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This is an interesting question. Three things to bear in mind are that a) there is often a run up before a severe crash (dot-com, Japan, and US in 1929) and b) new money invested after the crash will often have a good return (e.g., money invested in 2003 had a 100% return over the next decade or so) and c) that falling gilt yields meant that bond fund returns were pretty good during the dot-com crash.
You might be interested in DC part of my paper at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4473093, where I looked at three stock allocation glidepaths in accumulation (see Figure 4 in paper), 100% equities until 6 years before retirement with a reduction of 10pp per year until retirement (i.e., finishing at 40%) and two others approximating different ‘lifestrategy’ options. While this isn’t a systematic study of different glidepaths, a fast drop within the last 6 years did very well historically compared to most longer (and, not shown, shorter) glides (see Table 2).
I also note that ‘derisking with a purpose’ can be implemented by building an income floor (e.g., using an inflation linked gilt ladder) over the last decade or so of accumulation. Zwecher’s book (“Retirement Portfolios: Theory, Construction, and Management”) is, IMV, a useful read in this area (it was written not long after the GFC and reflects that, at the time, recent unpleasant memory).
Thanks @TA for another telepathically relevant piece, along with the derisking links. I’ve just moved one of my SIPPs into drawdown and sold down a small tranche of MMF to cash ready for my first flexible monthly withdrawal. Exciting times and your (and all at team Monevator’s) wisdom hugely appreciated on my FIRE journey.
Just to follow a thread from the weekend: Subscribe! It’s 250X cheaper (and is delivering me better results) than my long dispensed with IFA. DIY financial management – retirement side-hustle.
Back in December I went from 100% equity to 70% equity / 30% MMFs. I also took a chunk of tax free cash and paid off the mortgage that was coming to the end of its fix in the Spring. I was surprised how hard mentally it was to make this change. I’m planning to retire in August 2027 and had done my sums so knew that it was a prudent move. But I couldn’t shake the feeling that I would miss out on more returns even though I didn’t actually need them to make my retirement work. I suppose that’s just plain greed on my part?
Very relevant …. Have been thinking / wondering about this although am roughly 85/15 rather than 100/0. Have also been factoring in that I should be able to save approx 4-5 years expected retirement spend needs from my salary over the next X years before I retire (all going to plan) and so convincing myself that if the drop is recovered in that time I won’t have been a forced seller. I guess the questions then become is say 5 years cash reserve enough and even if it is will I be ok in practice as opposed to theory (Mr Tyson said something about everybody having a plan until they get punched in the face) sitting on a chunky loss and spending down the cash reserve while waiting / hoping for the 5 ish year recovery to happen.
I always remember that the market is supposed to be rational, but can also be intensely emotional, both on the way up and the way down. As Keynes is reputed to have said, “the market can remain irrational longer than you can remain liquid”. Or as he did say, “The long run is a misleading guide to current affairs. In the long run we are all dead”. I know I have left money on the table with a conservative portfolio, but I can also sleep at night.
As I enter the twilight of my life, I am acutely aware that investment in equities, no matter how diversified, is a bet, and a bet I don’t necessarily have a lot of time to recover from if it goes wrong!
Nothing wrong with 100% equities to the finish if……….
You have saved enough
You can live with the volatility and risk of this type of Asset Allocation
Most investors sadly are not in this happy position so……
You therefore reduce risk and volatility as you approach retirement ie introduce bonds, cash etc to your Asset Allocation-this also has the probability of preserving the wealth in your investment portfolio that you have accumulated over the years
Obviously fine tuning required on how you actually arrange your investment plan but these are the basic principles
xxd09
@EMcG67 – Similar story here. I’m mid 40’s with 4 or 5 years to FI and planning to retire in 5-10 years.
Even with a bit of slack in my forecasts I have found it difficult to give up potential returns for reduced variance.
Hearing all the noise around the current market valuations and “AI bubble”. Last year I gave the risk allocation within my ISA a lot of attention, ultimately rebalancing away from equities into commodities, bonds, and cash.
The experience over the last few weeks has been a very valuable first hand lesson in the virtues of holding a more balanced portfolio, and also forced me to revisit my pension glide path.
Some things need to be experience to be fully understood and can’t really be taught. I feel like risk tolerance falls into this category, particularly how this can change over quite a short period of time. So I’m currently coming out of the other side of this period of self reflection. Its not an easy question to answer. My conclusion is that I’d much rather have a little more certainly than upside at the moment. Perhaps once I reach the next milestone that will turn on its head again? Certainly above an FI baseline doesn’t seem as valuable or appealing as certainty of reaching the baseline…
Excellent article The Accumulator. Beautifully explained why bonds are useful.
@TA – excellent stuff as always.
I de-risked overnight from 100% equities to about 50% five or six or so years before my recent retirement. I must have left a lot of money on the table but I don’t regret it at all. I diversified into MMF, Gold, short term inflation bond funds (GISG, in and now out), BHMG, intermediate bonds (in and out and in and finally out again) and now, thanks to your excellent series, linker ladders which I’ll hold to maturity. I took the 25% tax free from the SIPP and have built (sort of independently, sort of TLIY-y inspired) ISA portfolio of dividend paying ITs and dividend focussed ETFs because I reckon they’re more value-y than the Global equity tracker I hold in my SIPP and I reckon dividends can be less volatile than prices. I think they declined only 25% post-Dot Com, as opposed to 50%. Not sure GFC and who knows next time? But a slightly different return profile than Tech/SW/AI dominated global tracker.
I also second Hariseldon’s comment:
https://monevator.com/decumulation-strategy-year-3-withdrawal-from-the-no-cat-food-portfolio-members/#comment-1941905
about taking the tax hit of SIPP withdrawals now, I don’t think the direction of travel favours the patient. And the tax treatment of linkers is very favourable.
I also diversified careers, taking a decently paid job in the Civil Service to double my State Pension floor. Yes, I was paid 70% of what I could have got in the private sector, but once you include the pension benefits, it narrows.
I was a chicken with too much to lose. I didn’t want to enter retirement the richest, just not the poorest. Now I SWAN very well.
As an erstwhile professional risk manager, I’ll add to the good words above by saying this is all about understanding your Risk Appetite, your Risk *Capacity* and the difference between the two.
Personally I’ve had my SIPP in more-or-less 100% global equities (hedged: IGWD) since I entered decumulation during the CoVID crash and it’s served me very well, but you do need a strong stomach and enough cash(like) reserves to fall back on when markets take a tumble.
Great piece The Accumulator. I have just retired at 56. Sitting at 40% equity 60% cash / short bonds / MMF / gold. If you look at the returns from a portfolio 40%/60% though to 60%/40% they are not that far apart and support quite similar SWR. Bengen – A Richer Retirement P109 – 46% stocks, SWR 4.62%, 60% stocks, SWR 4.67%.
I knock 1% off these for UK inflation vs Bengens US inflation assumptions and that gives me a SWR that works for me. Took the view that I would rather sleep well at night than chase returns I don’t really need.
However will be probably gliding this up to around 50%/50% over the coming few years.
I went through the GFC 100% in equities. I won’t forget it- it was just horrible. I also found (and I don’t suppose I was alone) that although I knew I should keep putting money in, the economic situation meant I didn’t have any extra money to invest!
Even having 10-20% in bonds might have given me something to rebalance with, and the psychological benefit of being able to buy some cheap equities would have given me at least a little bit of comfort.
Having to sit and watch through the window at the sale going on in the shop rubbed salt in my wounds big style. I was well trained- I didn’t sell and crystallise the losses, but my experience would have been less horrific with just a little bit of ability to do something to take the edge off the trauma!
I struggle with asset allocation. I am retired and have enough money…lucky me. Logically, if inflation didn’t exist I should be 100% cash. Why do otherwise ? So inflation is the thing I should worry about most. Actually I am about 50% equities at the moment but am moving to additional direct holdings of IL gilts. I would much rather be in equities so it’s a constant argument with myself.
I don’t think it’s necessarily a binary trade off of taking less risk for less return.
With static allocation diversification (away from equities) then, yes, it very likely (long term) such a binary choice (risk here being a proxy for less volatility and shorter and shallower maximum drawdowns).
But what about a dynamic momentum filter All Weather Portfolio?
ETF Universe: VUSA (Equities), IDTG (Long US Bonds), IGTG (Intermediate US Bonds), SGLN (Gold), and LCOM (Commodities).
Lookback: 12 month total return.
Monthly Action:
Rank all 5 ETFs by 12 month return.
Select the top 3 performing ETFs.
Absolute Filter: If a Top 3 asset’s return is negative (< 0%), move that portion (33% of total portfolio) into IGBP (cash like iShares 0-1 year US T-Bills) or CSH2 (£Stg Overnight Index Average) ETF.
Weight equally: 33.3% of funds split across these 3 choices.
Since 1970, the US version has produced a mid teens % CAGR (higher than 100% equities) with no leverage and with substantially lower drawdowns than an 'in equities only' portfolio (and even less extreme, and shorter, longest drawdown than for a 60/40 equity/intermediate bond mix; see allocatesmartly.com for the back test).
Obviously certain modifications to the US version have to be made for the availability of UCITS LSE + £Stg listed ETFs (and it goes without saying that the past performance is no guarantee whatsoever of anything for the future, as with any approach, asset class or security).
I'd take a look at the work of Dr. Wouter Keller, a prominent researcher at the University of Amsterdam on momentum based tactical asset allocation (TAA) strategies, often in collaboration with Adam Butler and Ilya Kipnis:
https://www.researchgate.net/profile/Wouter-J-Keller
Sequence risk is arguably better offset by a larger emergency fund close to hand than higher long term bond allocation, since bear markets are generally for a few years at most, it might give more safety for your buck.
Alleviate the sequence risk, tolerate more volatility
Also being willing to work on say a zero hours contract in retirement also reduces sequence risk, and just having that option could make people feel braver
Just to add actually the graph shows that even in that ideal timeframe for 60:40, 100% equities we’re not far behind
And in 2022, bonds with duration didn’t feel protective
> the deeper pain suffered by investors who thought their fortunes were made during the Dotcom Bubble…
hahaha I was that guy and I remember the grisly slip-sliding away long crawl out. Index investing didn’t help me any in the long drag out, with a CAT fees ISA which fees of only – wait for it – 1%, TA would have my guts for garters nowadays tolerating that usury on a FTSE index fund 😉
It was horrible. What can I say. And it will come to pass some day in the not so distant future. It’s never all different this time for that long.
@ Matthew #15
> being willing to work on say a zero hours contract in retirement
what part of retirement did you miss? 😉
I’ve never earned even 10% of my erstwhile full time earnings once I retired, and the attraction of working palled very very fast when I realised ‘If I rely on this, I am locked into The Man again’ so I stopped doing that. No consumer spending tastes as good as freedom feels
Excellent article. I started investing in 1999, putting some self-employment income in an ISA with 50% Polar Cap Tech and 50% Alliance Trust. It was only about the equivalent of a months worth of wages but needless to say it was a long time before I saw a real profit on that money. A good learning experience. I am about 55/35/10 now in equities/bonds/cash.
I’ve just completed my first year where we’ve had no accumulation of any kind. I was doing my annual review this week and even with all that’s happening, and 3 months of travel, we’re still up a significant amount, at least for now…
Oh and ZHC in retirement, no thanks! I still do some work on a self employment basis but the chances of me ever becoming an employee again are roughly zero.
@Rosario – I went through a similar experience to you. I was fine with 100% equities until I wasn’t. I didn’t care about market turbulence until the Christmas 2018 downturn. It was only a correction but somehow I’d crossed a threshold. Suddenly there was a lot at stake and that wobble made me sweat. Started derisking after that. @TI had already advised me to do it and he was right.
“Some things need to be experience to be fully understood and can’t really be taught.”
100% agree with this. Risk tolerance changes over time but you gotta feel it in your gut. A kindly IFA might do it for you, but a hard-charging DIY investor has to hope they get a warning from the market before a full-on seismic event.
@Windinthefens – That’s powerful testimony, thank you for writing it. The GFC was horrible. I didn’t have much in the market so I didn’t care about that. It was the hideous uncertainty and drumbeat of bad news that made it excruciating for me. Not to mention the stream of losses among colleagues and the general feeling that I was playing Russian roulette along with them.
Your point, along with @Rosario and @Ermine about the psychology of it all seems crucial to me. It’s less about the percentages and how it looks ten years later or whatever. It’s about how it makes you feel at the time. And ‘at the time’ can go on for five years or more.
@DH – Cheers for that. That’s going into my trend investing article notes for further exploration when I get the time 🙂
@Matthew Ainsworth – Yes I take your point. Though I’m not making the case here for an equities/bonds 60/40 portfolio. I’m focusing on this singular example because it makes a powerful case for diversification. Key components are an event without a V-shaped recovery and which didn’t occur in the days of black and white 🙂
Obvs in general I support being more widely diversified than just bonds. In principle I also take your point about working in retirement (if you want to) as a way of off-setting SORR. Or just because it’s good for the brain, or you enjoy the social contact, or whatever. The value of that has become more obvious to me since FIRE and @Ermine make a moving reference to such activities on another thread. Much as I think he’d tell you where to shove anything with “contract” in the title 🙂
Almost one year in post-working life @ 56yo – DB covering 23% of comfortable income which will step up to a third with wife’s DB joining the fray in Sept. Slowly moved SIPP/ISA allocation to 85% GD equities & 15% MMF/ bonds – with a bucketing strategy in place. Will likely fill the MMF pot a little more – as I strive to balance the “won the game” with too much over conservatism vs inflation. As ever a personal journey where you must hold yourself accountable and learn with each step forward – you are the adult in the room. Enjoy the ride all.
My story will definitely make some readers’ blood run cold.
I am 81 and have no pensions of any kind, not even the OAP. My wife has a civil service pension of 7K per annum. That’s it! This is due to 42 years spent galivanting overseas in 7 countries.
We live on natural yield alone. Our portfolio is about 50% Isas, so limited by the aforementioned dissolute foreign escapades. About half our holdings are ITs or ETFs and growing. All investments are equities with no bonds, etc. I selected slightly safer shares rather than the highest yielders. Total yield is currently 4.1%.
Scary or what?
We can still live comfortably if dividends drop 50% and have only one year’s cash. We normally underspend income by about 30%. This not because we are loaded but rather because we are, by nature, moderate spenders.
The above will no doubt seem madness to the average LMF reader.
TP2
@TP2 — Well I’m a fan of natural yield for drawdown in the right circumstances and with buffers — though I can’t really see a reason why not say 20% in bonds in the mix, personally — but what’s an LMF?
Gemini has some ‘colourful’ suggestions, which I can’t believe you mean… 😉
I am puzzled by the ‘L’. Reckon M = mother and f =….
Sincere apologies! LMF was referring erroneously to Lemon Fool when, of course I meant Monevator. Now you really believe I am 81.
TP2
@TP2 — All good. I can already barely remember what I had for dinner yesterday, so I think you’re probably doing something right at 81. 😉 Congrats!
Everybody else seems to like the article.
I thought it rather strange, because it never really gets to grips with the concept of volatility itself (for example, by discussing how one might measure it). The article focuses upon returns as a metric for assessing asset-allocation appropriateness.
Harry Markowitz’s 1990 Nobel-memorial economic-sciences prize was for making it clear how risk and return interacted, and showing us quantitatively that, for example, going from 80% equities to 100% is very expensive indeed, in terms of the huge amount of extra volatility one suffers.
Of course, finding the “efficient frontier”, the sweet spot where the gradient of the risk/return curve is optimal (whatever that means) is no easier than drawing the mythical Laffer Curve, but I think that you might have mentioned Sharpe ratios.
The whole counter-intuitive point is that people who want the biggest expected returns and opt for 100% equities get a very poor deal, while those who demand the lowest volatility and opt for 100% fixed-interest securities do even worse, missing out on both a better expected return and a lower expected volatility, where a sprinkle of equities improve the recipe enormously, granting the impossible “free lunch”.
Unrewarded risk is stupid. It’s not worth it.
@TP2 (#21)
While I don’t believe your use of natural yield is madness, I do think you are very brave to use it with 100% equities and a relatively small amount of guaranteed income.
There is very little research into natural yield – AFAIK, the only published historical backtest is presented at https://finalytiq.co.uk/natural-yield-totally-bonkers-retirement-income-strategy/ (FWIW, I do not agree with his use of the word ‘bonkers’). Having reproduced the work presented there, in real terms the income did become very small – e.g., with 100% equities, the minimum real income was as low as 0.9%, i.e., £900 on a £100k portfolio. It is also noteworthy that at 3.5%, the worst case real income since the mid-70s has, so far, been better than earlier in history.
Have you ever considered alternative sources of income such as an RPI annuity (after a quick search, I note that the payout rate for a joint, 100% beneficiary RPI annuity is about 6% at 75yo, so would be even better at 81, although buying one outside of a SIPP, a purchased life annuity, will reduce this) or an inflation linked gilt ladder (a 20 year ladder currently has a payout rate of about 5.6%)?
@Alan S — While I agree there are very legitimate questions and challenges around/against Natural Yield as a strategy — and I can only applaud that author for at least investigating the issue — I’m not sure his study is super-relevant to how it’s actually implemented by practitioners, at least as I understand it. He buys the market, overweights fixed income (versus how I typically see it deployed), and then rebalances automatically, none of which is in my Natural Yield manual. To his credit he warns readers that proponents of the strategy would say they’d invest differently — and he’s right — but that kind of admits his analysis isn’t very useful.
As I’ve said before, there’s no magic to Natural Yield. As a strategy I would expect it to lag the market. The way I’d employ it you’re swapping existential capital risk and potentially drawdowns for, hopefully, a predictably rising income, at the cost of *very likely* lower total returns in the long-term but also not spending to zero if that’s important to you.
We shouldn’t derail this thread with further Natural Yield talk, as it’s off-topic here (and TA is definitely not a fan!) but members can find some articles here:
https://monevator.com/?s=tag+natural+yield&id=74717
(The one with ‘quixotic’ in the headline is accessible by Mavens as well as Moguls. Also this tells me I should really make a proper Natural Yield tag! Cheers.
I hedge my bets – 50% global trackers in my SIPP (for legacy if all goes well), 50% (high) dividend ETFs and ITs in my ISA (for livin’).
So, a la Markowitz(?), I’ll always be 50% right and 50% wrong.
I’m a little under 2 years from FIRE and my de-risking has so far brought me to 62/38, the 38 made up of bonds/MMFs, cash and gold. I will continue to de-risk to 60/40, I think.
The recent drop in the market due to Trump shenanigans didn’t quite affect me as much as I thought it would, so perhaps I am already sheltered somewhat due to the changes I made to my portfolio.
With a DB pension to come later on my retirement, I think I will be happy with 60/40, with 1-2 years of cash reserves.
But I say this while I am still working and earning a wage. I might feel differently as I get closer to my retirement date.
“… I could see that many passive investors were throwing the bond baby out with the bond bear market bathwater.
Who could blame them after the post-Covid, post-Liz Truss bond rout?”
I suppose I would blame them.
Of course one sometimes loses money when investing in gilts. It’s an investment, not a risk-free asset.
People don’t stop investing in equities because they sometimes lose money, and anyone investing in gilts must also be prepared to lose money. Accepting that risk is what drives long-term returns, because one of being paid a premium for one’s ability to make life safe for one’s counterparty.
Gilts are an investment, they do badly when credit-worthiness (confidence) falls or the interest rate grows, they do well when credit-worthiness rise or the interest rate falls. These properties are what drive the lower correlation to equities, making them a valuable addition to a portfolio.
@Johnathan – I think gilt (funds) occupy that strange space of a risk asset that’s sold as being risk reducing vs simply holding cash, and whether it actually functions for peace of mind is debatable, if there was ever anything that shouldn’t be in a fund, I’d say it was gilts
@Jonathan the Evil — Wrong thread! 🙂
@TA#33
So it is, thanks.
I’m not competent to navigate the site’s main page.
There’s one other consideration/complication for anyone with plans for spending their 25% lump sum. Perhaps you can stomach a 50% drop in the value of the investment pot you’re going to live off for the rest of your life, but remember that your lump sum will drop by the same percentage. There must be people who need to derisk completely in the run-up to taking their lump sum (e.g. if paying off a mortgage) but who can then pile back into stocks afterwards.
@Invariant (35)
I’m now retired, but I remember that in the run up to the 2016 pension freedoms my employer’s DC scheme modified its lifestyling arrangements. I seem to recall that the proportion of equities was increased relative to the earlier arrangement in the years closer to retirement as a result of less likelihood of buying an annuity post-2016. However, 25% was preserved as cash or its near equivalent in order to protect the tax-free lump sum.
@DavidV – I don’t think that resolves the problem. Imagine you needed a £100k lump sum and had a £400k pot. You can convert £100k to cash in advance, but if the remaining £300k then crashes to £150k, then your total pot is now just £250k, meaning that your 25% allowance is now only worth £62.5k. You’d have to convert the whole pot to safe assets in advance to be sure you could take the £100k you needed.
@invariant – could use debt in lieu of the lump sum, and take tax free gradually with drawdown instead
@Invariant (37)
Yes, good point. I didn’t think that through properly, did I!
@TA
I’m very much in the school of 100% Equities doesn’t make much sense because it isn’t going to be the efficient frontier (you’re adding much more volatility than return). That being said, its tough that in an inflationary regime bonds and equities are now positively correlated. I therefore think it makes sense to use alts so I broadly run a 60/40 equities/alts portfolio.
Cliff Assness at AQR wrote a paper “Why we lever” – where he makes the intellectual case that if you want more return, don’t add more equities. Instead, find the efficient frontier of maximising return for a unit of risk and then lever the portfolio to your desired expected return. I appreciate this might not feel trivial for the armchair investor, but Finumus wrote a great article on it.
@mtm – levering a portfolio is sort of like shorting a bond to buy more of it, if you count the debt against your bond holding it would effectively cancel & change your overall allocation more towards equities, but changes in the capital value of that debt just might not be so visible.
Otherwise it’s borrowing yourself to lend out as a bond to someone else, whether the yield is the same would matter, and it might introduce a small default risk where there otherwise wouldn’t be
@Matthew Ainsworth — I think the bit you’re overlooking is the efficient frontier itself. A diversified portfolio blended to maximise Sharpe gives you more return per unit of risk than just adding equities. Lever that up to your desired return target and you get there with less volatility.
And you don’t need to do it yourself — funds like WisdomTree 90/60 or AQR’s risk parity strategies use futures to lever cheaply (financing at roughly the risk-free rate, not a margin rate). The heavy lifting is done for you. The Asness argument is that the diversification benefit of the levered efficient portfolio more than compensates for the financing cost.
@MTM – I suppose changes in the value of the debt don’t affect the frontier as the debt would be a defined amount, not the market value of a negative bond holding, so I accept that. I wonder what the rate is in that debt Vs bond yields, whether it’s profitable to borrow directly to lend, as maybe it could be thought of as something a bit like a negative bond, just not market priced, I’d be aware that this does present a service a fund manager might want to charge for, or use to be more unique
I had investments in US S&P, Dow Jones indices, but now gone to short term GBP accumulation money market. The US market is no longer efficient – it’s being gamed by the political / financial elites, so I’m out.
Delta Hedge #14 Could you give me a clue on where I might find more info on the etfs IGTG and LCOM? I fancy doing a few backtests but struggling.