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Weekend reading: What strategy is best for retirement portfolios?

Weekend reading

Good reads from around the Web.

Last week’s Weekend Reading was about fund fees, but the comments became a – um – spirited discussion about currency risk in post-retirement portfolios.

It was an argument caused by different perspectives as much as about the facts.

A similar thing often happens when we talk about investing risk.

Often when people say one investment is less or more risky than another, what they’re really describing is transforming risk from kind into another.

In the currency debate, I noted the shortened time horizons of a retired person and the need to spend your pot in your domestic currency to meet your day-to-day living costs made currency risk more important at 65, say, than when you’re saving into a pension at 30 and can take a sanguine long-term view.

I suggested a greater allocation (note: not 100% or anything like it) to your home stock market might therefore make sense, as might hedging a portion of your overseas exposure (again, not all, just a portion to dampen the swings).

The other side bridled at the consequent higher costs – even if those costs were just a hypothetical 0.25% extra annual charge applied to just a bit of the portfolio.

The 0.25% cost was a nailed-on expense to be paid every year of retirement, they pointed out, whereas the impact of currency risk was unknown. Better to risk a bigger hit to your retirement income from currency swings than to guarantee a modest hit by paying that charge every year.

For richer or poorer

How often do we get into similar disagreements when debating finances?

(Okay, not very often if you’re a normal person into football or Facebook – I mean us personal finance nerds!)

Paying down your mortgage versus investing, whether or not you should buy an annuity in retirement or to stay in shares and bonds – they’re not really arguments with the “right” answer, because they depend so much on your risk tolerance, your circumstances, even your philosophy of life.

Sticking with the retirement theme, retirement researcher Wade Pfau posed one of these eternal questions directly this week in his article: Which is better for retirement, insurance or investments?

Pfau wrote:

There are two fundamentally different philosophies for retirement income planning, which I call probability-based and safety-first.

Those philosophies diverge on the critical issue of where an individual is best served to place their trust: in the risk/reward trade-offs of an equity portfolio, or on the contractual guarantee of insurance products.

The fundamental question is about the type of strategy that can best meet the retirement income challenge for how to combine retirement income tools to meet goals and manage risks.

Those favoring investments rely on the notion that the market will eventually provide favorable returns for most retirees […] There is also a general unease about relying on the long-term prospects of insurance companies or bond issuers to meet contractual obligations.

Perhaps not fully understanding the implications of how sequence-of-returns risk differs from market risk, the belief is that in the rare event that the performance for the equity portfolio does not materialize, it would imply an economic catastrophe that would sink insurance companies as well.

Meanwhile, those favoring insurance believe that contractual guarantees are reliable and that an over-reliance on the assumption that favorable market returns will eventually arrive is emotionally overwhelming and dangerous for retirees […]

Even if there is a low probability of portfolio depletion, each retiree gets only one opportunity for a successful retirement.

This is the annuity versus income-portfolio-in-drawdown debate taken back to first principles.

At different times one approach might have an edge – when annuity rates are low, say, or stock markets scarily high.

But ultimately it’s a matter of philosophy and risk.

For better or worse

Coincidentally, Michael Kitces also published a really huge article comparing a whole bunch of different retirement strategies.

Again the same issue comes up:

What seems like a relatively simple question – which retirement income strategy is the best – is actually remarkably difficult to determine.

Because as it turns out, which is “best” depends heavily on how you measure what “best” really means in the first place.

This is a really in-depth article with some excellent graphs, and while it’s written from a US perspective there’s a lot to think about wherever you’re retiring.

Kitces also produced a table showing how the various strategies perform very differently across a range of outcomes:

One retiree's pleasure is another's poison.

One retiree’s pleasure is another’s poison.

Now, if you’re having a debate with someone who is most interested in (potentially) maximizing their final wealth, putting forward a strategy where at least some modest success is the top priority will cause some friction – unless maybe you both take a look at this table before you start your argument!

Retirement solved – and sold

You can also see from the table how the financial industry is able to spin the same problem into half-a-dozen different products for sale.

And that’s fine, if they’re providing different solutions for different needs.

But it can also be a misleading spin that says their favoured solution gets rid of the Worst outcome of some other hateful strategy – without pointing out the downsides of their own approach.

Remember, there are no free lunches in investing. Especially when you’re paying!

(Note: If you want to debate currency risk, could you please add your comments to last week’s thread. Obviously general comments on retirement strategies – or overall investing philosophy – are very welcome here).

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The Telegraph reckons the savings you can make from switching your energy provider are the highest they’ve ever been. There are various tools embedded in the article to help you find the best deal.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • Bond investors turn passive aggressive [Search result]FT
  • Swedroe: Passive investing without indexes [Technical]ETF.com

Active investing

A word from a broker

Other stuff worth reading

  • What would Brexit mean for me and my money? [Search result]FT
  • What retirees wish they’d known beforehand – ThisIsMoney
  • Can these celebrities afford to retire? – Telegraph
  • Merryn: Tax the living, and end IHT madness [Search result]FT
  • Will you pay extra stamp duty for the granny flat? – Guardian
  • Graduates from richer families earn more… – Bloomberg
  • …also, where the poor live longest [US but interesting]NY Times

Book of the week: Tech site The Verge describes Amazon’s new Kindle Oasis as “a cork in a desert of screw caps”, saying “consider that the whole reason for dedicated Kindle e-readers to exist is to recreate the reading experience with digital convenience for book lovers, and the Oasis starts to make a lot more sense.”

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  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. []

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{ 66 comments… add one }
  • 51 The Investor April 21, 2016, 9:37 am

    @Edward — I couldn’t agree more. However for reasons I’ve never understood, for some people the words “a house is a home” is a magic incantation that means it becomes immune to the normal rules and considerations of other assets/liabilities — even ones that will consume a huge amount of their annual income and in many cases eventually be the most valuable thing they own.

    This article might be of interest to you as a fellow traveler (though not particularly relevant to the subject at hand I concede!)

    http://monevator.com/why-house-is-an-investment-and-an-asset/

  • 52 John B April 21, 2016, 10:08 am

    Where property is relevant to retirement portfolios is how to make use of such a huge illiquid asset. My retirement model has 2 sales planned, from house with big garden (mmmm, plants) to flat to nursing home, as that’s the rational approach. But in reality the elderly stay in their houses well beyond the time they can maintain them, by which time the trauma of moving is too offputting, so their relations wait until the the nursing bills mount before trying to sell off a dilapidated house.

    How do you value a property that will be worth a lot at 70 when you can do DIY, but a burden at 85 when you can’t face getting tradesmen in for repairs.

    How do you exploit this asset? Equity release schemes are still an expensive niche market, and build up debt just as the property is falling in value, and you are beholden to market timing when you finally need to sell. Fire v London has used margin loans to allow him to use house equity in the markets, but he is an extremely sophisticated investor. Converting a wreck into a rental is expensive both in money and stress, and the returns are poor for anyone who’s age means that capital growth is of little use.

    Selling early and renting yourself would give more control, except who wants 6 month tenancies in their 80s.

    So, what do readers plan to do when they are 85 and house rich but cash poor?

  • 53 The Investor April 21, 2016, 10:12 am

    @John B — Can I ask, did you get an email alerting you to my recent comment (as I notice you’ve replied quickly) because you’ve subscribed to comments? As you’ll notice above, I’m trying to figure out if this system is broken or just glitching.

    Regarding the property issue, the point is — with respect to @Edward’s comment — as a homeowner you are exploiting the asset by living in it and not paying rent! If you weren’t, you’d have to find the money for rent, which for many would be substantial.

  • 54 coyrls April 21, 2016, 11:41 am

    The way I see it is that there are two critical numbers: a) the income you want to receive in retirement and b) the size of the “pot” that you think you need to provide a). Housing is going to affect both numbers. The effect on a) is pretty obvious, if you own a house outright then you only have to factor in maintenance but if you are renting, you will need to include rental costs in a).

    But your housing situation will also affect b). You can see from the discussion above that people have different views on how big b) needs to be in order to generate a given income. Factors that need to be taken into account with b) include the level of contingency that needs to be included in the total. I would say that your housing situation will affect this level of contingency. If you own your house outright you may well consider that the option of downsizing will reduce the contingency requirement that needs to be included in b), as your house already provides some contingency. If you are renting you may decide that you need a greater contingency in b) to cover, for example, rent increasing faster than inflation.

    So, while there may not be a “standard rule of thumb”, your housing situation should be feeding into your calculations both of the income that you require in retirement and the size of the “pot” that you need to provide that income.

  • 55 coyrls April 21, 2016, 11:44 am

    BTW I’m still not getting notification of comments even though above the “Submit” button it says: “You are subscribed to this entry.”

  • 56 The Investor April 21, 2016, 11:54 am

    @coryls — Thanks for the update. Working on it and indeed might just have solved it. (Please let me know if you get this one on email, if you have a moment! 🙂 )

  • 57 coyrls April 21, 2016, 11:57 am

    Yes, got the email!

  • 58 John B April 21, 2016, 12:10 pm

    The saved rental cost of house ownership is like SWR, OK for the long term, but of little use planning the last 5 years of life. One approach, favoured by the Tories IHT changes, is to plan to leave your house as a tax free inheritance and just spend cash and equity, but its much harder if you wish to die with nothing, as with house prices are 10*local wages, thats 15*local expenditure. At least the equity market, if flawed, gives you a feel for the capital drawdown rate for a pot, I suppose it could be applied to house equity and compared with equity release rates, but I worry you are just comparing high cost schemes with each other, as companies don’t take on risk without a hefty premium

    (didn’t ask for emails BTW)

  • 59 coyrls April 21, 2016, 12:15 pm

    How are you going to know whan you’ve reached “the last 5 years of life”?

  • 60 vanguardfan April 21, 2016, 12:55 pm

    Yes service has been resumed – thanks

  • 61 vanguardfan April 21, 2016, 1:02 pm

    Yes its all too full of unknowns, in some respects the easy bit is planning for income replacement for a fit and healthy lifestyle just after leaving work. The hard bit is exactly that ‘last 5 years of life’ which you can’t plan in either its timing or nature. Will you require years of expensive care and support, at home or in residential care? Or will the end come swiftly?
    Dealing with downsizing is difficult too. In my family no one has successfully downsized – while you can, you don’t want to, and when you need to, you can’t.

  • 62 gadgetmind April 21, 2016, 1:27 pm

    I’m trying to achieve £5k pcm after tax in retirement. My spreadsheet (which fully models for tax) suggests this will be a 4.3% drawdown from the total pot between retirement and state pension, and 3.3% afterwards. I’m not too happy with those percentages, but we can always cut back or downsize.

    BTW, my £1.7m is now looking closer to £1.6m plus a Tesla Model S P90D. 🙂

  • 63 John B April 21, 2016, 2:22 pm

    I just added a %wealth change column to my model, and have -0.8 to -1.3% annual changes to absolute wealth until 85, when I double the spending for care fees and the figure rises from -5 to -13% p/a. Thats with a 3% SWR covering most of the income early on.

  • 64 The Investor April 21, 2016, 2:42 pm

    Great — thanks for flagging up the glitch!

  • 65 The Rhino April 21, 2016, 3:09 pm

    @ GM – jesus! you could choke a dozen donkies on that, what do you do when your not funding pension pots, gadget, finance revolutions?

  • 66 gadgetmind April 21, 2016, 3:23 pm

    Well, I did start my first PEP at age 24 (same age was when bought first house) so I’ve been at it for a wee while now. After nearly three decades, dividends, diversity, rebalancing, and such like do all do their thing. I must admit that for about five years I have sometimes looked at the numbers in my spreadsheets and wondered where it all came from!

    Of course, a couple with middle of the road jobs but with final salary pensions could match our income (all from DC) fairly easily.

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