Investment returns and Inflation

tigerspill

I am currently doing my retirement planning as follows.

I am 49 (just) and planning to retire at 55.
Both my wife have reasonable DB schemes that we plan to start collecting somewhere between 55 & 60. We will also have the state mention at 67ish.
I have a pot of savings that I and looking to invest and have received much help on this site for that.
My plans assume I will run my capital down to zero by the time I am 80 and living on our pensions.
I have assumed a yearly expense that I use to determine what this will cost between now at 80.

The way I have done this is calculating everything in today's money - totally ignoring inflation and any investment return - just assuming my current capital amount will run to zero at 80.
So inflation erodes our money; Our pensions are index linked and I am assuming that over the years, my invested capital will grow in line with inflation at least.
So overall I am assuming inflation and return will balance.

Is this an OK/sensible way to approach this planning (ignoring inflation and investment return)?
I know that some suggest that a conservative sensible long term investment should return maybe 3% over inflation. Is this the case? I am assuming that this modest growth will act as a contingency plan and that my planning is pessimistic.

Does this make sense and is it a reasonable approach to retirement planning.

Thrugelmir

What if your investments suffer a sizable capital loss in the first few years of retirement. It's a proven fact that people don't recover from such situations. Investment returns are far from smooth.

tigerspill

Thrugelmir wrote: »

What if your investments suffer a sizable capital loss in the first few years of retirement. It's a proven fact that people don't recover from such situations. Investment returns are far from smooth.

I understand that and it is a fair point.
Not sure what your are suggesting I do differently in my calculations (other the the obvious - spend less and/or save more)?
How does this play into my question about is assuming parity between "normal" long term return and inflation?
PS. my investment strategy will be based on a conservative and very diversified portfolio in a bid to reduce the likelihood and impact of a big loss.

fwor

IMO it's a reasonable basis to work on.

I "retired" ten years ago and made a comprehensive income/spend model at the time, using that assumption, and ten years on it has not diverged too far from reality.

If anything it proved a bit pessimistic, but it's probably better that way, given that we can't predict what ~might~ happen to inflation and returns in future...

Linton

Your assumption of returns matching inflation is safely cautious in my view. 10 years ago I retired assuming 1% over inflation and have achieved significantly better than that despite the crash.

Why are you assuming running out of money at 80? At least one of you has a good chance of surviving into your 90s.

tigerspill

Linton wrote: »

Your assumption of returns matching inflation is safely cautious in my view. 10 years ago I retired assuming 1% over inflation and have achieved significantly better than that despite the crash.

Why are you assuming running out of money at 80? At least one of you has a good chance of surviving into your 90s.

Thanks Linton.

Re. running out of money at 80 - this is primarily just a calculation age. I have to pick something and the average life expectancy is currently around 80.
I may play around with this, but I have some mitigation in place.
1. We both have good DB pensions and our state pension will have kicked in at that point. So we wont be without income.
2. I have a fair amount of contingency build in to what we "need" as I am assuming that we will need pretty close to our current net employment income. In reality we can save around a third of that and don't expect this to change in retirement. So in reality, it will last longer than 80.
3. Assuming a conservative investment return as discussed above.

hugheskevi

Re. running out of money at 80 - this is primarily just a calculation age. I have to pick something and the average life expectancy is currently around 80.

There are 4 important ways in which you are not average:

(1) Average life expectancy (at birth) includes infant mortality and all the accidents that happen to kill people early in life. You have survived these.

(2) Average life expectancy makes no allowance for future mortality improvements, which for the last 20 years have been very rapid.

(3) You and your wife are DB scheme members. This group tend to have higher life expectancy than average (this probably just correlated with better-off than average individuals living longer).

(4) There are 2 of you, so the probability of either one of you living to any given age is higher than the probability which applies to each of you in isolation.

DB pension schemes would commonly assume that a member in your position is going to survive just into their 90s on average. Given the combined death probability with your spouse, choosing a terminal age such as 93 would be reasonable, and 95 would be prudent.

jamesd

tigerspill wrote: »

So overall I am assuming inflation and return will balance. ... Is this an OK/sensible way to approach this planning (ignoring inflation and investment return)?

The long term historic average return of the UK stock market over the last hundred plus years has been a bit over 5% plus inflation so it's not a very sensible approach given an objective to drain the money buy age 80: you'd be taking far too little income. For broadly mixed assets you might consider 4% or 3%. Going below 3% would be too low because that's less than the dividend yield expected from the UK market and also less than that achievable from many investments you'd diversify into. You can get capital value drops but income drops below that are much less likely.

I use zero as a very coarse initial estimate in posts here that I know costs too much but for more detailed planning you really should use a more likely estimate of returns and also be prepared to drop income if the returns turn out to be consistently below that for many years.

Thrugelmir wrote: »

What if your investments suffer a sizable capital loss in the first few years of retirement. It's a proven fact that people don't recover from such situations. Investment returns are far from smooth.

That's not a proven fact. What is known is that a drop at the start then a decade plus of minimal returns is the toughest historic test case for early retirement, based on a repeat of the Great Depression. That case is manageable by having a year of income in savings and by adjusting income level downwards to deal with it if it happens. The magnitude of the effect depends on how far the income being taken is above the natural yield of the investments, if it's the same it has no negative effect. Just one year of cash can deal with a substantial drop of income for a substantial time - a 10% income drop for a decade. But during the Great Depression incomes also dropped so a response of taking lower income after a few years is mandatory to deal with a repeat.

tigerspill wrote: »

Re. running out of money at 80 - this is primarily just a calculation age. I have to pick something and the average life expectancy is currently around 80.

Average life expectancy for who? That's about right for a newborn child but it's too low for adults close to retirement age. Cohort life expectancy at age 65 is around age 88. That's not a reason to modify your calculations if your remaining income is sufficient because it's also known that in general people tend to spend less as they get older. Better to try to maximise use of your money while you're able to enjoy things like travel.

saver861

tigerspill wrote: »

Is this an OK/sensible way to approach this planning (ignoring inflation and investment return)?
I know that some suggest that a conservative sensible long term investment should return maybe 3% over inflation. Is this the case? I am assuming that this modest growth will act as a contingency plan and that my planning is pessimistic.

As always with these things the devil is in the detail. Reasonable assumption that investment will outstrip inflation I would say. However you are just 6 years from your retirement date, it might be stating the obvious to be keeping an eye on moving high risk downwards. I put my total AVC fund into a near 0% Deposit fund two years before retirement so that I did not have to deal with any nasty shocks in that area on my retirement.