What caught my eye this week.
When I finally secured a huge mortgage to buy my London flat in 2018, I confided to a friend that I was excited but also nervous, because for the first time in my life I could go bankrupt.
My friend thought that was crazy talk. He knew I had enough in liquid investments – albeit mostly in ISAs, which I didn’t want to touch – to pay off the mortgage outright if I had to.
Maybe I was just trying to get out of buying the next round?
But I was dead serious and it wasn’t even difficult to imagine a scenario in which I lost everything.
A once-in-a-hundred years recession. Stagflation. Interest rates soar and the housing market collapses. The stock market crumbles – and my active investing does worse. Perhaps I try to trade my way through the unprecedented chaos and blow up completely.
After a few years of this I get ill and find it hard to work.
I’m in negative equity. A 1930s-style crash has toasted my shares. I’m spending the last of my savings to keep the lights on.
One day I update my spreadsheet on a now-ancient laptop and it shows I have a negative net worth.
The sort of thing that has happened to people throughout history.
All too plausible.
For whom the bell tolls
Of course I didn’t judge that my utter ruin was very likely. I’d hardly have bought with a mortgage if I thought bankruptcy was a 50/50 coin toss. Not even at 95/5 odds.
However I did see it was possible. Indeed I felt this new risk entering the fringes of my sense of self, like icy fingers reaching out from various potential futures. If I strained my imagination, I could almost see the hypothetical disaster lands in the distance – like Frodo and Sam seeing the smoke of Mordor from a sunny green hill, long before they get there.
This visceral reaction was not surprising to me. I’d always hated debt.
I’ve noted before that I’m pretty sure taking out the mortgage tilted my active investing. Particularly in 2018, when I was first getting used to having debt in the picture.
2022 felt much worse than previous bear markets, too. Previously I almost whistled through those.
When Liz Truss drove the ship straight into an iceberg – just as I was coming up to remortgage – I wasn’t whistling anymore.
There’d still be a long way to go, but I knew that any march towards one of my worst-case scenarios would start something like that.
“I wouldn’t risk it”
In my experience most people don’t think this way.
Rather, they see things as pretty binary.
People will take out a mortgage because they have a job and they can meet the payments. This makes the mortgage ‘safe’.
Or they won’t take out a mortgage because they are worried about what would happen if they lost their job, and house prices fell. Mortgages are ‘too risky’.
Of course, savvy Monevator types like us know both things are true, right?
Well yes – but then consider all the debate we have whenever we discuss paying off the mortgage versus investing.
I’ve been called an idiot who shouldn’t dare to blog about money for having a big mortgage while I’m also investing. At the same time I’ve been chided for being wary of leveraged ETFs by none other than Monevator contributor Finumus.
Or you’ll discover that those same people criticising me for preserving my ISAs while running a mortgage also have pensions and a big mortgage themselves. They are just bucketing differently to me.
The thing is, everyone is right!
Risk does increase expected returns.
At the same time risk increases, well, risk.
And not only along a smooth spectrum either, where riskier things are more volatile but if you ignore the noise you’ll be okay.
Also in a very Old Testament sense, where risky things can kill you.
Risk in the moment
Morgan Housel illustrated this brilliantly this week with a series of graphs. I won’t pinch them all (please read his excellent post) but here’s the gist:
The black line represents anything volatile. It could be the stock market, house prices, your income, your health. Perhaps a blend that represents how things are going for you right now.
The red lines are tolerance bands introduced by debt.
How much can you take?
It’s a notional concept – obviously if the stock market soared, say, that wouldn’t directly hurt someone just because they had a mortgage – so don’t take it literally.
Rather it shows how debt is narrowing your window of resilience.
Particularly if you have a lot of debt:
This is a great illustration for how I think about the interaction of debt and risk.
Go and read Morgan’s post for the full picture.
What doesn’t kill you can still kill you
Even a lot of debt and tough times won’t kill you if things go your way.
And milder brushes with danger are soon forgotten.
It’s 2024 and Liz Truss is now just a writer of comic novels. (Or biographies or political treaties, I’m not sure which). As things turned out I was able to remortgage for 4.49%, not 8-9%. And my portfolio has healed.
But there are worlds where those things didn’t happen. They got worse than merely wobbly for me.
Meanwhile, my friend from the 2018 chat is now more nervous about money than he was back then.
What has always seemed to me a gung-ho attitude serves him well in business. He’s a far better entrepreneur than I could ever be.
But yoyo-ing towards the fringes of an eight-figure net worth and back as private markets boomed and bust over the past few years has taken its toll.
Interestingly, he paid off his mortgage a few years ago, when times were especially rosy for him.
Perhaps he was thinking about more than just my next round when we had that conversation, after all?
Have a great weekend.
From Monevator
The decline and fall of a buy-to-let empire – Monevator
Correcting market failure – Monevator [Mogul members]
From the archive-ator: Adrift in the vastness on the way to FIRE – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
“I am moving – that is it”: tycoon speaks out about the end of non-dom tax status – Guardian
Slowdown in US jobs market revives rate cut talk – BBC
Five ways retirees are cashing in their pensions: latest FCA data – Which
£27bn Paddy Power owner Flutter to move its primary listing to New York – Independent
Young American’s wealth grew by 50% over the past four years – CNBC
Ireland reaps €700m Brexit bonanza from customs duties – Guardian
Brexit means Poles will be richer than Britons in five years, says Tusk – Telegraph via MSN
Buying a first home is even harder when you’re single – BBC
Products and services
Virgin Money offers unique 10% interest switch incentive – Which
Santander joins rivals in increasing mortgage rates [Twice!] – This Is Money
Get £200 cashback with an Interactive Investor SIPP. New customers only. Minimum £15,000 account size. Terms apply – Interactive Investor
Britons cashing in on high gold prices by selling gold back to the Mint – This Is Money
Mortgage rate switches explained – Be Clever With Your Cash
Transfer your ISA to InvestEngine by 31 May and you could get up to £2,500 as a cashback bonus (T&Cs apply. Capital at risk) – InvestEngine
M&S versus Waitrose: how do the upmarket grocers compare? – Which
Fractional home ownership is taking off in the US – Wired
Netflix forces Basic customers to change subscription – Be Clever With Your Cash
Remote coastal homes for sale, in pictures – Guardian
Comment and opinion
UK inflation: From too high to too low? [Search result] – FT
Gen Z aren’t lazy, they just know work doesn’t pay – CityAM
Whose tax is it anyway? [US taxes but interesting] – Of Dollars and Data
The fight or flight response and how to overcome it – Vanguard
Many young American women dream of being DINKS, not mothers – Fortune
Why is it so hard to talk about money? – Guardian
Queue with the peasants – Fortunes & Frictions
The pandemic’s aftermath is driving slower disinflation – S.A.H.M.
In my absence – Humble Dollar
The Quietly Saving blog is now 10-years old [Congrats!] – Quietly Saving
When to retire mini-special
My perfect daze – Humble Dollar
Can you afford to retire early? [Search result] – FT
Want to enjoy retirement? Consider delaying it – Bloomberg via AP
Adventure before dementia – Can I Retire Yet
You’ll need to work longer but will be forced to retire earlier – Random Roger
Naughty corner: Active antics
Berkshire after Buffett: can any stockpicker follow the Oracle? [Free to read] – FT
“Your fund is under attack” warns Blackrock as activist targets discounts – Bloomberg via P&I
Beware of benchmarks distorting your process – Klement on Investing
The curious case of catalysts – Behavioural Investment
Kindle book bargains
The Great Post Office Scandal by Nick Wallis – £0.99 on Kindle
Number Go Up by Zeke Faux – £0.99 on Kindle
Elon Musk by Ashlee Vance – £0.99 on Kindle
Chums: How a Tiny Caste of Oxford Tories Took Over the UK by Simon Kuper – £2.89 on Kindle
Environmental factors
Workers at the UK’s last coal-fired plant prepare to say goodbye – BBC
Microsoft signs deal to invest $10bn in renewable energy capacity for data centres – CNBC
Animals in the Galapagos live amid mounds of plastic waste… – Guardian
…could bacteria-infused self-destructing plastic help? – BBC
Let your garden waste rot in the soil – Guardian
London commercial property mini-special
The (almost) radical rebirth of King’s Cross – Guardian
Canary Wharf sees nearly £1.2bn slashed from property values – Reuters via Business Times
US spending on London commercial real estate rebounds to eight-year high – Reuters via LSE
Strongest rent expectations for prime London office rents since Q1 2016 – FMJ
Off our beat
The man compiling the UK’s rail-based walking network – Guardian
Beachcomber finally finds ‘holy grail’ Lego piece from spill 26 years ago – Independent
Seven rules for happiness – Scott Young [h/t Abnormal Returns]
Airpods are really a subscription business – Sherwood
Brooklyn’s bard: Paul Auster’s fiction captured a generation [RIP] – Guardian
Britain is not a sicknote nation, but a sick one – The Conversation
Wounded orangutan seen using plant as medicine – BBC
And finally…
“Ask the questions you need to ask, admit without apology what you don’t understand, and do the work to learn what you need to learn as quickly as you can.”
– Bob Iger, The Ride of a Lifetime
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One small addition to ‘products and services’ that might interest some: HL will refund £100 of trading costs for trades made by 21 June. Handy for anyone that already had some trades in mind.
Typo alert: Freudian “ouch” in second paragraph.
@ChesterDog — Ouch indeed! And I’ve sent the email 🙁 Thanks for the spot!
Debt-and the handling thereof is hardwired into your personal gene computer-self realisation helps one to then set your investing course and asset allocation etc
Bankruptcy and the fear thereof (that useful word again!) doesn’t seem to upset our American cousins nearly so much -almost regarded as a learning experience on the long investing road-another cultural difference!
xxd09
Debt is a funny thing. In the nineties I was paying my mortgage down as quickly as possible whilst planning a startup. I guess there was only so much total risk I could bear.
Thanks for the article. Yeah, if I had worried less and been less conservative I would have been better off. I reckon if you get your cash flow right and can protect that then you can worry less about the balance sheet side of things.
But yep, drawing down ISA’s is HARD so no judgement there.
Take it you didn’t buy Liz Truss’s book ? Just askin’.
The problem with leverage (paraphrasing Munger & Warren B) is it can interfere with the process of compounding. Nothing should interfere with that. When @TI covered the topic of “Taking more risk does not guarantee more reward”, back on 15 August 2018, @Naeclue (#30) summed up nicely why time in the market and giving time to compound matters so much: “Stock market returns can be approximated by a lognormal distribution in which the standard deviation (volatility) grows with the square root of time and mean return grows exponentially. The result, is that the variation in rate of return outcomes from stock markets narrows with time. To put some numbers on it, if we assume a real mean annual growth rate of 5% and annual volatility 15%, then after 1 year there is a roughly 2 in 3 chance that the growth will be between -9% and +21%. Quite a big range. After 4 years the mean growth would be about 22% and volatility 15% times the square root of 4 = 30%, leading to a 2 in 3 chance of the observed growth rate being between -1.1% and +12% [p.a]. After 9 years, the volatility goes up to 45%, with a 2 in 3 chance that the observed growth rate will be between +1.9% and +8.7% [p.a.]. After 25 years there is a 2 in 3 chance that the observed growth rate will be between 4.3% and 6.2% [p a.], even though volatility has risen to 75% (15% times square root of 25) [for a 186% to 350% total real return]”. If getting margin called, or worse going bankrupt, risks interrupting the time that is needed to realise the expected return, then it probably isn’t worth reaching for the prospect of ‘extra’ returns which using leverage might bring.
I’ve been bankrupt (nw zero) 3 times: in my late 20s, mid 30s, and mid 40s. Incredibly, no debt involved! Bad luck, unfortunate timing of employment and migration, missed job opportunities, missed employer-match / auto-enrollment etc. It obviously hits harder later in life with fewer years remaining to work with.
@xxd09 America’s system of fixed rate finance with the guaranteed right to refinance provides a fantastic one-way ratchet on the rate. Anecdotally a lot of people will take a big mortgage, expecting to refi into a lower rate sooner or later. Plus that other right to just hand over the keys with few repercussions if necessary.
I still remember as a six year old nipper sometime in the late 1960s hearing my German great grandmother describing to my mother what losing the family’s life savings twice was like.
My former rugrat self spoke no German, but the tone colour stayed with me, I could hear that something very intense had gone down though I didn’t understand the words. My mother summarised and simplified the gist afterwards. Many decades later I can still see the golden late summer in the grounds of the care home and recall that tone colour. That trauma echoed across generations – when I went to Germany on holiday in the 1990s expecting to use my credit cards – Nope. Germans didn’t do credit cards in any big way then, just didn’t trust it.
I had to use my eurocheque card, and failed to realise I was paying about £2 a transaction, I should have drawn a big wodge of cash from ATMs and used cash. I think they’ve gotten over that trauma now, enough time has passed.
So yeah, ruin is a big deal. For many years I railed against my pussycat former self that discharged my mortgage before the GFC, the twit, when investing the same into pretty much anything would have been a big win. I have mellowed as I got older, I still don’t believe in the EMH and I didn’t take a passive path. But your risk tolerance is dynamic, and it was tough enough to grab one hand with t’other and invest into those dark days of 2009. Doing it leveraged would have been the rational case, but doing that from a point of weakness in other areas, no. Instinct was wise though not technically correct. There is a lot of peace of mind in a paid off house, and in particular in owing nobody any money at all.
Morgan Housel’s illustration is nice, but it was Naseem Taleb’s Antifragile that explained why debt clobbers you that way, makes you fragile in his taxonomy. I had gathered that instinctively, but it was good to know why.
@ermine (#9)
Re: “There is a lot of peace of mind in a paid off house, and in particular in owing nobody any money at all.”
Amen to that!
On a very brief initial read of the FCA data linked in the Which article, “Five ways retirees are cashing in their pensions: latest FCA data” what jumps out for me is the continued drop in the sales of annuities from 2021/22 to 22/23 when increased yields have resulted in inflation protected annuities having payout rates comparable to or exceeding ‘safe’ withdrawal rates. The ‘annuity puzzle’ continues!
ps A further possible typo, whatever Liz Truss is writing (and I don’t think I will be buying it even if/when it is offered at 99p on kobo) it is more likely to be a political treatise not a political treaty.
@Alan S #11
It’s a dirty old job but somebody’s gotta do it. The Annuity puzzle is perfectly explained by middle class parents wanting to featherbed their nippers, pensions are outside the estate for IHT and the news is spreading. The sooner we follow the American example with a required minimum distribution post 70 the better IMO, evading IHT is not what the pension system is designed for. This was an unforeseen side-effect of Osborne dropping the requirement to buy an annuity to use a DC pension
@ermine (#12).
I’m with you ermine. DC pensions have become part of estate planning. Not what they were intended to provide. It is both illogical, and unstable (but then that is pretty much a definition of our tax law in the UK!).
@ermine (#12)
I’m not entirely convinced that it is down to IHT since fewer than 4% of deaths attract IHT (2020-21) and much of the literature on ‘the annuity puzzle’ is US based where estate tax has much higher thresholds and, consequently, an even lower (0.2%) fraction of estates pay it.
I’m no expert on tax, but the key age of death in terms of what happens to left over DC pensions/annuities etc. in the UK appears to be 75 (which is a more abrupt transition than the US RMD approach).
Just read the article about the nom-nom guy and all I can say is good riddance. If he isn’t paying tax then just how much is he contributing by being here (other than inflating the cost of property in London).
I’m also somewhat pleased that his £350,000 contribution to the Tory party didn’t buy him what he expected.
@ermine (#12)
Thinking about it, the reason most retirees don’t buy an annuity is because they don’t need one beyond the one they already have – i.e., the state pension.
For example, for a couple each with a full state pension have an inflation linked floor of about £23k. If they have a combined pension pot and savings of about £100k (in the latest FCA data, the average pension pot accessed for the first time was about £57k), they could get an inflation linked £3500 per year from drawdown which means the floor is about 87% of their total income of £26.5k (if they chose a 4% constant percentage of portfolio, historically, 80% of withdrawals would have been somewhere between about £2k and £7k in real terms, i.e. total income from about £25k to £30k- this variation can be tamed to taste, e.g. using portfolio smoothing or Carlson’s endowment formula, etc.). There is probably no strong financial case to purchase an annuity (except that annuity rates are a bit better than safe withdrawal rates).
For a pot of £500k (only about 10% of pots were larger than £250k, so this is well above average), inflation linked drawdown would have been about £17.5k for a total income of £40.5k (dynamic withdrawals might have delivered between £10k and £35k for a total of somewhere between £33k to £58k). The flooring forms just over 50% of the total income and so, again, there may be no compelling financial case for an annuity.
@Alan S I’d agree with you in the case of the £100k combined against a SP, it’s the larger amounts I was thinking of. It is possible that I have been spending too much time with the Telegraph which has become an AI bot hollering all tax bad but especially IHT bad, but I do think the estate planning is an influence on the larger DC pots.
Annuities come with much weird mental baggage for many. I had to garnish the truth somewhat with my mother when the SOLLA IFA advised putting a fair amount of what she had to a PLA. We had to describe it as insurance, because an annuity was just a no-no, she wouldn’t have the thought. It was an insurance, against living too long. She got a ropey deal as it happened, but by definition she wasn’t going to find that out!
I have some of the same pathology, I am not yet SP age. But I haven’t touched my ISA, though I have burned down my more modest SIPP to the ground in the gap between retiring and taking the DB pension at almost the normal retirement age in the industry. Because the annuity that is my DB pension is enough to live on and then some. Which is a little bit mad. I have spent some of the last couple of weeks visiting someone in hospital and when you see the fragility of life hanging by a thread in critical care with all the monitors and tubes it does make you think. In some ways an annuity purchase gets you to spend more rationally and measured way across the lifespan, assuming you have some basic working capital for emergencies and the odd non-annual luxury.
The trouble with an annuity is that it makes you think about your own death in a very straight-between-the-eyes way. And people just don’t like doing that. Myself included 😉
@Alan S (#16):
Good point, well made.
OOI, what percentage of income need do you think people should try to floor?
And does the target flooring percentage possibly vary with the income need – ie target flooring %age reduces as income need increases above some certain threshold.
Thanks in advance for any thoughts you have.
@Al Cam (#18)
Most of the work I’ve seen (e.g., Pfau’s book, Zwecher’s book) targets ‘core’ expenditure (or ‘essential’ – depends on what you want to call it) as the floor which, of course, will vary from one retiree to another. I think there are several factors:
1) ‘Core’ and ‘essential’ expenditure (‘lifestyle’)
2) Simplicity
3) Willingness to take market risk
4) Couple or single
1) For couples, the state pension covers a ‘minimum’ lifestyle (e.g., see https://www.retirementlivingstandards.org.uk), so if that’s a satisfactory living standard then there may be no need for more flooring. However, for a ‘moderate’ lifestyle (£43k according to the PLSA, although I note that the Which survey has a middle lifestyle at £28k but that is from their 2023 survey – so add another 10%, i.e., about £31k ), so retirees aiming at this might want a bit more floor than just the state pension.
2) Having money turn up on a monthly basis with no effort and little worry will be attractive to some. Whether this comes from state pension, DB pension, annuity, or linker ladder, the prep is all upfront. For those worried about cognitive decline (and that may be many of us!), this is also an attractive part of flooring.
3) This one is complex, since the presence of flooring both allows more risk (i.e. higher stock allocations since variability in portfolio income is less important) and less (since the ‘game’ has been won).
4) It is particularly difficult for a single retiree (who was part of a couple) since the floor from the state pension will be cut in half (this will be true for some DB pensions too), while lifestyle expenditure is greater than half of that for a couple.
One way of dealing with the level of uncertainty is to draw up a table of consequences of the retirement plan (i.e., a list of ‘what ifs’). For example, if the market is not kind and portfolio runs out early or withdrawals become very small, will I/we be able to manage on the income from the flooring? Drawing up a list of ‘what ifs’ can be quite unpleasant (as alluded to by @ermine, #17), but at least identifies potential problems.
@ermine (#17)
You’re right that for larger pots, annuity purchase is more nuanced – IMV, a RPI linked one should be at the least considered for various reasons (some of which are in #19) even if then rejected. It is sometimes interesting to read the discussions at bogleheads where some posters treat insurance companies as the spawn of the devil (although I think the UK industry is somewhat more staid and regulated than the US one). I think one big problem is the ‘hit by a bus after leaving the broker’s office’ scenario which in the imagination trumps the ‘running out of money’ at 90yo (after all, who can imagine ever being 90!) – however, in reality the cost of guarantee periods is not that great for RPI annuities or, sort of equivalently, term life insurance.
The other problem is that people underestimate how long they are likely to live (e.g., see https://www.ftadviser.com/pensions/2024/02/13/underestimating-life-expectancy-huge-challenge-for-pensions-industry) so underestimate the likely total income from an annuity. They also underestimate the effect of a prolonged period of poor real market returns (doesn’t have to be spectacularly bad, just persistently poor) on their portfolio, particularly as the last decade or so has generally been kind.
@ Alan S (#19 & #20):
Thanks for your thoughts – which all seem perfectly sensible to me.
I think there are probably a few additional factors at play in #19, namely:
5) Need/desire to leave a legacy;
6) For early retires: the period(s) until DB and/or SP turn on;
7) At the point of retirement, the ratio of the Pot [realistically available* to fund the retirement] to your foreseen annual expenditure; and
8) Reserves (or if you prefer your risk budget).
Both Zwecher and Milevsky make the point that the higher the ratio of means to need (#7) then the more sustainable the plan. Consequently, above a certain level of means to need, flooring does not improve the sustainability of the plan. Interestingly they somewhat disagree on the actual threshold with Z implying both 29 and 33 and M mentions 40 – both, IIRC, for the US market. Also, I would imagine few folks in the UK have no flooring entitlement.
Another fairly obvious consequence is that flooring >100% of the need could be seen as wasteful.
My own experience of early retirement is that it is hard to define the need in advance – even with many years of historical information. Furthermore, all the regular categorisations of spending (Ess/Des, etc) are not in reality terribly helpful – but, at best, might be an aid to planning prior to pulling the plug. If possible I would suggest one adopts as flexible an approach [at the point of retirement] as possible and finesse it as you go along as and when you gain some experience and/or insights. That is, avoid locking yourself into anything as long as possible; and learn to value true reversibility.
*there being no point in including any assets that you are not fully prepared to liquidate
@AlanS #20 > people underestimate how long they are likely to live
Yep. I’m trying to work out if I am that guy. Probably. Mrs Ermine may appreciate it 😉
Trouble is, it is hard to square with experience. In my childhood, adults often were seriously infirm by 45. These were blue collar manual workers, both musculoskeletal stuff like rheumatism and arthritis, and respiratory grief – the end of TB but some smoked like chimneys, London was not a healthy place in the 1960s/70s. Then there’s the biblical three score years and ten. And Covid, which did seem to paste a fair number before their time. Your link would indicate* I can expect to die at 80, indeed it’s getting worse, 78 now. Did Covid take years off my life though I am still standing? I’m not surprised that people struggle to make headway against these confounding elements.
* I am aware that life expectancy and birth != life expectancy at a more advanced age 😉
Interesting comments re funding retirement.
We will each have just one experience of retirement, with a lot of what ifs.
Since retiring in my late 40’s in November 2007, despite an immediate significant market fall, with an equity heavy portfolio, it has worked out well….so far.
Inflation adjusted spending has increased by 50%, but the original level of spending was actually quite generous and we could revert to that level without significant difficulty.
The portfolio has risen by 100% in real terms over 17 years.
The risk of failure has clearly dropped, more funds, less years to fund, the uncertainties remain, with one parent having made it to 99 and the other one still going at 98, perhaps the years to fund has not declined as much…
Having a plan , a fallback position makes sense but its not risk that we need to worry about, but uncertainty, the things we cannot predict or assess the likelihood of occurring.
@HS (#23):
Interesting – I bet your earliest years were a bit hairy?
Agree 100% with path dependency.
A couple of further Q’s if I may:
a) is all of your portfolio growth organic or did you have any “injections”, such as, say, an inheritance or some periods of paid work over the last 17 years;
b) I would guess you must be around your SP age – is that about correct
Lastly and fwiw, risk/uncertainty/unknown unknowns – shxt happens whatever the lingo!
@Alan S, Al Cam, ermine, HS – I agree with most of your points about the hard floor, particularly the idea of leaving your options open as long as possible. I am considering delaying the purchase of an annuity for part of the hard floor as long as possible.
There is one small detail related to annuities that hardly gets mentioned. Even with the government guarantee, it is in a sense a concentration of risk in one company, one country, and one government. Just because there is no known case of annuity failure, it does not mean it will never happen. It seems to be a hidden risk that is just not being considered. At least with market portfolios, you can easily diversify geographically, by asset class, by fund provider, and by platform.
@TBDW:
I thought the standard mitigation to this risk was to split your annuities across two or more unrelated providers. Granted, who knows how long they would remain independent!
Over-flooring is a real possibility! I did it in my Gap, and I would suggest @ermine has possibly done it by holding off taking his DB to NRA. @HS hints that he had the same underlying issue, namely: over-estimating his initial need on pulling the plug. OTOH, I am sure there are cases of the other side of the coin – where folks have under-estimated their initial need.
One thing is for sure though, as life evolves things will change and they will keep on changing too! Accepting this might just be the answer – ie remain aware and flexible. In reality, there is much more going on hereabouts than just nice tractable numbers!
@Al Cam – Yes, this is another great point: things will change. So I think it makes much more sense to do the flooring as late as possible and in stages rather than all in one go up front. Doing it in stages might even reduce the need to have an inflation protected annuity.
As to using different annuity providers, I agree it will diversify a bit but there is still the concentrated geographical risk with one national government guarantee only that might not be honoured. As you wrote: things will change. And that should hold for whole nations and societies too.
Thanks for the shout out! Also means I’m celebrating ten years of reading Monevator, so many thanks for all those years!
@al cam
Sequence of returns in 2007-2009 writ large !!!
Oddly enough the major market falls did provide opportunities.
No significant injections of capital since retirement 2007 to 2023 and yes State Pension is due this year.
Whilst I have worked part time since 2009 doing what I would have liked to have done at 17, it didn’t make any money at all, it didn’t lose any but I congratulated myself at being to recognise a duff career path at 17…
There was a small inheritance very recently, approx 2 ½ % of net worth, is that a significant amount ?
@HS (#29):
Thanks for the additional details.
IMO your journey since pulling the plug would make for a great fire side chat. Failing that, a graph of how your real Pot developed from pulling the plug to today would, I imagine, be quite fascinating.
That you retired [early] into the GFC but seventeen years later as you are about to pick up your SP your real annual spend has increased by 50% and your [real] Pot is twice as big (as when you retired) is very eye catching!
I suspect your [real] Pot today must therefore be around four times what it fell to not long after jumping ship.
I assume you grew your annual spend as your Pot grew because you could afford to do so. OOI, how did you actually do that and did you find it easy to do?
@al cam
Underlying spend does grow, with extensive travel being the main driver, but I suspect it could be reined back without too much of a struggle, Covid demonstrated that spending could be reduced dramatically and in fact the quality of life did not decline.
The big takeaway is that if you are lucky the original withdrawal rate falls significantly over time, the sequence of returns issue feels scary but opportunities opened up to gain from the experience. ( Investment trust discounts widened to a crazy extent and significant growth followed..)
Equally you can do the right things and it may not work out, its very path dependent but I always had the dreaded option to go back to work as a fallback…
@Hariseldon (#23, 29, 31) – I found your comments and experiences very interesting. I departed the world of employment at the end of 2022 at a similar age as you were back in 2007. Also, with an equity heavy portfolio. My story was featured in a Fire-side chat in Feb 2023 (domestic geo-arbitrage made it possible) and then again in a catch-up chat in Jan 2024 (rekindled: a year in the country).
Sequence of returns risk is a heavy consideration for a lot of people especially in the first five plus years. If you don’t mind, I have some questions for you as follows:
What kind of percentage falls did your net worth suffered in year 1, 2, and possibly 3?
How long did it take for your net worth to recover to the same level as November 2007?
Was your spending in those first few volatile years of de-accumulation covered by cash? (i.e. you were not a forced seller of equities in a falling market)
Did you take any action such as buying, selling, revising the portfolio allocation, or were you able to stay on your chosen path at that time?
How did the worst-case scenario relating to Sequence of returns risk happening to you affect you mentally? For example, did you have sleepless nights, were you continuously anxious about the situation, did it feel like you had made a mistake, did you consider going back to work?
Has the makeup of your portfolio changed over the 17 years, are you still heavily invested in equities?
I appreciate that I have asked a lot of questions (I do have more!). I am genuinely interested as I am only at the beginning of my de-accumulation journey, and I can see some similarities in our stories.
Been deaccumulatng now for 21 years now -aged 78
Investment portfolio was required to produce 55% of post retirement income @3.2-3.5% withdrawal rate
Done the job so far
3 index funds only -asset allocation was 30/70 equities/bonds at retiral-now 34/60/6 where 6= 2+ years of living expenses
Total return gone for-ie sell required number of fund units once a year to top up living expenses account maintaining Asset Allocation
If you have a mixture of ISAs and SIPPs then aim to have equities in your ISAs and bonds in your SIPPs
By definition you will mostly be selling equities- if equities in ISA then frequent years of tax free income
All very personal however-did I save a lot,did I keep my expenses very low(Total running cost of a low 7 figure portfolio is 0.27 basis points) and did I live frugally-probably-these last 3 factors being under the investors direct control
However the stockmarket without any help from me must get the most thanks!
Portfolio a good deal larger than 21 years ago
So far so good!
xxd09
@Jake (#32):
As HS says it is very path dependent.
For example, my own Pot* recently hit a nominal high. However, the real (CPIH adjusted) trajectory is rather different. Since I pulled the plug at the end of 2016, my real story goes as follows:
a) all time [real] high hit in Jul ’18;
b) notable, short sharp dip at the start of 2020 but never really threatened to drop below CPIH;
c) quickly recovered most of the lost ground to hit the next highest real point in May ’21;
d) after which all real gains [vs CPIH], and more, were progressively surrendered;
e) first dipped below real Dec ’16 value in Jun ’22;
f) hit real bottom [to date] in Apr ’23 at a handful of percentage points below Dec ’16 value;
g) since when I have crawled back to a handful of percentage points above the real position immediately prior to my pulling the plug
The Pot funded a significant fraction of our lifestyle until about a year ago when I commenced my DB pension somewhat earlier than I had initially planned.
* with an allocation to equities more akin to xxd09’s than HS’s
The point being it was not a bad sequence of returns in the first five years that knocked me back but rather rampant inflation that really began to take off more than five years down-stream. There be many dragons!!
@Jake
The fall was fairly brutal, around 40%…I had some external cash coming in to a portfolio that was 95% equities…Oddly enough I was not unduly concerned, I assumed that it would right itself at some point, it did, with hindsight that was probably naive in the extreme, perhaps an inner defence mechanism !
I had previously had a superb experience with equity income investment trusts, had dabbled extensively with a HYP collection of individual shares, I baled out in April 2008 before much damage was done. There was a lot opportunities in good investment trusts with extreme discounts, this was very helpful indeed. I had fully recovered by April 2011, there followed 4 years of returns around 15% after living costs deducted.
An investment approach can work for a long time…until it doesn’t , the lesson was that it probably won’t work again for a very long time.
It worked out, lessons learnt now that the portfolio is large enough for a burn rate of 2% or so is to add a defensive allocation to bonds of about 30%, to cover 15 years plus of living at a very comfortable standard. The equity portfolio can be left alone to look after itself now!
Bonds do need a little maintenance and I was able to avoid significant harm in 2022 by keeping duration very low and some indexed bonds, tips and linkers.
Whilst my equity portfolio is pretty much left alone and is largely index funds/ETFs, I have been fairly active managing bond index funds to reflect developing circumstances, I am aiming to manage the portfolio in the future by means of a checklist, that will be interesting !!!
@HS (#31):
Thanks very much for the additional details.
I see now where you are principally coming from re growth in your spending.
I’m pretty sure our spending is creeping up too (and not just vs Covid times either) – but it is a bit too early to be definitive about this.
For those of us lucky enough to survive the lurgy IMO it should have taught us all loads of things. However, in general, it strikes me that an awful lot seems to have been forgotten already – which is bit of a pity, but perhaps not a surprise!!
Re going back to work: I know what you mean, but ultimately that option will expire, if it has not expired already. FWIW, I did turn down a couple of well-paid unsolicited offers.
@Al Cam (#21)
Thanks for your thoughts too – with 8 different parameters, I’m fairly certain that optimising the flooring level (sort of where we started the conversation) is difficult or, probably not even possible. But I’d agree that too much flooring is wasteful (a position I will ‘enjoy’ when our state pensions kick in)
To take a much simpler optimisation example, Milevsky and Young’s seminal paper on the ideal age at which to purchase an annuity came up with the result that everyone remembers that deferring to sometime in your 80s was optimal. What people forget is that
1) The optimal deferral period was strongly dependent on risk aversion (the optimal age was lower for those with high risk aversion) and ranged from mid-60s to mid-80s.
2) That even with the optimal deferral, the total income was lower in about 35% of cases. Doing a similar analysis with historical data I found that deferring typically meant the worst retirement periods got worse.
3) Although I’ve never exactly repeated their work, I suspect that changing the relative or absolute value of the risk free rate (6% in the paper) and stock returns (12% with 20% variance) might also shift the optimum purchase age.
The worst problem with deferral was when the real value of the portfolio fell faster than annuity payout rate increased with age.
@TBDH (#27) buying successive annuities is one solution, but level ones are always susceptible to a period of high inflation (e.g. 10 years of 8% inflation – not outrageous in a historical context – reduces the real income by over 50%) regardless of when you purchased the annuity.
The retirees main nightmare is a stockmarket drop at retirement
Obviously even more so if retirement income is totally stockmarket dependent
Failure of retirement income from the investment portfolio is not an option as often human capital is all gone
The retiree to some extent is obviously in the lap of the gods as no one can predict stockmarket behaviour at any given time
The retiree however does need to have a plan to deal with this potentially disastrous scenario but live in hope that it never occurs in this particular timeframe ie at retirement-though serious stockmarket drops will occur and reoccur regularly throughout a 30+ year retirement
Classically a % of bonds added to the portfolio was the way of handling this potentially dire situation -varying from 30-70% of the portfolio-though as we saw in 2022 bonds can have their down days too along with a parallel equity drop!
Arguably bonds still do their job as they normally never drop as much as equities
A retiree having 2+ years of living expenses in cash at all times and especially at retirement is another help to bridge an potentially upsetting income drop at retirement
xxd09
@Hariseldon — If you were willing to submit to the FIRE-side chat interrogation (they are loooong pieces 😉 ) then I agree that yours would be an interesting story. It would be interesting to have a ‘chat’ with someone as hands-on and active as you were/are, and you’ve clearly been thoughtful and dare I say a bit humble about it all too. Let me know! 🙂
@Al Cam — You write:
It doesn’t sound like you need consoling as such, but anyway I was reading this week that this is apparently a very common place for typical portfolios to be sitting in real (after-inflation) terms right now.
From Trustnet:
https://www.trustnet.com/news/13413397/typical-portfolio-worth-no-more-than-it-was-in-2016
It’s an interesting article indeed, not least this bit:
Indeed. I refer readers to the answer I gave some moments ago. (Well okay, two years ago!)
https://monevator.com/is-your-early-retirement-under-threat-from-an-unlucky-sequence-of-returns/
What a rollercoaster the past eight years have been for UK investors!
@Investor (#39):
Re: “It doesn’t sound like you need consoling as such, …”
Indeed!
Very typical scenario I would imagine; although I am not sure everybody realises it – as most folks work in nominals!
I was just making the point that a big fall [peak to trough of maybe 25%] can happen for a variety of reasons – not just from a bad sequence of returns in the first five years!
@Alan S (#37):
Re: “But I’d agree that too much flooring is wasteful (a position I will ‘enjoy’ when our state pensions kick in)”
And IMO that is one good reason for taking a DB early.
I am coming round to the view that the answer to this ‘waste’ is to spend more.
And, whatever you do, do not buy too much annuity cover (real or nominal)! FWIW, I can see the case for nominal annuities if you believe your spending will decline through retirement. I suspect folks do buy too much, but so few folks buy annuities these days that it goes un-noted/un-reported. Waste is waste no matter what the VFM calculation. For some reason, this reminds me of the “it was a bargain” Monty Python sketch.
@xxd09 (#33):
Re: “If you have a mixture of ISAs and SIPPs then aim to have equities in your ISAs and bonds in your SIPPs
By definition you will mostly be selling equities- if equities in ISA then frequent years of tax free income”
Spot on use of the available wrappers – and a point often completely overlooked too IMO!
A quick Q if I may: before your SP’s kicked in what did you do with any [remaining] annual tax free allowances*
*assuming you had any remaining after ‘paying’ for the other 45% of your post retirement income not covered by the Pot
@HS (#35):
Is your estimated drawdown figure (c. 40%) and the recovery time (around 3.5 years) vs a nominal Pot or an inflation adjusted (aka real) Pot?
Principle reason for asking is that nearly six years down the line I still have some way to go to recover to my real high of Jul ’18, although I am now well ahead in nominals! I would like to be comparing apples with apples.
Also, an admittedly slightly cheeky question: do you have a plan for your “equity portfolio” and do you really intend for it to be “left alone to look after itself now” or is this what you hope to possibly ‘automate’ via your “checklist”? If so, I am sure that will be very interesting.
Al Cam
Well spotted -I did miss using the balance of my tax free allowance for a couple of years after State Pension kicked in -took my eye off the ball!–was originally in the region in my case of £3000+ pa -currently £2000+ pa -available tax free -till a poster on a Citywire forum made your exact point
Every little bit of tax free income helps!
Amateurs running their own retirement portfolios!!!
xxd09
@xxd09 (#44):
Re: “Amateurs running their own retirement portfolios!!!”
Go on, IMO you have done very well!
And, a pro would happily eat that amount (and more) in fees!
@Alan S (#19):
A problem with Zwecher, Pfau, Milevsky et al is that they all offer theoretical viewpoints – with little, if any, guidance on real-world practical implementation.
To my eyes, the best practical information about floor & upside (F&U) comes from the late great Dirk Cotton (who retired early in 2005 and sadly passed away in 2021). His blog (which thankfully is still active) http://www.theretirementcafe.com/2018/02/whats-floor.html gives IMO a particularly good summary. It might also interest you to see how Dirk changed his view about how much flooring over time too – take a look at his first answer in this post from only three years earlier: http://www.theretirementcafe.com/2015/02/pure-and-mixed-strategies.html.
Another good source of practical F&U info from a retired actuary (Ken Steiner) is available at:
https://howmuchcaniaffordtospendinretirement.blogspot.com/2021/02/building-your-floor-portfolio.html
It is worth noting that Ken’s blog has recently “retired” too.
So, AFAICT, there is no current source of practical information about implementing F&U – which is a real pity!
@al cam
The recovery time was for the nominal value not inflation adjusted.
I have inflation adjusted figures for the portfolio value ( as a net wealth total including a stake in a commercial property but not residential property ) which peaked in April 2007 and fully recovered by April 2012
The bulk of the portfolio was the quoted equity stakes, this peaked in April 2007 and fully recovered by April 2011 in inflation adjusted terms.
Because of annual figures there is a discrepancy of a year, in reality annual figures hide a much smaller difference in timing in reality, it would have been a few months.
Looking at later years the portfolio peaked in real terms in April 2017, April 2021, April 2022 and in real terms was below the 2021 peak as of April this year.
Portfolio values are volatile, it’s important to look through the noisy movements. ( in April 2020 jumped by 7% just a day after the annual portfolio valuation ) and look at the trend over say five year rolling periods.
(I have just added this rolling figure to my spreadsheet and it provides confidence… )
You might find the fact that your portfolio is below its 2018 peak in inflation adjusted terms less concerning when viewed over a rolling period.
@investor ,Thank you for the invitation, I would be happy to do the fireside chat, I have messaged you via the contact form on the website.
@HS (#47):
Thank you again for further details.
IMO, you did very well to recover [your equities] in [real terms] in four [or even five] years. I am sure I remember ERN suggesting it was much longer for a US-based [global?] passive approach.
OOI, nearly ten years ago I “discovered” that seven years was the appropriate integration period for our spending, I was never able to fully work out why [although I had a few ideas]. I suspect it may now have increased a bit too – which may just be something to do with getting older.
It is not too great a leap of logic to apply a similar approach to tracking ones Pot. However, it is worth noting that such an approach puts an enormous delay into the picture, and could, cause one to miss things going wrong with the Pot – see e.g. your comment above about “a HYP collection of individual shares”.
Re: “You might find the fact that your portfolio is below its 2018 peak in inflation adjusted terms less concerning when viewed over a rolling period.”
As it happens I am not bothered about this, as I always expected my Pot to decrease across the Gap years [from when I jumped ship] until I started my DB. That for about one and a half years it increased was just something of a bonus! Also, in real terms, when I started my DB the Pot was just a handful of percentage points below where it started out – which was also significantly better than my model predicted.
P.S. reading between your lines I assume you track these things annually around the tax year boundary. FWIW, I do it monthly and you sure do get some oddities in monthly data – but sometimes the additional resolution is helpful too. Having said that, I have never been tempted by daily (or even more frequent) tracking!
Once again, thanks very much and I very much look forward to reading your fire-side chat in due course!
@HS (#48):
Re: “I am sure I remember ERN suggesting it was much longer for a US-based [global?] passive approach.”
Please see table in:
https://earlyretirementnow.com/2020/03/18/what-kind-of-bear-will-it-be/
Recovery (in real terms) from GFC took about 5.5 years according to ERN for a vanilla total returns S&P 500 passive approach. Thus, if you were living off your Pot (ie doing some drawdowns) and did manage to recover in four or even five years you did indeed do rather well!
Worth noting the equivalent real recovery times in ERNS’ table for other notable bears e.g. 1929, 1972, 2000, etc – YIKES!!
@Al Cam Thank you for your link, interesting to read.
I find myself riding two horses, both at being 17 years into Fire and approaching ’normal’ retirement and the receipt of a state pension.
With my increased bond allocation at around 30% and the anticipated state pension/s*. I suspect my 70% equity allocation could be untouched for 20 years or so. The remaining equity portfolio is likely to be much larger in real terms after 20 years.
With TIPs yielding a real 2.2% you can create a TIPs ladder to fund retirement at a fairly attractive rate , add in an equity allocation to run alongside and be untouched for an extended period , a bonds heavy approach is very feasible.
(For UK investors there is a currency /different inflation rate issues but over time that tends to wash out , my father was drawing both a US and UK state pension for 34 years and the currency swing was visible year to year but overall not a problem. )
In fact if you plug in 2.2% real yield from TIPs into a financial calculator with a 5% drawdown you get exhaustion of the funds at 27 years. If you invested entirely in a TIPs ladder , with the famed 4% drawdown with inflation linking you’d manage 37 years.
IE a TIPs only approach to retirement is a possibility.
*Mrs Hari doesn’t receive a pension for 8 years but we have commercial rental that fills that gap.
@HS:
ERN’s stuff is usually pretty interesting. I am not sure of any UK equivalent analysis but given the S&P500 is such a major part of any global holding ERN’s analysis is certainly IMO indicative.
The bedrock of our retirement is now the DB pension. I started this about a year ago – some four years earlier than I originally planned. I strongly suspect by the time we get our SP’s we could be somewhat “over-floored” again (see e.g. #26 & #37 above) and, like you, may well finally end up with a rather large [equity] Pot. That I currently have a smaller allocation to equities does not change the likely outcome IMO. Whether we burn any of our Pot between now and starting our SP’s is not entirely clear yet either, but if we do it will almost certainly not be equities. Thus, over sufficient time, it seems likely that our equities allocation should [naturally] rise too.
OOI, do you have any specific plan for distributing/disposing of your equity Pot in due course? I ask as I currently see this as potentially a major challenge downstream – assuming we get there and the world remains moderately sane in the mean time too.
@HS (#50):
In your financial calculator calcs (PMT in Excel) I think you have opted to take the payment at the end of the year. If you were to take the payment at the start of the year (which is more conventional) your funds last approx 1 year less – which, of course, is not a biggie
@al cam
You are correct, however a regular annuity calculation is such that the payment is at the end of the period. Whilst an ‘annuity due’ is at the beginning of the period.
Being roughly right is good enough for these calculations, it’s all back of an envelope , a lot of stuff will happen between now and then.
I favour the old school method of using an HP12C calculator rather than Excel, they are very good and grew up with HP calculators of various types, I have an original from the 80’s plus a more modern version, (love that they slow down the processor in the newer one to run at the same speed as the original , such that people wouldn’t trust instant answers if it worked as quickly as it could !!!)
You can also do a lot of bond & loan calculations etc without the need to open up Excel.
There is a simulator app on iOS for the iPhone if you want to experiment, they use RPN reverse polish notation such that calculations are entered in a different order but you do not need brackets for complex calculations, again very effect once you get used to it.
@HS (#53):
Woh, that takes me back a bit! I used to use a Texas TI59C programmable calculator. Although, it must be around forty years since I last switched it on.
I am a big fan of Excel, but – out of principle – avoid using any visual basic. The thing I most like about Excel is the pre-loaded functions. I still clearly remember just how many hours it took me to program[me] Bessel functions in FORTRAN via punch cards, etc. Oh, the good old days!
Totally with you that it is hard enough to know what will happen in the next three weeks never mind the next three decades. So I agree, to quote Keynes (although others say the quote should be attributed to Carveth Read): “It’s better to be roughly right than precisely wrong”.
@Hariseldon @Al Cam
I’ve never used a business calculator and have always used Excel for financial functions. I do have fond memories of RPN on HP scientific calculators. My favoured scientific calculator app on my Android phone – RealCalc – allows the option to select RPN mode.
Came across this recently that might just help a bit with assessing the level of flooring “required”: https://retirementresearcher.com/essential-vs-discretionary-spending-planning-your-retirement-budget/
In spite of my noting at #46 above that Ken Steiner’s blog had “retired”, he has been posting occasionally.
This recent post of his contains some interesting assumptions about percentage of expenses floored and likely cost of a retired survivor scenario (vs cost of a retired couple): https://howmuchcaniaffordtospendinretirement.blogspot.com/2024/08/the-future-wont-happen-as-assumed.html
I suspect, although I cannot be sure, that his selected level of flooring is quite high (at 80%), but that may be because the scenario covers only recurring spending. IIRC, one relatively small instance of non-recurring spending is mentioned. Ken picks this point up in his next post called: Self-Insuring Your Long-Term Care (and Other Non-Recurring Expenses)