A couple of years ago I buffed up my crystal ball with Mr Sheen but the picture was still a dark one. Specifically, the risk to near-term retirees running into a poor sequence of returns looked high to me.
As things turned out, soaring inflation together with tumbling equity and especially bond markets did indeed make 2022 a year to forget for diversified investors.
One crappy year is easy to ride out when you’re young, accumulating savings, and many years away from pulling the plug. Lower prices are a bonus, enabling you to buy assets more cheaply.
However a bear market is a scarier and potentially more damaging prospect around retirement age.
Sequence of returns risk turns on the order in which investment returns occur. And we need to pay particular attention in the early years of retirement.
Negative returns at the start of retirement can lop chunks off the longevity of a retirement portfolio, due to your need to make withdrawals for income from your shrinking pot.
That’s true even if you eventually see decent average annual returns over the length of your retirement.
The bright side
Hopefully the pointers in my piece on how to soften the blow were helpful if you were retiring – or just thinking about it – in 2022.
What’s more, the worst of the portfolio drawdown was short-lived. Equity gains in 2023 and 2024 – beginning shortly after the Truss fuss – plastered over much of the damage. At least in nominal terms.
On the other hand, while bonds long ago stopped plunging, they’ve barely bounced. Bonds are like a coin that’s fallen out of your pocket to skitter beneath the sofa. Down, out of sight, and maybe out of mind.
As for inflation, thankfully it’s returned to near-target levels. But that doesn’t undo the prior period of very fast rising prices.
Downgraded retirement dreams
Once prices go up they usually stay up. That’s what makes runaway inflation so terrifying to those on fixed incomes.
The Pension and Lifetime Savings Association has hiked by 34% its estimate of the annual income required for a ‘comfortable retirement’ for a single person, compared to 2022. That’s more than enough to eat into the income buffer of almost any plan.
We can debate the PLSA’s assumptions (and Monevator readers did at the time). But everyone agrees the cost-of-living has soared.
For many retirees, this will mean a much tighter spending budget than they expected to play with. Or even a return to work for some.
Things could only get better
It’s important to stress that those who retired in 2021 or 2022 aren’t doomed to penury, just because of a single annus horribilis.
Sustainable withdrawal rate assumptions underpin many plans – often simplified to the 4% rule. And these are backtested across far worse bear markets and inflationary episodes than our recent wobble.
Think wars, depressions, and even gnarlier inflation.
True, the 2022 vintage of retirees will see lower returns in the future from pulling their 4%-or-whatever out of a smaller pot of savings in the first year. That’s just maths.
They’ll probably more feel the pain of higher prices too, compared to someone whose portfolio was fattened for years before we ran into the inflationary buzzsaw.
But assuming they had enough money at the start to prudently retire in a sustainable way, the past couple of years shouldn’t derail them.
Yet at the same time, anyone who delayed retirement until after bonds had finished their swan dive and inflation its Olympic high jump might be feeling quite smug today.
Bonds are back
Much of what dinged the prospects for a 2022 retiree now gives today’s sufficiently well-funded retiree more reason to look forward to life on their 4% – or thereabouts – withdrawal rate.
Note: I’m not forecasting a bull market here. (Nor was I predicting a certain equity crash in 2022.)
Forecasting future equity returns, especially over the short-term, is either very hard or impossible, depending on who you believe. Equity valuation levels can give us a clue to longer-term returns. And very high valuations do tend to point to lower returns eventually. But even this method isn’t foolproof, and it’s definitely no short-term timing signal.
However things are different with bonds (and perhaps also with so-called bond proxies).
Bond maths rules the roost. Higher bond yields will deliver higher future returns, versus lower yields.
Conversely, very low yields on bonds was exactly what made the outlook in early 2022 so troublesome. As central banks hiked interest rates aggressively against a backdrop of rocketing inflation, bond prices were nailed-on to fall.
In the end yields across the market went much higher than almost anyone had predicted, putting bond prices in the dumpster.
It was the worst bond rout of all-time in the US – and the UK was not far behind.
But those same falls also transformed the prospects for bonds. The negative bond yields of a few years ago have been vanquished. Even after a recent rally, ten-year gilts are still yielding 3.9% nominal. Buy and hold such a bond to maturity and that’s the return you’ll get.
It’s a similar story with inflation-linked bonds and – to widen the lens – annuities.
A better time to retire on an annuity
The following table shows changes in annuity rates since December 2021:
Source: Sharing Pensions
To be sure, annuity payouts need to be higher – inflation pumped up retirement costs by 30% or more remember. Yet even that vertiginous ascent has been outpaced by the rise in what £100,000 now gets you.
Property rental yields have risen too – albeit offset by higher borrowing costs – for those who still fancy the challenged buy-to-let route to a retirement income.
Naturally speaking, incomes are higher
We can also see the better sitrep for today’s imminent retirees by considering the level of natural yield your money now buys you.
Aiming to live on the income thrown off your portfolio is controversial. I won’t re-litigate the pros and cons in this post. I’m not suggesting this is how you should invest your retirement savings or that lifelong passive investors should buy active funds.
See my Mavens post from January if you’re curious.
Instead let’s simply consider the sort of hands-off-ish portfolio I personally might put together, assuming I wanted to live on a natural yield today. Just as a pointer to the value on offer:
| Asset | Allocation (%) | Yield (%) |
| JP Morgan Claverhouse | 10 | 5.0 |
| Murray Income | 10 | 4.4 |
| City of London Trust | 10 | 4.7 |
| Bankers Investment Trust | 10 | 2.4 |
| Henderson Far East Income | 5 | 10.8 |
| Renewable Trusts basket | 5 | 7.5 |
| Infrastructure Trusts basket | 5 | 6.5 |
| UK Property REIT (IUKP) | 5 | 3.7 |
| Intermediate (10yr) gilts | 20 | 3.9 |
| Index-linked gilt ladder | 20 | 0.5* |
| Portfolio yield | 4.0% |
Source: AIC, ETF factsheets, author’s calculations and guesstimates. *See comment #9 below for more on the index-linked yield, which is real where the others are nominal.
Despite my allocating a fifth of the portfolio to index-linked gilts for safety reasons, we’re still hitting a 4% initial natural yield, which I have every reason to believe would grow over time – and with a decent shot of keeping up with inflation over the long-term.
Compare that to when I sounded the sequence of returns alarm in early 2022.
The 10-year was then yielding about 1.6% and the yield on linkers was negative. Without looking back and doing a deep comparison, I know equity income trusts were on average around par so we can assume slightly lower yields, while infrastructure and renewable trusts were about to nosedive from high premiums to deep discounts. I’d estimate that added about 200 basis points to their running yields.
If I plug my 2022 yield guesswork into the same assets I get an estimated 2022 yield of just 2.9%.
This isn’t even to talk about the pounding of capital values that was about to hit such a portfolio over the rest of 2022 and beyond – from which it wouldn’t have yet recovered.
Indulging retirement daydreams
Of course you might reasonably argue that if you were being active about things, then perhaps you’d have owned a different portfolio in 2022.
A global tracker didn’t yield much in 2022, but it’s well up in capital terms over the past two years.
However I stress again I’m not citing this portfolio to sneak in a pitch for natural yield. I’m just showing how the re-pricing of assets – and the taming of inflation – might make today’s retirees more confident.
Of course inflation may not be tamed.
Inflation erodes the purchasing power of your money, making it one of the biggest threats to retirement income. As we saw above higher inflation also means higher living costs. If inflation takes off again then my example 4% nominal yield will obviously wilt in real terms.
But as best I can tell the omens on inflation look good.
Higher yields make this a better time to retire
Of course an equity market crash could happen at any time, too.
The US in particular still looks historically expensive, despite the recent wobble. While that doesn’t mean it’s sure to decline, it does mean we should curb our expectations for equity returns on a ten-year view. Especially given the big proportion the US makes up of global tracker funds. (Around two-thirds).
This isn’t like after the global financial crisis, when you could feel fairly confident you were buying up bargains.
On the other hand, much of the rest of the world’s equities look fairly valued. And my own income preference – to lean into equity income trusts – would see my hypothetical portfolio very tilted towards UK equities, which seems a pretty good place to be. The UK market has only just started coming back into favour.
But most importantly, far higher bond yields – and the repricing away of crash-risk in these assets – means you can diversify a portfolio without feeling like you’re sitting on a box of nitroglycerine.
I’d far rather start from here than there!
Retired last month although it didn’t involve any financial analysis, rather my business just came to a natural end. Sounds like lucky timing on my part.
I suppose we can all argue about stock selection but that list looks a bit heavy on the UK and UK equity income in particular. Your January piece mentioned dividend aristocrats etc but they’re not here. Personally I added a global income growth fund, SAIN and, adventurous me, iShares LTAM to my attempt at a long term income generating portfolio (40 % bonds).
As someone said against your January piece, it is very very hard to sell an ISA so perhaps I am just rationalising !
I don’t know how @TA and you manage to keep up the writing schedule @TI. Very impressive and another thoughtful and useful piece. Thank you.
Some years ago IIRC you did a list of UK equity income ITs that you were actively monitoring. Maybe that could be revisited and updated for a future Moguls’ deep dive?
There’s the unanswerable conundrum of course which underscores this issue of balancing out accumulation and capital growth concerns with decumulation and securing reliable and inflation resistant income (and when, if, and how to make the switch over as retirement approaches).
Is this the sell signal
Addendum: reminded myself of MV’s excellent pieces in 2008 (swapping shares for discounted ITs), 2010 (getting an income from ITs), 2015 x2 (ITs are one answer to retirement income, and are politicians to blame for IT discounts), 2016 (ITs for decumulators), 2019 x 2 (ITs for retirement income, both @Graybeard pieces), plus several more during current 2022 onwards era of persistent discounts.
It’s not only the markets that are difficult to predict. I’m still a few years away from pulling the trigger, but we haven’t seen what Labour has in store for us yet and if I was closer to the day, I’d be wanting to see Rachel Reeves showing her hand first. For many One More Year is more practical, and palletable, than a return to work after retirement.
Thanks for a great piece – interesting and very practical. One question if I may, and apologies if this is a dumb one – why are you expecting the index linked gilt ladder to yield only 0.5% p.a.? Aren’t index linked gilts trading at a positive real yield at the moment such that the nominal yield (as used in the table) must surely be well above 0.5% p.a.? Again, apologies if this question is misconceived.
Think it’s the real (inflation adjusted) annualised yield to maturity averaged out across the ladder @JPGR.
So, unless inflation is exactly nil over the duration of each gilt in the index linked gilt ladder, the total annual nominal average return, if each index linked gilt in the ladder is held to maturity, will be more than 0.5%.
@JPGR — Definitely not a dumb question — I probably should have spelt it out more and indeed the table is I suppose a bit misleading. As @Delta Hedge my 0.5% is (very!) roughly the real return from a basket of index linked gilts last I looked. I’m assuming this is spendable as income, while leaving the (inflation adjusted capital/coupons) intact, as per the other assets here. But it is a bit odd (as befits linkers!) and arguably this treatment doesn’t make sense when I have the nominal yield from 10-year gilts in the table (where you’d actually want/need to reinvest some appropriate share of the income paid out to try to preserve your bond holding’s purchasing power). You might knock the yield on 10-year gilts down to, say, 1.75% to reflect this (with a bit of wiggle room), which would take a little bit off the portfolio ‘spending’ yield.
Of course the same would be true — but the outcome even worse — with a notional early 2022 portfolio, which is the main point I’m trying to make with this table.
Also, I’d treat linkers as a safety cushion / insurance policy, at least for the first couple of decades of such a natural yield portfolio’s life, so to that end all income would be reinvested and any contribution from linkers to the spending power of the portfolio in practice moot (pending if needed a future switch to capital drawdown).
@Nutkin — Yes it is a great shame the rules change so often, but I suspect it will ever be so.
@Delta Hedge — Thanks for the kind words and useful comments as always, and for playing house historian! 😉
@Prometheus — Very droll! 🙂 Though I went out of my way in the piece to note this isn’t predicting equity returns…
@Paul_a38 — Yes, it’s just a quick and general income portfolio to share how generous yields are on many useful assets, not a definitive one. Though I’d note only 35% is in pure UK focused trusts. Bankers is Global, the clue is in the Henderson name, and my renewables and infrastructure trust baskets would all have overseas exposure, albeit with a UK predominance. As noted in the piece I’d be comfortable with a UK equity bias right now. And of course it helps with currency risk etc, though there are cleaner ways to address that issue with hedged equity ETFs I agree. You could certainly diversify into hedged global government bonds too, depending on your fears and biases. 🙂
@TheInvestor and @ DeltacHedge – thank you very much for the clear explanation. Yes, it was the fact that the table in every instance (other than the linkers) gives a nominal (rather than real) yield which I found confusing.
@JPGR — I see the issue. I could amend the table but I don’t want to draw more attention to the mechanics of running the portfolio etc as that is going to take away from the point.
For now I’ll add a pointer to these comments. Cheers!
I still come back to what I said during late 2022: that the rise in bond yields was the best thing that had happened for those looking to retire for well over a decade. Everyone was actually much better off by the end of 22 than at the start.
Instead, lots of commentators on this site seem to be very bothered about the price falls in bonds (and equity falls triggered by that). They were too focussed on the size of their capital pot and not at all focussed of the income it could safely generate. Most of that was because they were still operating with the idea of a SWR of 4% in 2021 even with bond real yields at -3%. I think that was just deluded tbh. RPI linked annuities were at 1.6% by end 21. That was the best approximation of the SWR.
Now we sit with inflation-linked annuities at over 3% for a 55 year old and 4% for a 60 year old. There is no doubt that the SWR is at least 3-4%. Normal service has resumed. The biggest fear everyone should have is going back to the situation of 2021, yet instead people still harp on about how they can never buy a bond again.
I’ll second that one @ZX. We’d all be much better off and perhaps happier too if asset prices were half where we are at now and yields were double. Much less risky for an investor and for a decumulator.
But since we moved to a pure fiat system, when Nixon went on TV (and interrupted Bonanza!) fifty three years ago yesterday to announce the ‘temporary’ (but since never reversed) suspension of dollars for gold convertibility; the whole system has, in essence, become built around waves of liquidity provision which, over time, I think, are trending asset prices up, and yields down (albeit, of course, with plenty of counter trends and counter cycles to the primary one).
@TI: Henderson Far East Income Ltd’s an interesting one. Down about a third or so over 5 years but still only moved from a small premium to a small discount in 2022. Now is on small premium. Dividend payments have held out and slightly increased in cash terms. I’m back of the envelope/ mental arithmeticing the yield going from about 6.5ish% to 10.8% over that time. Big EM risk I imagine, but for a possible 5%er allocation it’s interesting to monitor. Worth perhaps also giving an quick honourable mention here to TwentyFour Income and Select Monthly Income closed end funds yielding 10%-11% presently.
Another good and interesting article, thanks. As a fairly inexperienced passive investor though I do read a lot of conflicting information and it does make you wonder if you are doing the right thing. For instance despite reading numerous articles (not just on Monevator I add) advocating for just investing in a global tracker (for equities) and staying the course/not listening to the noise and saying that you will likely still do better than many/most of those that don’t.
But with many saying it is likely/inevitable that US equity returns are likely to be poorer over the next decade or so (although that has probably been said for around the last decade also don’t forget) it does get a bit confusing.
Although I know writers are not giving direct advice to do this or that, and I’m not singling out/blaming Monevator at all either, as I’ve read many posts from the likes of Vanguard/numerous other blogs saying we should diversify globally/passively and stay the course whilst the next minute giving their reducing forecasts for US equities, it sounds like we would be better off for the next decade or so, reducing our US exposure drastically and investing in UK equities/elsewhere and we would likely do better but again, no guarantees.
But then that wouldn’t be passive investing would it – would be an active decision and then would likely cause us to come off worse and to stay the course so we are told!! I’m not really sure which it is TBH (but it can’t be both) and I don’t think anyone else does? We all know it’s coming one day but we don’t know which one – which is I suppose why market timing isn’t a good idea.
Also I have read many pieces on bonds and what other investors say, like many on here, how you must have them when near/in retirement for protection against SORR etc. but then I read articles like this from 2023 – “All-Equity Portfolio Beats Bonds In Retirement Plans, New Research Finds”
and which includes when actually in retirement – not just leading up to it apparently and which says “The benefit from the all-stocks approach continued after retirement, the study showed.” “Given the sheer magnitude of US retirement savings, we estimate that Americans could realize trillions of dollars in welfare gains by adopting the all-equity strategy,” the researchers wrote. “Bonds add virtually no value for the lifecycle investors we consider.”
The link to this is here:
https://www.fa-mag.com/news/you-re-better-off-going-all-in-on-stocks-than-bonds–new-research-finds-75713.html?section=3
Not sure how good the article is or those that wrote it or who did the research but it seems all a bit confusing/contradictory out there and difficult for newer/more inexperienced investors to navigate. Just my thoughts. Does anyone else think the same?
IL Gilts are an attractive investment if your ISAs are full because the (nominal) capital gains go untaxed and the income is modest enough that it may well be untaxed too, depending on your other savings income.
Moreover with Two-Tier’s government spending like a drunken sailor it might be a good time to buy some inflation-protection. I think I’ll do some more homework on them and be ready to pounce after Ms Reeves’ Budget if she leaves the CGT treatment untouched. Or should I pull my finger out and hurry up a bit?
You can currently get a single life RPI protected annuity with payout rates of 3.9% (aged 60) and 4.6% (aged 65) and joint versions (100% beneficiary) with rates of 3.4% (aged 60) and 3.8% (aged 65). While there are still risks (e.g., insurance company default and gilt default) with annuities, combined with the state pension these give a solid income floor and enable the retiree to live with the much higher variability in income that arises out of a natural yield approach or other dynamic withdrawal methods (and thereby avoiding the market, inflation, and longevity risks of the SWR approach).
As an alternative to the annuity (with only risks of gilt default and reinvestment risks covering gaps), a non rolling inflation linked gilt ladder would provide a payout rate of about 3.3% for 35 years – probably covering a lifetime for the 65 year olds, but introducing a possibly unacceptable amount of longevity risk for the 60 year olds.
Definitely agree that higher annuity rates and fixed income yields make a better basis for retirement.
A question out loud.
Is the price of certainty too high here?
Scenario 1: Age 60 and put 100% of capital into a 35 year non rolling gilt ladder and spend 3.3% p.a. to have nothing left at age 95.
Scenario 2: Age 60 and buy an annuity with 100% of capital for a lifetime 3.9% p.a. spend rate which is RPI proofed.
But in each case die with nothing.
Obviously you can’t take it with you but are these obviously ‘better’ than:
Scenario 3: Age 60 and putting 100% of capital into a carefully chosen mix of UK listed equity income ITs on discounts and then ‘pulling down’ (via natural dividend yield) a 4% p a. (or slightly more) spend rate and potentially having an equity investment still worth roughly the same in real terms 30 or 35 years later whilst also quite possibly seeing the dividends keep pace with inflation?
I don’t know the answer, but I think the question is worth asking.
@Delta Hedge hits the nail on the head. I can see that TI sees the nail, but isn’t prepared to hit it with his hammer for fear of all hell being let lose (again) by the anti natural income crowd.
Of course option (4) – a 60/40 portfolio with a 2.5% just-to-be-on-the-safe-side SWR also hoping to die before one is broke is even more mad.
I’m 59, just retired and (as far as I am aware) in good health. This article and the comments are just so incredibly helpful. Thank you to everyone. And thank you @ The Investor for annotating the table per our earlier correspondence!
My approach, right or wrong has been – c.70% of investable assets in a Gilts/TIPS ladder (terminating when I’m 85) and c.30% of investable assets in a mix of cheap index funds (such that 40% in US, 10% UK and 50% in rest of the world).
My thinking: the ladder will likely (at least actuarially) see me through to death – generating enough cash flows to live on I hope/expect. If I live longer then hopefully the equities will see me through to death.
Would welcome any thoughts – no need to be nuanced in your responses!
@DH (#17)
I don’t know the answer to your interesting question either (in fact no-one will until towards the end of their retirement) except
Scenario 3. There is no certainty that a) the 4% (or slightly more) yield will keep up with inflation (notwithstanding that the gearing that ITs can use potentially gives them an edge over the natural yield from index funds, although higher fees will nibble at that edge), b) the real value of whatever remains at the end may, or may not, be more or less than the initial value, but this is also true for historical indices whether using SWR or percentage of portfolio withdrawals. In general, AFAIK, the available history of income ITs (i.e., income and price) is not sufficient to cover the really testing bits of history (e.g., for the UK, the early 20th century, pre-WWII, and the 1970s).
Anyway, IMV, the question is not quite either/or (i.e., it is probably unwise to invest 100% in anything!). IMO, it is a matter of buying enough (potentially) ‘expensive’ guaranteed income to cover core (sometimes called either essential or non-discretionary) spending and then take risk with the portfolio to provide the discretionary income. This approach, also known as floor and upside (e.g., see books by Brodie and Zwecher) was discussed widely in the aftermath of 2008. For most people in the UK (if not on this site), the state pension will probably provide sufficient floor to cover their baseline expenditure (judging by the minimum retirement living standards which are about 20% higher than the SP for a single retiree and just under 2*SP for a couple).
JPGR- that’s a similar portfolio to myself when I retired 21 years ago (now aged 78)
30% equities/70% bonds-it’s an often recommended Asset Allocation for a new retiree-supposedly a “safe”scenario
Of course personal circumstances seriously affect a retirees income stream-availability of pensions ,amount of savings amassed etc
I have managed to live off this Asset Allocation successfully-so far!-suited my conservative outlook
Must have saved enough?,lived in fortunate times?
Currently Asset Allocation is 35/59/6 where 6 = 2 years living expenses in cash
xxd09
AFAIK, the only published investigation of natural yield is at https://finalytiq.co.uk/natural-yield-totally-bonkers-retirement-income-strategy/
Of necessity, this used historical market yields (i.e., dividends and gilt yields) rather than ITs. You can see the author’s view of the approach in the title of the webpage, although I disagree with part of their conclusions since retirees with a solid income floor can accept variation in their portfolio income and natural yield is no different in this respect to any other percentage of portfolio strategy.
I have a soft spot for natural yield, since my parent’s portfolio consisted of a number of individual equities timed to provide regular dividends and some individual bonds (issued by banks) with coupons of 8% or more (this was the 1980s). It required little or no maintenance and, in days when transaction fees were high, no buying or selling. I don’t know how well it would have survived in the long term (e.g., at least one of the equity investments was delisted about a decade later).
Very interesting and many thanks @Alan S. All very valid points made in that article. I guess you really do need an income floor of some sort whether from DB, fixed income, SP or a combination.
Quite odd though that there are so few studies of the natural yield approach in the UK.
I would have though that more people would be riled at the thought of either handing over their pension pot (which could for some be their life savings) to an annuity provider or (since ‘pension freedom’) apprehensive about investing the lot into ‘safe’, but also historically much lower return (compared to equity) gilts/ILGs.
I suppose that the intermediaries like the Pension providers etc don’t have a great incentive to write about alternative approaches, and (because it’s shares) when the AIC does do some advocacy for ITs it’s just seen as them talking their book (which it is, but it is also when the Pension industry stresses the risk of longevity and outliving your income over and above all other possible considerations).
The Pension industry has a lot more firepower to boot than the AIC. Just reading that Local Council pension schemes in England and Wales (with some £360 bn in assets) spend over £2 bn each year on consultants and other fees (so ~ 0.6% p.a., which is steep IMHO). Big fee income buys big lobbying. Not so much so for the UK IT sector I suspect.
9 months out from the finish line – determined to avoid the OMY challenge (will be 55). With a DB that will cover 20% of target income – got roughly 10% of bonds and rest of ISA & DC pots in globally diversified index funds. Wife has additional DB pensions kicking in later and with SP will mean later years income will be covered with mainly guaranteed income streams. At some stage selling home & moving from commuter zone property will also unlock further funds – hopefully with an option to pass some onto kids at that point. All our journeys are nuanced with our working lives, relationships and health – you have to do you – and with that comes taking action and making decisions. Tweaking of the plan will be required as things beyond your control play out – again, will require big boy/girl pants to be pulled up & action taken. Good luck to all on our respective journeys. Keep on….
I think that article on natural yield is worth a read for anyone wanting a full picture of the strategy (upside and downside) but he’s not criticising it as I would implement it anyway.
As Alan says, he focuses on raw market yields. There appears to be no cash buffer in place. And it’s not like other strategies don’t suffer from volatility. Income volatility is generally lower than quoted market volatility.
I’ve never argued a natural yield approach should be considered for any alleged market-beating capacity. It may or may not do better than a total return strategy, but most of the time I’d expect it to do worse, for the usual passive-vs-active reasons. (Right now might be one of those times it is set to outperform, but that’s just a hunch and nobody but me should invest over the next 30 years of retirement as determined by my hunches!)
The reasons to do it for me (with sensible income generating vehicles and cash buffers, as I’ve outlined before) is it’s less stressful, it is not predicated on running out of money in a race with death, it’s more robust to aging and decline in terms of investing decision making, and it intellectually is more attractive to me compared to backtested data-mined drawdown strategies. (I’d have to expand the latter in a whole post).
For me the big drawbacks with natural yield are you’ll need (much?) more money to begin with, you’ll probably die with a lot more than zero which is probably not optimal for spending your way to a good life (though again, not seeing my assets run to zero would cheer me up every day!), and you’ll probably do at least slightly worse in terms of returns than if you’d gone for a total return with its own pros and cons.
It is definitely not for everyone, or even most people. But it has a place and it’s not ‘bonkers’ for those it appeals to provided they understand the pros and cons.
@Jon — Your long and thoughtful question may have inspired an imminent article by way of response. Watch this space! 🙂
@all — Thanks for the great comments and feedback!
@DH (#17) & JPGR (#19)
FWIW, I agree with Alan S (#20) and “the question is not quite either/or” but more a bit of each, or – if you prefer – floor and upside. Which rapidly brings us back to the thorny question of how much floor, or to steal from the late great Dirk Cotton:
“The most important decision you will make in retirement planning is how much of your resources to allocate to the upside and floor portfolios” and “The correct balance [between the upside and floor portfolios] will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.”
My experience to date (I jumped > 7 years ago) is that:
a) whilst it may be initially tempting to maximise your level of flooring, this could be a mistake and a better strategy may be to set the flooring as low as practicable and organise the upside such as to minimise the probability of ever having to live from just the floor; easy to say/write, but not so easy to implement, e.g.
b) even with extensive records of expenditure prior to retiring it is not easy to accurately estimate the level of flooring actually required in retirement*;
c) things, including expenditure, shall (not might!) change and often in ways you cannot control or even influence;
d) excess flooring may actually be wasteful;
e) survivor [and/or legacy] scenarios could be important considerations;
f) think really hard before locking yourself into anything or making irreversible decisions; true flexibility IMO has real value;
g) you might also want to explicitly consider holding reserves too
*to date, if anything, I over-estimated; but the opposite outcome could have occurred too
@TI (#25):
FWIW, Zwecher’s book “Retirement Portfolios” (often referred to be myself (and others) as the floor & upside ‘bible’) explicitly acknowledges that if you are rich enough then yield based strategies are perfectly viable!
Just to say you are preaching to the converted on natural income portfolios, mine is spookily similar in make up to the one you threw up above, including some of the same investment trusts, green energy infrastructure and so on.
I will probably also end up with about 20% in conventional gilts, but the main difference at present is I am yet to add any index linked gilts, and may even end up with 20% in corporate bonds.
Which is something Jack Bogle wasn’t averse to when he was interviewed talking about his personal view on bond allocation (if I recall, a 50/50 equity/bond split, with bond allocation split between treasuries and corp bonds).
Anyway, as you say, the future for such a portfolio is looking much brighter than it did a few years ago.
@TI (#25):
Re: “though again, not seeing my assets run to zero would cheer me up every day!”
One other thing I have learned in the last few years is that living this [your assets running down] in retirement is far far harder than thinking (ahead of retiring) that you could live with this in retirement!
IMO, @ermine captured this lesson very well in the quoted phrase and the following para-phrased sentences:
“Playing a capital sum into retiring well is just as much performance art as detailed planning.”
That is, it’s not only what it is. It’s what it feels like!
And whilst good competence in planning is necessary, it may not be sufficient, particularly as the initial trajectory suffers the cumulative slings and arrows of time and economic policy.
Reading this article and comments makes me feel entirely unsophisticated in my retirement approach yet grateful for the knowledge that trickles down to me from Monevator and those who read and take the time to comment on your articles. I pulled the plug in 2018 at 48 existing on rental income alone from residential properties held for circa 30 years purchased during my working life. Since the recent increase in interest rates I drained the family ISAs to clear BTL mortgage debts and cleared those mortgages entirely very recently at 55 using my SIPP PCLS. The ISA / SIPP accounts all hold or held Vanguard global index trackers with varying degrees of bonds. I have not changed the underlying investments in this now crystallised SIPP account and am using the drawdown facility to take a withdrawal rate of 2.26%. According to the illustration document my SIPP provider (ii) is obligated to provide by the FCA I will not run out of funds by the time I’m 100 in any of the published scenarios. I still have 3 pensions to come – an Armed Forces and BT pension at 60 and a full state pension. My view is if the SIPP funds decline significantly in value at any point I will simply turn that tap off until normal service resumes and rely more heavily on my other assets to do the retirement income heavy lifting. Perhaps this reads as uninformed investment suicide given the sophistication that exists in the Monevator readership yet I was having lunch with a few close friends yesterday and it struck me that, despite coming home and feeling somewhat ignorant having read this article and well informed comments, I understand so much more than those friends I ate with. I think they represent the average and whilst I’m slightly better informed I’m far less knowledgeable than many readers here. I wonder what this means for the nation given the increasing cost of free advice and the recently publicised announcements (from BBC Radio 4 as I recall) that many financial advisors are not prepared to even talk to someone without a fairly sizeable asset pot. I’ll end this ramble by thanking this community for being so generous in sharing their knowledge. I do think you represent a small fraction of the UK in terms of your financial sophistication and we get to read your wisdom for free each weekend. It is something I feel very grateful for.
@TI (#25)
“you’ll probably die with a lot more than zero which is probably not optimal for spending your way to a good life (though again, not seeing my assets run to zero would cheer me up every day!)”
I note that natural yield shares many characteristics with a simple constant percentage of portfolio, i.e. variable income and a reduced range of final portfolio values compared to the SWR approach (which is, IMV, an awful strategy to actually use).
For example, backtested results (!) indicate that for a portfolio for 50% UK stocks and 50% UK bonds (returns from macrohistory.net) the portfolio value after 30 years, expressed, in real terms, as a percentage of the initial portfolio value, ranges from 15% to 200% for natural yield, 20% to 300% for constant percentage (4.5% of portfolio), and 0% to 800% for SWR (initial withdrawal 3.5% of portfolio).
While future numbers will vary (and backtested numbers depend on the portfolio modelled, inflation series used etc.), the principle will not – compared to SWR, in bad retirements natural yield and percentage of portfolio strategies will leave more money in the portfolio while in good retirements they will leave less. Whether this is good or bad depends on what you want out of your portfolio.
“is more attractive to me compared to backtested data-mined drawdown strategies”
FWIW, my view is that backtesting is useful for studying and comparing the behaviour of different strategies under a (relatively limited) range of market conditions. If you have some handle on the behaviour, you can pick the right tool for the job. However, they are less/not useful for predicting what will happen and arguing over decimal places in SWRs or any other parameter (as I’ve seen on other forums, and don’t get me started on SWRs quoted to two decimal places or the ‘safe’ in safe withdrawal rates!) is a fruitless activity.
@ Alan S:
OOI, are you familiar with the work of Patrick J Collins (PJC)*? In any case, he produced IMO a very useful annotated bibliography of related works, the latest version of which is available from: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4026805
*Your mention of “a simple constant percentage of portfolio” was what reminded me of him, albeit PJC often uses the phrase “percentage of corpus”.
@TI. “Natural yield …. it intellectually is more attractive to me compared to backtested data-mined drawdown strategies. ”
I would say that is jumping from the frying pan into the fire. Both are intellectually weak. Equities don’t really have a “natural yield”. They are not bonds and nothing will make them into bonds.
The withdrawal rate problem is essentially one of being short a path-dependant barrier option of unknown maturity, with strike A-L =0 (where A is the asset + income portfolio and L is the liability portfolio, including legacies). Being path-dependent it’s not an easy problem but the idea that “natural yield” is a solution seems a heroic assumption.
The best approaches are those used by option traders to hedge these types of positions i.e. “bending the barrier” by breaking the long-dated path-dependent option into a discrete series of of short-dated at-expiry options.
@ZX: I’m a simple layperson with no professional background in either finance or economics, so please don’t flame me if I’ve got this wrong 😉 but if I understand what you’re saying in your paragraphs 3 and 4 above, in layperson’s terms, when trying to determine how much money one can withdraw from a retirement portfolio without running out of funds one can liken it to holding a “path-dependent barrier option,” which means its value depends on the entire history of the portfolio’s performance, not just its current state, where the “strike” or critical point is when assets equal liabilities, where relying solely on the portfolio’s natural yield to solve this problem is overly optimistic, and where the the best way to manage risk is similar to what professional option traders do in taking a complicated, long-term investment and breaking it down into a series of smaller, short-term investments to better handle changes in the market and reduce potential losses (i.e. like a rolling gilt ladder perhaps). Have I got that right?
BTW the market technician Michael Gayed (of the Lead-Lag report) has an excellent saying (IMHO) that “the pathway is more important than the prediction” or “path matters more than prediction”. I think he was thinking more in terms of the effects of leverage and volatility drag, but it holds true for a lot more.
http://www.theretirementcafe.com/2019/04/a-good-many-retirees-seem-to-be.html
Hard gig living off your money isn’t it….
Al Cam has it spot on “One other thing I have learned in the last few years is that living this [your assets running down] in retirement is far far harder than thinking (ahead of retiring) that you could live with this in retirement!”
Good example of the problems with living off the natural yield is the FTSE 100. Good dividend yield, multi-national companies, global exposure, what’s not to like…well terrible 20 year performance for example where the value of your capital has been cut in half in real terms for one.
The issue is, we’re not programmed to deal with massive amounts of volatility in our wealth. It’s sort of fine when we’re accumulating but for those without an DB / Annuity floor the market blip the other week (and it was nothing more than a blip) probably had a few retirees worried. I’m certainly not sure how I’ll deal with the volatility, once the plane’s engines have been switched off and I’m riding the air currents of market returns. I suspect I’m going to massively overcompensate on my required altitude. But who can predict the future?
One mental approach I’ve taken is to say ok – currently I can fairly safely withdraw around x % a year of my portfolio. If markets are cut in half, yes my capital value has been but my ‘safe’ withdrawal amount has also increased.
It’s tempting to look hard at gilts but if you have a 50 year time horizon – kind of where I am at, you really need to be in deep with equities.
@SF:
A lot of things change when you pull the plug, and to be honest I have really had a pretty easy ride thus far too*. If my experience is anything to go by, it will take a few years before you sort of really feel the changes. And I had had the benefit of year plus ‘practice run’ some years earlier too. Whilst that earlier sojourn did teach me a few, mostly mechanical things, it did not confer all the learning I had sort of hoped for; so be it. On a more positive note, things changed again, and very much for the better too (although the subsequent numbers are not in any way astonishing), when I switched on my DB pension a number of years before I had initially planned. In summary, I agree that it is tough “living off your money”, but it was a useful experience and I 100% would do it again!
*I have never once fallen behind my baseline plan; however – and with the benefit of >7 years of experience – I now realise that such a plan is really just numbers in a spreadsheet and there is just so much more to this than digits!
@Seeking Fire #35: The FTSE 100’s performance is an argument for diversification but even just holding Vanguard Global All Cap (so all in equities) would have protected here despite crashes in 2000-02, 2007-09, 2020 and 2022. It’s really a single country thing. And the UK has had it bad since 2000 in large cap land. Maybe an exaggeration to say that everything that could have gone wrong for the FTSE 100 did go wrong after December 1999; but it’s not so far off the mark. New Year’s Eve 1999, the FTSE 100 closed at a then-record high of 6930. By 31 December 2019, exactly 20 years on, the FTSE 100 would barely have moved. It stood at 7542, just over 600 points higher. Price-wise, that’s an average annual return of 0.4%. However, with dividends it returned 122% cumulative or 4% p.a. nominal (so £1,000 into £1,088 without dividends, but £1,000 into £2,220 with). That’s not great with inflation at 2% p.a. from 2000 to 2019, but it’s not catastrophic either.
@Frank (#30):
Re: “I wonder what this means for the nation …”
You are not alone, and IMO this is especially concerning as DB pensions become ever rarer.
I assume your forces and BT pension are DB in nature.
With various tax thresholds frozen until at least April 2028, is there any possibility of you becoming a HR tax payer once all your pensions (including your state pension) come on stream?
@DH. Sorry been busy. First, a 100% equity portfolio based on “natural yield” is just a 100% equity portfolio. Total returns will be the same. Natural yield doesn’t change risk. In fact, if anything, too high a yield is an indicator of poor total return performance. Don’t pretend an equity is a bond.
Thinking about the retirement problem, one way to see this is effectively like being short a barrier option where the net value of your wealth must stay positive definite until you die. If it goes negative, the barrier is knocked out. It’s then a question of minimizing the probability of being knocked out.
We have a panoply of techniques to value path-dependent options. The simplest is to deconstruct the long-expiry option into a series of short expiry options. It’s then easier to approximate those short-dated options using simple Black models. So let’s imagine you split a 30-year retirement in 10 x 3-year segments. You start off by calculating what set of acceptable portfolios 27 years from now, generate a 30-year net positive portfolio values within defined risk management limits (guardrails). You then work out what set of portfolios in 24-years generate that 27-year set of portfolios. Repeat until you get back to the initial portfolio. It’s a lattice type approach. It’s more numerically intensive than a Monte Carlo but given we all now go around with cheap nVidia GPUs that’s not an issue!
It shouldn’t surprise anyone that the initial portfolio spat out tends to be overweight safe assets (cash, linkers) and underweight risky ones (equities). Sort of “floor and upside” (F&A). At the start, you cannot risk getting too close to the barrier. As time goes on, however, what tends to be generated is a portfolio with a higher weight of risky assets. Like a reverse equity glidepath (REG). The point though is that unlike F&A or REG, there is no defined path. It’s not static. The path changes dynamically. As it should.
Very much obliged for the thoughtful and thought provoking response @ZX. Thank you also for taking the time.
Intuitively, REG makes sense. Retirement day is a point of maximum risk as it’s the longest time without any employment earnings until death.
So it makes sense to use a glide down allocation for the risk-on sleeve of the asset allocation mix using the standard “100 minus age” formula up to retirement day and then, after retirement day, switch to a glide up for the risk-on sleeve of the allocation, increasing that sleeve’s share by 1% p.a. of the total portfolio until the earlier of either 100% allocation to risk-on assets is reached or death comes.
I used to post as @Time Like Infinity/@TLI (too close to @TI, so changed to @DH), and back then you correctly and perceptively noted that I was too equity centric.
Since then I’ve been thinking about what to do in order to try and remedy that.
I’ve been close to 100% global equities, overwhelmingly via index trackers, during my investing journey, and at approaching 50 I need to derisk overall.
I’m lucky to have a DB pension as a floor. But FOMO and an excessive risk appetite has stopped me from diversifying to date.
I’ve been thinking over an idea to square the circle. It might be bonkers, but I hope not.
It’s a variant of Taleb’s barbell idea of taking a sliver of maximally risky equity exposure and putting the rest into relatively safer (lower volatility and less risk of permanent loss of capital) assets.
My idea is as follows:
– 1% of starting capital into a maximally risky leveraged ETF rotation strategy. This amount would not ever be rebalanced. It would just stay in the strategy come what may. If it goes to zero (a very real possibility), then the most that can be lost from the starting portfolio value is just the 1% initially allocated to it, leaving the other 99% of the portfolio starting value unaffected. In other words, a total loss here can’t make any difference to my future standard of living (having 99, rather than 100, being functionally indistinguishable).
– The remaining 99% of the portfolio starting value goes into a considerably less risky mix of assets (which will be rebalanced annually) than the almost 100% equity portfolio which I’ve (still) got presently.
The 1% of portfolio starting value in the LETF rotation strategy has uncapped potential and limited downside. It will not be topped up, nor sold down, but instead the strategy will be executed and held for as long as possible (decades, if possible, to allow it to compound, if successful).
In contrast, the remaining 99% of the portfolio starting value would be invested more cautiously than presently, and used from age 60 to top up my DB pension floor in retirement.
The LETF rotation strategy for the 1% of portfolio starting value is a ‘Max Pain’ one which seeks the highest possible long term growth, regardless of both draw down severity (depth/duration) and volatility.
The strategy is described by the 7circles and Dual Momentum Systems sites here:
https://the7circles.uk/dual-momentum-systems/
And here:
https://dualmomentumsystems.com/strategies/maxpain/
https://dualmomentumsystems.com/resources/High-Test/High-Test-2024-05.pdf
From your hedge fund risk management perspective, it’d be interesting to hear any thoughts that you might perhaps be able to share.
Thanks in advance. 🙂
@DH (#41):
Interesting idea.
Slightly puzzled why you appear to be so focussed on the details of the 1% aspects. IMO, there are plenty of toughies to tackle with the 99%, see e.g. my comment #26 above.
Architecturally, your approach seems to be floor & upside with the upside sub-divided into main portfolio and a ‘play pot’ – for want of a better name. Personally I reckon it is worth considering an additional partition, i.e.: floor, upside, & reserves.
The chatter at this post from a couple of months ago might be of some interest:
https://simplelivingsomerset.wordpress.com/2024/06/04/decumulation-deliberations-and-dilemmas/
Re: the focus on the 1%: The problem with any Leveraged ETF strategy is that you’re at the intersection of volatility drag and a potential bonus from daily rebalancing.
It normally ends up going against the investor and very few ideas like this actually work in practice.
And if the 7%/13%/20% circuit breakers fail on the US exchanges (in, say, an October 1987 re-run) then the LETFs at x3 leverage go to zero at -33% down on the day on the indices.
Something not too dissimilar happened to the IVIX (inverse VIX) ETF during the ‘Volmageddon’ event in February 2018.
So it’s playing with matches sitting atop a pile of dynamite.
OTOH, just look at $ returns on ‘Max Pain’ from 1979 to 2024.
A half a million fold cumulative nominal return, at 34% p.a. (which is an over 100,000x return in real terms over the 45 years).
In the past decade I’ve looked at hundreds of rule based tactical asset allocations including scores of leveraged ones and none of the others claim a back test going back that long with returns that high.
So I’m interested but very sceptical.
That means, I think, using something like the Kelly criteria to size any position plus an overlay of some sort of future regret minimisation framework.
So, if the odds of the claimed backtest performance for the past 45 years 1979-2024 actually repeating itself over the next 45 years 2025-2070 (if I make it that far) are just 1%, then the position size should not exceed 1%, regardless of the potential return multiple.
At a 1% position size, a 100,000 fold real return over 45 years would turn the position into 1,000x the original total portfolio starting value.
But if the strategy fails then 99% of the portfolio is untouched by the strategy.
A complete loss of the 1% allocated to the strategy means that the remaining 99% will return 0.99x of what it would have done had no money ever been allocated to the LETF approach.
And having 0.99 or 1 is FAPP the same thing.
So, a tiny but never rebalanced starting allocation (of 1%) effectively minimises the consequences of strategy failure to the point of irrelevance whilst, over 45 years, still holding out a small prospect of an amazing outperform.
@DH
Thanks I get the idea that “a tiny but never rebalanced starting allocation (of 1%) effectively minimises the consequences of strategy failure to the point of irrelevance whilst, over 45 years, still holding out a small prospect of an amazing outperform”.
But having said that I am interested how you think you might react if/when that 1%:
a) burns out – by far the most likely outcome; or
b) takes off.
In scenario a) some folks would try again, as after all it is only another 1%.
IMO scenario b) is probably even trickier. I would have absolutely no idea what to do with that sort of a windfall – and actually seeing it developing that way over the ensuing years may not help that much either?!?
As I said above, I reckon there will be challenges aplenty in sorting out your 99%. Depending on when you want to pull the plug, my experience suggests that leaving all of that until later could/would be a mistake.
@Al Cam: Got to be philosophical one way or the other. If it goes it goes. It’s only a percent to begin with. And if it grows it grows. Don’t interrupt compounding.
But keep the other 99% more or less conventional and relatively safer.
The 1% would be in ISA and probably have to move it to IBkr to get access to the US LETFs (there’s no UCITs equivalent for 3x Russell 2000 and 3x US mid caps). IBkr has a 0.03% FX rate, making it doable.
On the 99%, minded (treating it as 100):
– 60 in equities *
– 20 to 25 in broad commodities (UC15 ETF)
– 5 to 10 in gold (SGOL ETF)
– 5 in trend (Winton Trend) and/or listed Global Macro Hedge Fund (BHMG IT)
0 to 10 in Long Duration TIPS ETF (e.g. UBTL and/or T10G ETFs)
* Treating the 60 in equities as 100, this is then broken down as:
– 40 into WTEF ETF (1.5x 60 S&P 500 with full physical replication plus 40 US intermediate duration Treasury Bonds via rolling futures).
– 25 into UK equity income ITs, either as 1 each into 25 ITs, in order to get widest coverage, or as 5 each into the 5 most attractively discounted out of CTY, FGT, EDIN, LWDB, MUT, MRCH and TMPL.
– 5 into a Global REIT ETF
– 10 into listed infrastructure ITs
– 5 into something like Invesco S&P Emerging Markets Low Volatility ETF (EELV).
– 5 into HFEL IT.
– 10 into CGT, PNL, RICA and RCP ITs.
P.S.: on the 5% potentially planned for trend following/managed futures and/or global macro: frankly I’d prefer any of DBi DBMF Managed Futures, AQR Managed Futures, RSST ETF or Schroder GAIA BlueTrend fund to Winton Trend, but it looks like they’re not readily available.
PPS: if I do move to IBkr then that would/ could/ should enable access to other (i.e. in addition to WTEF/NTSX) returned stacked and capital efficient ETFs available in the US from WisdomTree and ReSolve Asset Management. This in turn might change my plans.
@DH:
Thanks for the 99% details. Looks like a rather complex variant of a 60/40 arrangement me.
I am not too sure how that would map to a floor plus upside (F&U) approach. Perhaps you view your floor as being just your pensions. In which case I guess the date you “jump ship” and associated level of flooring are somewhat pre-determined. I originally envisaged my floor as a [real] amount derived from spending history, that would largely, in due course, comprise pensions (DB and SP). However, a substantial “gap” would need flooring if I jumped ship prior to starting my DB (@NRA) and a smaller gap until my SP came on stream, with the possibility of a low-level tail shortfall to floor until expiration hopefully some years later.
Some of my experiences about setting up and managing my F&U approach are outlined at: https://monevator.com/should-you-build-an-index-linked-gilt-ladder/
wherein I note you commented under a previous sobriquet (@TLI) .
I also note [at that post] some of the key things that I learned (to date) and provide a link to IMO the best F&U reference text.
IMO, there is very little written about how to practically enact a F&U approach and AFAICT nothing at all about doing so in the UK. I kind of made it up as I went along (albeit with guidance from Zwecher) and amongst other things had to develop my own home-brewed monitoring tools.
I am unsure how familiar you are with the Z text (if at all), but one thing I would say (with the benefit of some limited hindsight) is that in places it now strikes me as being rather dogmatic and overly theoretical. A good example being the rules they lay down for re-balancing between floor & upside for what they call a static implementation. Basically, it states repeatedly that in such an approach you should only ever re-balance towards the flooring. Whilst this is consistent with the book’s primary goal of “protecting the lifestyle floor” it somewhat pre-supposes it is feasible to enumerate said “lifestyle floor” in advance.
@DH:
Re-reading our chatter above and your earlier comments at the index-linked guilts post, it may be that you wish to implement F&U using what Z calls an active risk management (ARM) approach as opposed to the static approach that I used. Fair enough. However, IMO still lots to do in the mean time, not least of which may be working out the nitty gritty details of your risk management approach.
For info, the ARM approach (and some suggestions for risk management) is described in chapter 9 of the Z book
AFAICT, there is even less written about the ARM approach [than static], but I do recall reading somewhere that ARM might be Z’s personal preference.
If ARM F&U is your plan then this quote [from said books Chapter 9] (allegedly attributable to Thomas Edison) might raise a Monday morning smile “good risk management is 1 percent quantification and 99 percent beating the cocksure over the head with a stick”.
Thanks Al Cam. I’ve got a a legacy DB FSS and a current DB CARES as my Floor from 60 plus the SP which for me will be (on current government policy) available from 68. Everything else (SIPP and ISA wise, and any future inheritance) is a bonus in terms of retirement planning.
I’m no fan of CAPE as a market valuation tool (much less still for tactical asset allocation/ market timing), but it does make sense I think for working out a plausibly useful SWR for SIPP/DC.
Over at the 7circles PF/ FIRE site they mention using CAPE for this and I adapted it as following for SWR:
((% in equities/100) X (100/CAPE ratio)) + (% in bonds/100 X real YTM, but with a zero real yield floor)
Worked examples:
A high CAPE and a low real YTM scenario at the point of retirement:
– 60% in global equities at CAPE of 35 and
40% in ILGs at minus 1% real YTM = SWR of ((60/100 X (100/35)) + (ignore the ILGs here as the YTM is negative) = 1.7% p.a.
A low CAPE and a high real YTM scenario at the point of retirement:
– 60 in global equities at CAPE of 10 plus 40 in ILGs at 4% real YTM = SWR of ((60/100) X (100/10)) + ((40/100 X 4) = 7.6% p.a.
@DH (#49):
Thanks for additional info.
I will mull it over, but my first impression is: your pensions, and only your pensions, comprise your floor!
A couple of other things that occurred to me:
a) Wade Pfau provides a simpler description of what I distinguished as the ‘static’ and ‘ARM’ F&U approaches as follows (N.B. typos are in my copy of the 2012 MPRA paper: Choosing a Retirement Income Strategy: Outcome Measures and Best Practices):
“Another matter relates to building a floor, or at least having funds readily available to build a floor. Is there any effort to either lock-in lifetime flooring to protect from longevity risk or to monitor the amount of flooring that could be purchased as the portfolio fluctuates and take action to lock in flooring if the portfolio falls too low? Or is the portfolio left exposed [to?] depletion?
Creating flooring does not necessarily require building a build [bond?] ladder or purchasing annuitized products, but for practical purposes it requires vigilance to lock in some amount of client-identified minimal needs before it becomes too late in the event of a market drop”.
b) your 1/99 proposal has some similarity with Jason Scott and John Watson’s 2013 Floor-leverage Rule for Retirement.
@DH:
I guess you are aiming to retire aged 60, and somewhat reading between the lines (or just guessing) your DB pensions at 60 will provide you with about enough flooring. If this is correct then the SP, to some extent at least, will be icing on the cake. This might possibly be wasteful, in the sense I used ‘wasteful’ above. Have you considered retiring before your DB NRA, or are there some impediments to that?
I think you might be using 120 minus age for your glide down allocation for the risk-on sleeve. This is assuming you intend to have 60% equities at age 60 as mentioned at #45. If so, you should now be around 70% equities. I guess there could be quite some work [and/or costs?] in getting your Pot into that shape?
Retiring before you start your DB scheme may also provide you with some additional opportunities to cost-effectively manage the glide down – but that is very much speculation on my behalf.
I think Mike @7circles cribbed most of his CAPE ideas from ERN*, see e.g. https://earlyretirementnow.com/2017/08/30/the-ultimate-guide-to-safe-withdrawal-rates-part-18-flexibility-CAPE-Based-Rules/
In any case, the range of CAPE based SWR’s you calculate at 60 is quite alarming. However, if I understand ERN’s work correctly these CAPE based SWR’s should be re-calculated every withdrawal, ie not just once. BTW, ERN’s part 47 provides some guidance on intra-year fluctuations in withdrawals.
Lastly, there are quite a few reviews of Scott & Watsons Floor-leverage rule on the web.
*it is hard to be sure seeing as Mike now has his summaries of ERN’s work behind a paywall!!
Unfortunately (or perhaps fortunately, as it’s turned out so far) since 2013, when my better half and I went back to almost 100% in equities, we haven’t had any sort of cross-asset diversification.
We just thought, in an unsophisticated way, that equities were most likely to deliver the highest cumulative return (based on their being an ERP).
We went with global equities to at least divest country specific risk but never foresaw just how much the US would outperform leading to the situation now of over 70% of developed market and over 60% of All World capitalisations being in US companies (overwhelmingly US mega caps).
As a result of this, neither she nor I have actually been following any sort of glide path down, with decreasing equity and increasing bond sleeves, as the possibility of retirement begins to appear on the far horizon.
Increasingly though, since bonds became attractive again in 2022, I’m thinking that it would make more sense now for us to apply some measure of risk mitigation using a more conventional asset allocation mix for our ages (coming up to 50 now), hence my thinking about a glide path or using a possibly better mousetrap version of the 60/40.
My own problem here is that the falls/ drawdowns/ volatility of being a 100 in equities makes me fell sick (e.g. March 2020 and at the start of this month, with the fallout from Japan) but I feel sicker still to miss out on any gains.
There’s just nothing worse than being on the sidelines and then seeing the market go up.
At the moment I’m feeling fairly fixed on the ideas of either full retirement at 60 or going PT from that time.
I in effect ‘have’ to take the legacy FSS DB pension at 60 as that’s that scheme’s NRA, and they don’t increase/ enhance the payout at all for delaying taking the payout until a point after the scheme NRA. So every year that pension is not taken after 60 is a lost year.
The CARES DB has a NRA of the SP retirement age but my better half and I are paying an amount each month to bring forward the NRA for that scheme by 2 years (i.e. to 66, by the time that we get to that age). There’s then a 5% reduction p.a. for taking the CARES pension before that ‘accelerated’ NRA.
@DH:
Sounds like wrt pensions you are well placed.
One thing that may not have occurred to you yet, is how your pension income places you (in due course) with regards to the HR threshold. I first looked at this many years ago and concluded it was not a worry and the erstwhile LTA was a bigger threat to me. However, since then we have had (and still have in some cases) frozen allowances, rampant inflation, and somewhat increased interest rates too. The upshot of which is I will almost certainly be a HR tax payer again when my SP commences. Thus, on pulling the plug (a bit before I turned 55) I soon set about emptying my erstwhile DC/SIPP. Paying HR to draw from a SIPP just does not seem like a good move to me, and in such circumstances the SIPP could be seen as a hostage*. One of the few downsides with DB pensions (inc the SP) is they have very limited (and in some cases zero) payments flexibility.
Just a thought.
*Personally I have no interest in the IHT aspects of SIPPs and have never believed they will be around long term anyway.
tbh I hate paying HRT and within the AA constraints of the DB PIA I pay as much as I am allowed to under the AA into the SIPP to partly ‘neutralise’ the HRT.
I’ll be screwed here if Rachel Reeves gets rid of HR relief on pension contributions.
When I retire at 60 (or part retire) I plan on taking the max 25% as PCLS which, even with the SP added from age 68, will still leave me around £10k p.a. short of the current HR threshold. I plan on using SIPP flexi drawdown from age 68 to ‘use up’ that last 10k of the Basic Rate.
As I’ll otherwise have £22k p.a. of ‘unused’ BR from ages 60 to 68 I’m considering going PT instead of fully retiring at 60, but FT earnings are now just under £80k p.a. and the minimum PT working allowed presently for my work is 0.4 FTE. So going to 0.4 FTE at 60 would put me into HRT again.
I’m hoping that in the next decade the policy changes at work and they’ll allow part retirement on just 0.2 FTE / 1 day per week PT working. That would use up £16k p.a of the £22k p.a. gap, which is near enough.
@DH (and @Al Cam)
I have the dubious distinction of most likely being the person thought of by Al Cam when he talks of a SIPP being a hostage. I am considerably older than both of you and have been drawing my DB and state pensions for over five years now. Like you I thought I had plenty of headroom between this income and the HRT threshold. However, PCLS (from my DB AVC and a Section 32 DC policy) and an inheritance produced a considerable amount of unsheltered funds that will take some years to get into my ISA. I even foolishly continued adding £2880 pa to my SIPP to try to shelter as much as possible.
In the meantime the reduced dividend allowance, high interest rates on unsheltered cash and high inflation resulting in inflation-linked increases to DB and SP have brought me much closer to the frozen HRT threshold than I ever thought possible. I am now in the position Al Cam describes where I am unable to access much of my SIPP without paying HRT. I do still have the PCLS from this to access unless Rachel Reeves closes off this path. I am reluctant to take preemptive action on this as it will only add to my unsheltered funds and create more taxable income.
@DavidV (#55):
Thanks for popping by and adding your cautionary tale. It is always just so much more impactful to hear these things from source. As I mentioned at #53 this situation sort of crept up on me even though I initially assumed it would not. I was going to reply accordingly – but your story makes the point very clearly.
@DH:
A lot can (and will, I should imagine) happen between here and your likely retirement age. If my and David V’s experience is anything to go by, the majority of any future [pensions and tax related] changes will, one way or another, possibly work against you. An area to monitor/watch carefully.
One explicit thing I should add to DavidV’s reply is that I did overlook (initially at least) the exact inflator used and the impact of differentials in uprating, assuming (presumably CPI) indexation will at some point be re-introduced to allowances, tax bands, etc. For example, with the triple lock, the SP is guaranteed to always rise by at least CPI, but the increase has often exceeded CPI. The details of all your DB pensions revaluation and indexation approaches could also be important; for example do any of these use RPI or even RPI and/or CPI plus? OTOH, any caps imposed (such as, say LPI to 5%) might reduce this effect. And, of course, the impact of any further career progression and/or pay increases. Over ten years any such differentials and/or pay rises could chip away, possibly substantially, at your presumed headroom.
Am I to correct to infer:
a) that you (and your OH) can each only retire once from your DB scheme (that comprises both a FSS tranche and a CARES tranche, albeit they have different NRA’s)?; and
b) the PCLS you refer to in #54 is from your SIPP
FWIW a) above applied to my DB scheme too; albeit it does have both early retirement and later payment factors, ERF’s and LPF’s. Having said that, you are not the first person I have spoken to who has described a DB scheme with no LPF’s.
Re b) at any given retirement age, the only way I know of managing a DB scheme taxable payout is via a [voluntary] lump sum payment – but often the commutation factors (CF) used make this route IMO rather poor value for money. FWIW, I took the full 25% PCLS from my SIPP but only a very small PCLS from my DB scheme, which at the point of my retirement happened to be using about acceptable CF’s in the sense that the scheme would still win gross but I would be about OK net at BR.
@DH:
For some additional context, DavidV and I have discussed this HRT issue several times over the last few years, see e.g. https://simplelivingsomerset.wordpress.com/2024/04/11/vanguards-cautionary-tale-hidden-in-plain-sight/#comment-42631