part? I am also not at risk of having to pay tax re the LTA even if the total amount exceeds the LTA. I would then intend to drawdown from about age 59 and the value would subsequently go below the LTA by the time I reach 75. Hope this makes sense. Thanks
@Cruncher It’s pretty important you get this right, I’m just some random guy on the internet 😉 as I said before I really think it might be worth speaking with pension wise.
My understanding is if you want to try and minimise your chance of exceeding the LTA you need to crystallise as much as you can at 55. If you only crystallise 200k you can only take 50k tax free cash and you are not really helping yourself to avoid the LTA. You probably want to crystallise £1 million, take 250k TFC which you are free to spend as you like. The 750k will be in flexi access drawdown, but you can’t access this otherwise you will trigger the MPAA. You would leave say £100 uncrystallised not in FAD (as I said before think this would be a separate account). From 55 to 59 you could put another 70k into the pension, this would also include any growth, so you still may exceed limit. If it’s under 70k you could crystallise the rest or just up to 70k to delay paying the LTA.
You third test against the LTA would be at 75, you will probably be OK assuming you withdraw reasonable amounts, but depending on markets there will be a chance of exceeding. Basically you can choose to “defer” the LTA by how much you (and when) crystallise. Could you speak with your employer to see if they would pay you extra salary instead of contributions? Mine agreed to reduce their contributions and instead let me use this for other flexi benefits.
@Whettam:
I have to say I admire your admiration for pension wise.
What is this based on?
@Cruncher, you can crystallise 200k and take a 50k PCLS. What you must not do is take anything from the remaining 150k. Crystallising 200k would use about 20% of your LTA (taking the LTA as 1m). Do it again and that is another 20% used up. You can keep crystallising bits like this until you reach 100%. At that point there will be no more PCLS for you to take. Also, once you reach 100% of LTA, you will be subject to a charge every time you crystallise more. Even then you would not run into MPAA problems as long as you don’t draw anything.
Crystallising above your LTA is pointless though unless you need to draw the money. Better to leave it and hope for all the LTA nonsense to be abolished 🙂
I agree with Whettam and you should consider crystallising as much as you can whilst leaving the SIPP still open for additional contributions as it is worthwhile maximising the proportion of the pension you can take as a PCLS. Crystallising everything eliminates the risk that your existing pot will grow to exceed the LTA. If you just crystallise 200k, you still have a substantial pot which may grow to more than 80%of the LTA. We fully crystallised our SIPPs as soon as we were 55 as they were approaching their LTAs.
For some people this may not be the best course of action though and we do not know your full circumstances and are not qualified to offer advice. One reason I can think of why someone may choose not to crystallise is that they have limited life expectancy. If someone dies before age 75 their entire SIPP can be drawn by beneficiaries free of inheritance tax and income tax. Someone in that position may not want to have 250k brought into their estate which ends up being hit for inheritance tax. Another reason might be that you have a DB pension and would prefer to fully crystallise the DB pension first, even if that means paying an LTA charge on the SIPP.
A problem you will face if you do crystallise about 1m is that it will leave you with 250k outside a tax shelter. Investing that will give rise to taxable income and taxable capital gains. You might be able to mitigate tax by giving half to your wife to invest and gradually working into ISAs.
@Naeclue:
Re: “Crystallising everything eliminates the risk that your existing pot will grow to exceed the LTA”
I assume you are ignoring the second test at age 75 for brevity.
@Al Cam, yes. Eliminates the risk that your existing pot will grow to exceed the LTA before the SIPP is fully crystallised.
Example, 900k pension 1m LTA, headroom 100k and contributions continuing. If the fund grows 10%, there is only 10k headroom left for continuing contributions. If fully crystallised the headroom stays at 100k. The flexi-access drawdown pot grows of course, but that growth is not tested until age 75.
@TI Should one factor in the decreasing number of companies that are choosing not to be listed on public markets? It would seem that us great unwashed are being excluded more and more from the good investments.
“The number of companies listed on the London Stock Exchange with shares available to the general public has fallen by half since its peak in 1975; and almost half of those remaining listings are now on AIM—the secondary market that was created in 1995 with much weaker supervision than that applied to the main market. The US has experienced a similar decline in the scope of public markets.
Over the last two decades, less money has been raised on the stock markets of Britain and the US than has been taken out through acquisitions for cash and “share buybacks”—the process by which a company uses its cash to purchase its own shares on the stock market.”
https://www.prospectmagazine.co.uk/magazine/plc-corporation-private-equity-companies
@Naeclue:
Thanks and as I thought.
I generally refer to the second LTA test (BCE5 series) as the sting in the tail! And that helped shape my view that (with the possible exception of IHT issues) beyond a critical point the SIPP is an inferior wrapper compared to an ISA – as they are currently defined!
@ Naeclue – this is interesting and I’d just like to kicking the tyres of this a bit more if that’s OK? No worries if I’ve tried your patience long enough.
Take the 70:30 example again. This time, you live off the bonds and reinvest the dividends in your equities and allow them to compound.
When your bonds run dry you sell the reinvested dividend portion of your portfolio that’s been compounding in the background. You sell that into bonds and live off that money until the bonds run dry again. At which point, you sell the dividend growth portion again. How does that look?
Re: acc vs inc fund costs. Vanguard publish a list of costs incurred by their acc and inc funds here:
https://www.vanguardinvestor.co.uk/content/documents/legal/vanguard-full-fund-costs-and-charges.pdf
The costs are identical across all items. That includes transaction costs where Vanguard report broker commissions, spreads etc.
We could get into the annual reports for a belt and braces check.
@Al Cam, whether ISAs work out better really depends on what taxes and charges are applied when and whether the full 25% PCLS can be taken. For most people I suspect SIPPs still have the edge even before IHT considerations.
It is likely I will have to pay a LTA charge under BCE5A (the investment growth rule), but I am comfortable with it even though I would prefer not to pay it. I managed to fully crystallise, so took 25% tax free from the bit that will exceed the LTA. Assuming the part subject to the charge can be drawn at 20%, the combined tax and charge rate works out at 30%. Instead of investing in a SIPP I could have taken the final pension contributions as a bonus in the years the contributions were made, but if I had then I would have paid more than 30% tax. Had I not been able to fully crystallise, the combined rate would have been 40%, so still ok. I would not have been able to put the money into ISAs either as our ISAs were already being fully utilised. Had I been able to take bonuses at basic rate tax I would of course be much less happy.
@TA, An interesting option. You could do as you say and reinvest dividends into another pot then draw them if you run out of bonds. Whether you would want to invest all dividends back into the growth pot is a matter of choice. I only keep 6 years of safe assets (cash at present), and my preference would be to invest the dividends in safe assets. If you are holding bonds that will last longer than that then perhaps reinvesting some or all back into risk assets makes sense.
Or maybe a hybrid approach of some sort, eg reinvest into growth, but if you get down to only 4 years of bonds, switch to spending dividends (or reinvesting in safe assets). Or have some some kind of sliding scale.
I quite like this approach, but it would not work for us as our strategy says if we hold more than 6 years in cash the excess is given away (our strategy incorporates beneficiaries interests).
Regarding fund charges and other costs, yes they are the same for ACC and INC. Not really sure what the question is, but if you are paid a dividend then at that point the dividend is no longer subject to costs and risk. If you choose to reinvest, then the dividends become subject to costs and risk. This happens irrespective of whether you hold INC or ACC units. If reinvesting is the intention, then ACC is likely the most efficient choice, but if you want to spend the dividend, INC is likely to be more efficient than selling ACC units as it avoids the dividend getting round tripped.
@Naeclue:
I probably did not explain myself well enough on the SIPP vs ISA issue. What I was trying to get across was that beyond a certain point in your life, see e.g. (#127) at https://monevator.com/decumulation-a-real-life-plan/
the ISA is a better choice than a SIPP. Up until that point, the SIPP is usually a clear winner. Also, whether anybody is actually able to engineer the circumstances that permit such a swap from SIPP to ISA (and thus effectively side-step the second LTA test) is an entirely different matter.
@Naeclue (#122):
Looking again at your numbers I assume to get to an overall 30% hit you are incorporating some combination of: a) annual tax free allowance and b) that not all of the SIPP is subject to the LTA (ie when you fully crystallised at 55 there was still some LTA remaining). Otherwise, I would have expected the overall hit to be 40%.
Is that about correct?
And if so I guess you will also have had to make some assumption about future growth and does the calculation allow for the drag introduced by this weeks budgets freezing of the LTA too?
@Al Cam. Actually 30% is the upper limit. In practice it will always be less because it is only growth that counts towards BCE5A. Take LTA 1m, 1m crystallised, so no LTA left. Growth is a factor of 10 before BCE5A (I am being deliberately extreme here). PCLS grows to 2.5m outside the SIPP. drawdown pot becomes 7.5m before LTA charge, 6.75m of which is subject to the charge at 25%. Drawdown pot reduced to 5.8125m. Withdrawn and tax paid at 20%, this becomes 4.65m. Adding back the grown PCLS gives 7.15m, an effective tax rate of 28.5%.
@Al Cam, I forgot to mention I had assumed no withdrawals between crystallisation and BCE5A. Another extreme case.
@AlCam, also forgot to mention 40% scenario. You get to that by not crystallising at all before age 75 (not crystallising the bit over the LTA). You then get hit by an LTA charge on the whole lot (BCE5B) of 25% and withdraw at 20%, for a combined charge and tax of 40%.
@Naeclue (#125):
As I see it:
a) as presented (noting #126, etc) the hit on the growth is 40%; but
b) if the money were in an ISA the hit on the growth would be 0%.
Only remaining issue is any net hit in transforming the SIPP to an ISA.
IMO, the best way to minimise the LTA hit is to avoid it – if you can!
I like the idea of a plan and working the numbers to death but my experience of the last 14 years has been more pragmatic, things happen along the way.
I have read McClungs book and many others but you are always looking backwards and stuff happens.
Age 49 , retired in November 2007, almost entirely in equities but I did have a small amount of income from an industrial property and was owed a very modest amount payable in instalments over a couple of years.
The plan was UK equity income trusts ( some from Individual High Yielding uk equities) and some global investment trusts, these had a great track record and allowed me to retire early in the first place….4% swr, what could wrong ? It had a great track record, was the perceived wisdom and I had sailed through 2000-2003 declines keeping my nerve.
Whatever the plan things happen and my plan failed by April 2008 and got worse…
However I adapted , dumped the HYP shares, sold some of the investments that held up well and bought into some ITs that had fallen heavily, reinvested all dividends and lived off the very modest cash reserves and the incoming rent and owed money, in all sufficient to keep me going through the down period.
My portfolio dealings with the volatile ITs paid off over the next few years and then I moved into the new fangled ETFs…
It’s worked out well, capital is up very substantially and income as a drawdown % has tumbled.
I keep making plans but things happen and they soon become less relevant. I. I still have 90% plus equity holdings, a little property and enough cash to last five years at a basic level of expenditure, it’ll be ok.
Strange as it sounds I just money, it’s fungible it doesn’t matter where it comes from, it’s all the same. I sell non tax sheltered holdings and reinvest in ISA’a and if I need a bit more cash then sell a little more.
The cash drag effect is minimal because you can invest the rest profitably with the longer term view point with equity returns.
I cannot over emphasise that the present investing environment will change dramatically over time, it will not be the same as any period in the past, there may be similarities but the previous plans will look fairly hopeless, better to adapt as you go along.
If one is concerned then just hold more cash,( bonds are presently more equity like unless the duration is short)
Heavy market falls can be uncomfortable when you are in drawdown but they offer opportunities. I missed the January to March market volatility as I was on a trip around South America but the market volatility of April to July did present some simple trading profits, lots of ITs fell heavily and a very crude risk on risk off switching with VUTY and VUSA
The punchline is that plans fall apart because the conditions will change, you cannot anticipate everything, thinking about the maybes is good but there is no master plan or system that will work going forward. Adapt.
A solid amount of cash gives you time to deal with events without panicking.
The market volatility is great for a little active trading between portfolio assets.
The downturns we fear actually provide the additional returns that increase the margin of safety of the portfolio.
@HariSeldon – You are my brother from another mother it seems (or my sister? 🙂 ) and the way you’ve proceeded is pretty much how I’d live off investment income. (See: https://monevator.com/how-to-live-off-investment-income/)
However while your comments about understanding things change is a very valid contribution, and a note for all to consider, most of your tactics/strategy is clearly active investing. And as such it’s well off-topic for this thread.
I understand this thread has taken a few different twists away from the post, but I think debating the pros and cons of aspects of a freewheeling active strategy would be a step too far for keeping the conversation enduring and relevant.
So before anyone else chimes in, I’d suggest reading @Hari’s interesting post but keeping any comments broadly on the passive/plan topic please.
(As an aside, I’m hoping to do some sort of members-only active post/wall at some point in the next few months. Hope to see you on the other side! Everyone please don’t comment on that tidbit on this thread either. Just don’t want more active readers to think they’ve been forgotten by Monevator, despite it (rightly) being a bastion of passive investing. 🙂 )
@TI:
Apologies for taking “a few different twists away from the post” – but the LTA, in particular, is a tricky topic, which IMO is highly situational too.
And, as you say even more off topic – but ever since I first heard about Hari’s retirement date and his investment set-up at the time I have been keen to hear about his experiences and especially the impact of the GFC.
@Al Cam:
No worries, your contributions to the site over the past few weeks have been very helpful. Keeping blog comment threads ‘on-topic’ is a bit of amorphous challenge, and probably strikes some readers as control freakery or worse. 🙂
However I’d say the mechanics of the LTA management and drawdown is more on-topic (if still pretty niche for most people, though possibly not most Monevator readers — maybe I should do a poll?) compared to @Hari’s active adventures (which as I say, like you, I’m personally very interested in. I think I recognize a refugee from the old TMF bulletin boards in @Hari, also. 🙂 )
Let’s leave this meta discussion here, before the thread gets derailed in a new direction!
Thanks to everyone while I’m here though for the usual high-quality contributions.
@TA – rereading the thread I came across your query on my approach to decision making on threshold numbers that have been “tuned” by backtesting. Like some other commenters I think that a level of pragmatism is required.
First – a plan and a selected strategy for calculation of variable income is useful in and of itself (to me anyway) to provide structure + confidence and lower the emotional temperature and the propensity to meddle/overreact/make poor decisions. The plan if implemented year by year fairly consistently also offers the opportunity to build confidence and validate that family are onboard with the mechanics or – if it proves not to be so to have laid appropriate plans in good time – advised (to continue DC drawdown) or a GI product.
As far as the specific “following the Prime Harvesting” what to sell to generate a given EM calculated income question. My commitment to the backtested, tuned parameters in a given year is in the end not tested. I was/am planning a 3.5% planned, 2.5% floor, a fairly chunky buffer for SORR (Current valuation fear – normal CAPE/revaluation expectations) with ISA recycling of unspent and ungifted (Potentially Exempt Transfers) TFC. 100% crystallisation at 55. Draw nominal growth, frontloaded as a profile slightly to manage the arrival of SP at 67. The draw nominal growth approach limits the LTA charge to 25% x the excess at crystallisation and its 20 years growth to 75 – plus any (much smaller) charge on the tracking error on the crystallised nominal growth.
Tax rate is mostly basic rate for most of it on “moderate” return and inflation expectations. One can of course create horror shows with markets crashing up, inflation spiking and tax thresholds held constant. So some HRB tax may be paid if fiscal drag on thresholds continues and inflationary and real portfolio growth are larger than the basic rate band. (Inflation is in my LTA tax calculation due to an unindexed LTA from Fixed Protection (rather than unindexed because Rishi chooses to not CPI index it in any given period).
Consequently the calculation of variable income by whatever method is really only providing a selection of green and red channel marker buoys which roughly mark the edges of a safe channel between tidal sand banks about what income “should” be taken. I may still take more money from the pension and put it in the ISA whether that is to the lower or upper threshold of the basic rate band. Driven by the perversity of the retrospectively introducted LTA regimen. But the income markers will tell me I have “overconsumed” for one or several years if i just go and spend it).
As with the pilotage of navigating a boat into a tidal harbour and crashing on either side so with dropping an orbital capsule back into the atmosphere. It is possible to get it wrong both ways. To come either too steep or too shallow and there is a “window” within which things (hopefully) don’t get more exciting than necessary.
For the LTA corner cases – the tax planning number and the “safe income level” number are different. For my risk appetite (6-7/10) – the one taking a 40 year income plan with near depletion as a scenario in stress markets but otherwise below MSWR (3.5% target, 2.5% floor) and the other worked up purely around SA thresholds, ISA recycling and LTA BCE5A at 75)
Clearly you need a worked up solution to IHT planning under current rules if you are going to ISA recycle out of the IHT protected SIPP wrapper. I don’t think the current regimen will last 20 years let alone 40 but the point stands. The LTA drives crystallisation but you should not do it if you don’t have an IHT consumption and gifting plan worked up or the 40% is worse than the 25%. You don’t want to take large amounts of money back into your estate and then die without giving it away (the assumption being that for LTA corner cases you likely own a house and that this consumes most/all of your IHT allowances as presently defined).
@gmo (#133)
Lots of details there, and I think I generally agree with most of it.
There are a couple of other key points I can think of off the top of my head – neither, or one, of which may not actually apply to you and/or me.
These are:
a) presence (but possibly not yet in payment) of a DB scheme pension, which combined with SP pushes taxable income close to (or even closer, due to latest budget) HRT;
b) significant GIA holdings
IMO none of the regimens you talk about seem to last terribly long these days – so there is inevitably an element of speculation required. And, win or lose, these are absolutely not the worst problems to be facing!
Any thoughts on the McClung-Smooth variation, as suggested by ERN:
https://earlyretirementnow.com/2017/04/19/the-ultimate-guide-to-safe-withdrawal-rates-part-13-dynamic-stock-bond-allocation-through-prime-harvesting
I think the observations on smoothing are fair enough if like ERN you want to model and process monthly. This was not a consideration for me as I would be happy to rebalance and DC sort drawdown approx annually. Living off your money book goes on to examine combining PH with variable income methods which ERN indicates would be interesting to explore further. In the end all the differences examined are so small as to be inside the error bar (of total risk including speculative risk vs backtested known market risk). For me these methods perform very close to “the same” for all practical purposes.
Additionally the observations mildly discounting past good performance of PH when bonds did well and equities lay untouched are to my mind not as well considered as the other analysis. PH (smoothed or not) backtests for all past cohorts vs any other method and gives a particular result. Once you start editing the known market risk scenario to take out bits you don’t like you are doing something different. Modelling a different market. McClung also does this in later chapters to create a stress market worse than the known history series.
The observation that we are unlikely to see a bond boom (rising interest rates when/if inflation is acknowledged as ticking up past targets (and central bank buffers) are a counter pressure on capital value vs any rise in yield. But the future is unpredictable as is often the case.
@ Norman – I concur with gmo but would also add… good as ERN is, he wrote a blog post on the topic. McClung spent years of his life researching and testing an entire raft of methodologies and then wrote a book about it. Given ERN’s criticism is minor and he concludes that Prime Harvesting checks out I decided the ‘smooth’ variant was something I could live without.
Others have tested Prime Harvesting too and, again, gave it a thumbs up.
Just a follow up on my experience with updating McClung’s prime harvesting (PH) pst #55. And relevant to preceding posts from @gmo.
I had an attempt at revising my original PH spreadsheet (initiated 4 years back) to account for my changed portfolio construction – I’ve significantly more equity exposure now. The spreadsheet from McClung’s website is slightly updated to a version 2. However, it is tricky (impossible?) to find the correct information to enter into the initial withdrawal worksheet. Key stats are required from the US Fed Stats dept. – (the link in the spreadhseet is inaccurate but I found the relavant document here: https://www.federalreserve.gov/releases/z1/20210610/z1.pdf
If anyone knows the required stats maybe pist them in this thread. I used LM883164115 and LM883164105 – pure guesswork).
The alternative is to skip this step and put in your best guess at a starting withdrawal rate, but this seems to defeat a lot of the point of using the spreadsheet.
Further data is required on Emerging markets and Developed World ex-US CAPE but these are behind a paywall now, and not easily found on the internet in my hands.
So I’ve given up on this attempted revision for the time being. Maybe a table with a few basics stats like these could be maintained on Monevator?
My difficulty updating my PH spreadsheet highlights the longevity risk of relying on weakly supported or unsupported software and calculators. Maybe some of the larger online FI communities have a greater chance of maintaining resources like these over a period compatible with the length of a retirement. At least ERNs calculators rely on easier to obtain information that has a greater chance of being maintained long term.
@gmo #136 makes a good point about how many of the differences between retirement spending models are in the noise, and much of this noise is ‘behavioural’, certainly in my case. I have found comparing model outputs reassuring during the first 6 years of retirement though, as they triangulate around pretty much the same results using different approaches.
I’m quite happy to play around with all these calculators and spreadsheets, but I don’t know for how much longer. And I guess there are quite a lot of folk who are not. I suppose this is a simple 4% SWR rule plus ‘floor and upside’ monitoring when you make an annual withdrawal are appealing. But they are also risky and probably inefficient.
Maybe a post on how simple can you take retirement planning and still be ‘safe’ is worth a thought. Of course, using most of your portfolio to buy an annuity is the gold standard for safety. Maybe that’s the way to go long-term.
I’ve read McClungs book but am also reading more on asset allocation – and among them are the books by Meb Faber.
Towards the end of The Ivy Portfolio he describes a trend following approach – buying and selling according to a 200 day simple moving average of the s&p500 price.
This yields very impressive results, beating the S&P500 return with less volatility and avoiding the large drawdowns of the recent crashes.
In particular though I thought that it looked beneficial in also avoiding the heartaches of seeing large drawdowns in retirement and having to keep rebalancing through them – which looks to be tough to do according to posts I have seen from veterans of the 2008 crisis.
I wondered if you had seen this strategy ?
I was not aware that Meb Faber had sugested trend following as a useful retirement strategy. However, there are several academic papers by Andrew Claire and collegues at Bayes Business School (formerly Cass) that argue this case, and also that it is a good defence against sequence of returns risk. Here’s an example “Can sustainable withdrawal rates be enhanced by trend
following?” https://onlinelibrary.wiley.com/doi/epdf/10.1002/ijfe.1774
I’ve not looked into this carefully for my own situation as one thing that is not considered in their models are the tax implications of switching your entire portfolio in and out of equities something like once or twice a year. Perhaps if the strategy was applied only to the tax sheltered part of your portfolio it might be worth considering, otherwise the capital gains tax would be exessive. Having said that, with CGT relief of £12,300 you can sell up to £164,000 tax free in the tax year assuming 7.5% return (£12,300/7.5% I think…). Plus I guess if the market is sinking you’d be selling on the down trend, so losing some of your returns that year.
It’s all a bit active sounding really… OTOH I was coincidentally redistibuting my portfolio between several low cost brokers in early 2020 when the covid flash crash occurred and had a lot of it in cash, so did well in the end by pure luck. But it does show if you can switch into cash at the right time it may work out to your advantage – but it is surely a gamble as an investing strategy.
I should have mentioned the tax bit myself, as I have quite a bit in a GIA account so I’m not going to try it there!
But it seems only mildly active and the backtested results looked compelling, especially when considering the posts from retirees about the difficulty of rebalancing and reading other stuff about behavioural finance. You would just be responding to slow-moving triggers rather than applying any, possibly faulty, logic.
If you tracked the right indexes you could also apply this to factors within your equities – possibly.
The reduction in stress from getting out of drawdowns could even add years to your life ?
IanH – what a great link, thanks.
It references the Faber paper and uses the 200 day simple moving average, which is much less TA-like than some of the other trend strategies and looks much safer and stress reducing.
It also address global equity and multi-asset portfolios.
Shows that the strategy works very well for bumping up the SWR.
Think I am going to use it for my SIPP and ISA accounts.
@ Andrew – yes, it does look good. Early Retirement Now wrote an excellent analysis on Momentum / Trend Following:
https://earlyretirementnow.com/2018/04/25/market-timing-and-risk-management-part-2-momentum/
He shows that most of the time the signal gives a false reading but occasionally hits the jackpot. I decided that would be a hard strategy for me to stick with psychologically.
It’s worth reading the comments as well as the piece. You may have to put up with it undermining your returns for over a decade. Funnily enough, I can do this with risk factors passively but I’m dubious about my ability to keep that up if I’m actively involved.
Which of Faber’s books would you most recommend, btw?
@ IanH – thank you for the link to the paper. Will check that out.
Another good link – I haven’t spent much time on that site – I got a bit of a windfall last xmas when the company I worked for was bought out and have since been trying to figure out how to ‘safely’ invest this, and my consolidated SIPP funds, after figuring out that I might actually be able to retire early if I avoid doing anything too stupid.
I hadn’t really paid attention to investing so am trying to bring myself up to speed now without getting overwhelmed/misdirected by the amount of information out there in the FIRE movement.
So far I’ve read ‘The Ivy Portfolio’, ‘Shareholder yield’, ‘Global Value’ and ‘Global Asset Allocation’ of Mebs books, several of which you can get for free from his site, or £2 as Amazon Kindle.
I’ve enjoyed them all, quick reads and good summaries of stuff I had read elsewhere. And some good ideas.
With bonds at the end of their bull run, inflation coming and valuations high I realise I need a smarter portfolio than just a 60/40, and get to the point that I have a decent level of confidence in what I am doing.
I did mess around buying and selling Ethereum to get some ‘skin in the game’ and experience the difficulties of fighting behavioural baises, which was useful experience.
I am not worried about under performing the market so much, more about decent returns to at least keep up with inflation, and safety. The fact the gains are sometime more is a side benefit, I’m more interested in the smoothing effect of this strategy – and mechanically following the triggers could remove the anxiety caused by the behavioural finance issues.
Plus I am a programmer so was thinking that I could automate a lot of the trigger monitoring to reduce the management burden – choosing different indexes for different parts of the portfolio.
Hello @The Accumulator
I’ve now got the McClung become and read through at high-level. I understand/like the key ideas – Stock / Bond % split, Asset Allocation, Drawdown method, Variable withdrawals, and Rebalancing.
Three things come to mind as I design a plan around this approach that I thought you probably encountered.
1. How to calculate the Harvesting Ratio. The calculation is (portfolio return – (inflation + withdrawal rate)) / portfolio volatility. If I was looking to compare funds say on Trustnet, what values would I use?
For example for Ruffer Total Return you get the Ratio information. Volatility is the first row and return could be taken from the Discrete performance. What do you think is best approach to be reliable?
https://www.trustnet.com/factsheets/o/gs9y/lf-ruffer-total-return-c-acc
2. SWR – I really liked the Guyton Klinger approach. Do you think EM is essential? Or does the act of making variable withdrawals using a method work
3. Cash safety fund – I can see why there is no need to have X-years cash just in case, at circa 50% bonds its gonna be safe. So maybe 2-years max?
Regards Robin
I like Living Off Your Money’s spreadsheet because it clearly shows inflation adjustments, I’m starting the book this weekend. Currently trying to figure out if ERN’s Cape Based Rule requires an adjustment for inflation after the Target Withdrawal ($/month) is calculated, but I can’t find a definitive answer on that.