Should I choose income or growth?

gadgetmind

4% certainly carries a risk of going wrong unless you can tighten your belt if markets drop, but I think you're over-egging the pudding.

To answer the OP, I've never really been that convinced by either an income nor a growth strategy. Both involve restricting yourself to a subset of the market and often to using active management.

I prefer to keep fees low and holdings broad, but I will admit to dabbling with some directly held income assets.

bigadaj

But that would only leave a drawdown rate of 1.9% given the 95th percentile outcome which is incredibly low. Rate of return and drawdown are two elements but given the OPs original post another approach is to vary the income taken out, reducing after periods of poor return to retain capital. This obviously requires appropriate sums and expectations but isn't unreasonable. The problem with being too conservative is that you end up being rich after you're dead, which isn't ideal for many people.

jamesd

4% has a reasonable chance of failure but rather than using that it's better to use Firecalc and set the income level that has the desired success rate based on past US market performance. The highest risk case is a big market drop just after retirement that is sustained for many years. Handling that case in your planning will give you substantially higher safe income levels in more normal cases.

There are several important ways to deal with this. One is to use Firecalc so you can see the pattern and get a better feeling for the range of results and necessary safety margins.

Another protective measure is to have a cash reserve of at least one year that you use as your income source, with investment income paying into it. In a normal or high market you can withdraw capital to top this up or increase it. In a down market you can stop selling capital and leave the capital to recover. Larger than one year amounts increase the ability to survive prolonged income drops and downturns.

With a FTSE yield in the 3.5-4% or so range there's little reason to go lower than that for income planning unless you want to assume long term growth that is below inflation. As a practical matter you can start out substantially above 3.5% provided you're willing to adjust the income level if you do happen to experience one of the unfortunate patterns of bad initial investment performance. One additional beneficial factor is that because those are most dangerous early on, that's also when you're early in retirement and most able to do something like resuming some work to reduce the adverse effect.

Overall this is about balancing two risks: failing to maintain your desired income level and failing to retire as early as you could. Each of us will have different preference in the spectrum of possibilities for that choice, just as we do in our choice about how much to invest to get us to the point where we make that decision.

So far as capital or income goes it's really total return that matters but there's a substantial viewpoint that drawing only the natural income of the investments is safer than drawing capital. The safety of that view is correct but it's not clear that it is the best choice because it's likely to leave substantial capital at death. For a person with no desire to leave an inheritance all money left at death is money that was wasted and could have been used to improve their lifestyle while alive, if they had known their date of death in advance. As it is, some level of remainder is necessary insurance against a long life's income needs.

In general my own view is that it is desirable to pick at least a minimum and a target income level and plan sufficient safety margin so that you get the target level with confidence above 95% and do not fall below the minimum with confidence level of 98-100%. If you are happy to adjust the spending level within a larger range you can drop the initial confidence level from 95% to 90 or 80% and increase the normal case income level that you take. You'll have a higher chance of ending up at the lower level if you do this. However, this assumes that you don't change your plans much.If you're reading this you know that the highest risk is a drop in the early years that is sustained and if you see that drop you can immediately reduce your income level to the 95% confidence level income amount instead of the 80-90% one. Or lower, closer to the 98-100% case, or work a bit more.

orangello

jamesd wrote: »

4% has a reasonable chance of failure but rather than using that it's better to use Firecalc and set the income level that has the desired success rate based on past US market performance. The highest risk case is a big market drop just after retirement that is sustained for many years. Handling that case in your planning will give you substantially higher safe income levels in more normal cases.

There are several important ways to deal with this. One is to use Firecalc so you can see the pattern and get a better feeling for the range of results and necessary safety margins.

Another protective measure is to have a cash reserve of at least one year that you use as your income source, with investment income paying into it. In a normal or high market you can withdraw capital to top this up or increase it. In a down market you can stop selling capital and leave the capital to recover. Larger than one year amounts increase the ability to survive prolonged income drops and downturns.

With a FTSE yield in the 3.5-4% or so range there's little reason to go lower than that for income planning unless you want to assume long term growth that is below inflation. As a practical matter you can start out substantially above 3.5% provided you're willing to adjust the income level if you do happen to experience one of the unfortunate patterns of bad initial investment performance. One additional beneficial factor is that because those are most dangerous early on, that's also when you're early in retirement and most able to do something like resuming some work to reduce the adverse effect.

Overall this is about balancing two risks: failing to maintain your desired income level and failing to retire as early as you could. Each of us will have different preference in the spectrum of possibilities for that choice, just as we do in our choice about how much to invest to get us to the point where we make that decision.

So far as capital or income goes it's really total return that matters but there's a substantial viewpoint that drawing only the natural income of the investments is safer than drawing capital. The safety of that view is correct but it's not clear that it is the best choice because it's likely to leave substantial capital at death. For a person with no desire to leave an inheritance all money left at death is money that was wasted and could have been used to improve their lifestyle while alive, if they had known their date of death in advance. As it is, some level of remainder is necessary insurance against a long life's income needs.

In general my own view is that it is desirable to pick at least a minimum and a target income level and plan sufficient safety margin so that you get the target level with confidence above 95% and do not fall below the minimum with confidence level of 98-100%. If you are happy to adjust the spending level within a larger range you can drop the initial confidence level from 95% to 90 or 80% and increase the normal case income level that you take. You'll have a higher chance of ending up at the lower level if you do this. However, this assumes that you don't change your plans much.If you're reading this you know that the highest risk is a drop in the early years that is sustained and if you see that drop you can immediately reduce your income level to the 95% confidence level income amount instead of the 80-90% one. Or lower, closer to the 98-100% case, or work a bit more.

Very helpful reply with lots to consider. Thank you.

I agree with having a cash reserve to fund living costs if the investment suffers a downturn. Is there anything to be said for having x% portfolio in cash in the early years specifically ready to buy into equities if the market does dip sharply. In effect this would be like increasing allocation (not simply rebalancing to target allocation) to equities on sharp dips, with a view to recovering the fund size faster on the eventual upturn?

jamesd

There is a proven correct theory that keeping the total value growing at the planned rate is desirable and produces an increase in returns. What this does is cause investment during downturns and disinvestment during upturns, when the value gets ahead of projections.

There's a catch, though. When waiting to invest the money isn't getting investment level returns and since investment trends in general are upwards that costs. That means that you need to find something productive to do with it in the meantime and that may well be other types of investment.

The classic rebalancing approach does some of the sort of shifting you're asking about by shifting out of high volatility investments to lower volatility during upturns because the upturn causes the target percentage to be too high, producing the rebalancing away from it.

Some cash component of investments can be useful but not necessarily a lot. Less at younger ages.

I have reservations about what you're suggesting because it leaves money uninvested. However there are things you can do to reduce or eliminate that problem. One of the easiest is to keep a generous near-cash emergency fund and reduce that during downturns to increase the amount you invest. At highs, do the opposite. Another way is to borrow to invest more, perhaps bringing forward the rate of investing, doing two months worth instead of one and catching up later, with lowered contributions after a year or two, say. Or you can buy leveraged investments instead of unleveraged during dips, another form of borrowing. Say the x2 tracker ETFs instead of unleveraged.

I used a credit card stooze pot in 2009 and have also at times used leveraged ETFs. Also some spread betting, though that's not to my taste. I park uninvested money in a mortgage offset account, mainly. In my case that's 3% tax free. I've also varied my stooze pot size according to whether I thought there were good or bad opportunities.

orangello

Thanks again.

The earlier posts which discuss research on rate of withdrawal suggest 1.9% is a safe level. This would mean someone with a retirement pot of £1 million, could expect to take only £19,000 p.a. If true I think this would make many people give up even trying to save for a pension.

dunstonh

orangello wrote: »

Thanks again.

The earlier posts which discuss research on rate of withdrawal suggest 1.9% is a safe level. This would mean someone with a retirement pot of £1 million, could expect to take only £19,000 p.a. If true I think this would make many people give up even trying to save for a pension.

That has nothing to do with a pension. The same would apply if it was an ISA or unwrapped investments. It would be even less with cash deposits.