The right portfolio for extended retirement

diveleader

Afternoon all.

I am in the privileged position of entering retirement at 48.

Our company goodwill has now been sold and we will run the company down over the next few years to minimise the tax implications.

After this, there will be no more topping up of the ISA, SIPP's etc - this is quite a sobering thought, as it reduces your opportunities to benefit when markets change.

Typically if retiring at a later age, you would shift your investments into less volatile categories. However, with (hopefully) 30+ years ahead of us, I feel that the investments need to keep on working for us.

So what is the correct portfolio for extended retirement?
And if you have a large percentage in equities, how much should you keep in 'cash' to save you from drawing on them when they are low (and conversely, possibly topping them up when they are low)?

I would welcome your thoughts on the above.

dunstonh

So what is the correct portfolio for extended retirement?

There is no one option that is correct. Although there are plenty of wrong ways of doing it.

nd if you have a large percentage in equities, how much should you keep in 'cash' to save you from drawing on them when they are low (and conversely, possibly topping them up when they are low)?

Depends on the volatility band that you are aiming to achieve with your overall investments. Obviously cash and equities are just two parts but I assume your portfolio would income fixed interest securities and property as well and they will have an impact on the volatility.

Rebalancing the portfolio will help keep things in the required range but you shouldnt aim to go chasing returns on perceived highs and lows as that is a recipe for disaster.

jamesd

US research suggests that the equity part of the mixture should be increased with expected retirement duration, up to 90% for the longer durations.

US research also suggests that you can improve success rates by keeping a year's worth of anticipated investment income in cash. What I tend to do is suggest having that in a savings or interest paying current account that has a standing order to pay to your main account. Have the investments pay into the savings buffer account. Top the account up from equity sales during the best market years, let it draw down to avoid any capital sales during bad ones.

You might also find Equity release for risk reduction of interest. As well as borrowing that mentions the the Guyton or Guyton and Klinger safeguard rules that reduce income to increase overall success rate:

1. "there is no increase in withdrawals following a year in which the portfolio’s total investment return is negative, and there is no make-up for a missed increase in any subsequent year"
2. "the maximum inflationary increase in any given year is 6 percent, and there is no make-up for a capped inflation adjustment in any subsequent year"

Both of those rules implement income cuts in adverse investment return circumstances.

You might also consider substantial use of peer to peer lending as an alternative asset class from the more usual shares, bonds and commercial property. Equity returns or greater can currently be achieved, but with minimal correlation with equity or bond markets.

Choice of a sustainable income level is key. A commonly quoted value is 4% of the starting capital, increasing with inflation. However that's from a study where the optimal result was less than that at younger ages and more at higher, so the appropriate rate for your age would be more like 3.5% than 4%. It's also of note that this rate was established without using the additional rules and that those were found to increase the 4% 30 year drawing rate to close to 6% with the same overall success rate. So if you're willing to use the rules and adjust income later you could perhaps draw 4-5% or so. It's also worth knowing that these studies tend to assume a failure rate of no higher than 10% as OK, but if you happen to be in the time period where there's 10% failure due to the specific market movements during that time you might not like that failure rate. It's not random 10%, it's specifically sustained bad market performance during a particular period and your chance of being in such a period.

Once you get to state pension age you might consider deferring claiming since under the rules that would at present apply to you you'd get 5.8% increase per year of deferral, inflation-linked. That's close to twice the RPI annuity rate and provides good long life income protection, at the cost of spending capital and reducing potential inheritance. This trade can be a good one to assure your core income during the final 20-40 years of life.

dunstonh

However, a portfolio of 90% equities would put you way above the volatility tolerance of the average uk investor and could well be outside your capacity for loss and possibly above the level of risk needed. Most income portfolios put equity content at around 40-70% equities.

It is all very well going 90% equity but its how you react when your portfolio drops 35% in value and the possibility of having to reduce your income for a period to reflect that drop. its not a case of it but when. You may get lucky and find an extended growth period in the early years but you may be unlucky and have a drop not long after investing.

jamesd

Capacity for loss is taken care of by the investment rules, which adjust income based on the market results actually seen.

Volatility tolerance is a big issue. While I can write about what the research shows, the individual person has to be willing to actually deal with a 30-35% total portfolio value reduction during a bad year once or twice a decade, or 15% or so two or three times.

The drawing during on capital during a downturn issue is taken care of by the buffer pot. That's its job. Though if 3.5% income is being taken that would be close to the native yield of the investments so it'd be much less of an issue.

Given current conditions I favour more well diversified P2P and less equities. That's because P2P is currently delivering equity-level returns without equity level volatility.

I agree that most income portfolios use more bonds. I expect that they seldom assume that investors are using investment rules that have been shown to be helpful, rather targeting primarily investment risk tolerance.

On the FA side, how much use do you see in the UK of research results like these when it comes to managing drawdown?

jamesd

Beyond those things there's also the question of objectives. Is it maximising income while alive? While young? Maximising inheritance for some nominated income level below the potentially achievable one? We don't know yet. If the desired income is £50,000 a year and 4% of the pot is £100,000 a year it's easy to achieve the income objective.

jamesd

diveleader wrote: »

I am in the privileged position of entering retirement at 48. ... with (hopefully) 30+ years ahead of us

Why such a short anticipated life expectancy? Major heart disease, heavy smoking and drinking or other adverse factors that will reduce your life expectancy by ten years?

The UK cohort life expectancy for males who are 48 in 2015 is 38.4 more years. For females it's 41.6 years. For planning you should be assuming living to at least 100, with 110 a better planing horizon to cover the long life case. That's an investment timescale of around sixty years.

Chickereeeee

jamesd wrote: »

Once you get to state pension age you might consider deferring claiming since under the rules that would at present apply to you you'd get 5.8% increase per year of deferral, inflation-linked. That's close to twice the RPI annuity rate and provides good long life income protection, at the cost of spending capital and reducing potential inheritance. This trade can be a good one to assure your core income during the final 20-40 years of life.

Assume £10k per year pension. After 20 years you are a total of £1200 ahead by deferring one year (and that is assuming you don't invest the first £10K of the non-deferred pension. If you can get 3% return above inflation you are worse off). Hardly worth the bother.

gadgetmind

dunstonh wrote: »

However, a portfolio of 90% equities would put you way above the volatility tolerance of the average uk investor

So what? Someone planning a 40+ year retirement is probably not what you'd call average.

above the level of risk needed. Most income portfolios put equity content at around 40-70% equities.

What rate of drawdown can these sustain for 40+ years with a 90% chance of success?

You may get lucky and find an extended growth period in the early years but you may be unlucky and have a drop not long after investing.

Yes, this sequence risk is a problem. There is a good argument for entering drawdown with a high bond allocation and then reducing it once you've ridden out the first cycle.

Personally, I'd rather hold a big slug on unwrapped cash, but that's just me.

chucknorris

gadgetmind wrote: »

Yes, this sequence risk is a problem. There is a good argument for entering drawdown with a high bond allocation and then reducing it once you've ridden out the first cycle.

Could you please elaborate on this, are you saying that if you are investing a significant lump sum, you are better off waiting to buy in after the next correction? I'm interested to know what you mean and why.

jamesd

Chickereeeee wrote: »

After 20 years you are £1200 ahead by deferring one year (and that is assuming you don't invest the first £10K of the non-deferred pension. If you can get 3% return above inflation you are worse off). Hardly worth the bother.

With an RPI annuity paying out just 2.5% at 65 the state pension deferral is an easy winner for secure inflation-linked income.

The UK long term stock market return is around 5% plus RPI inflation. The deferral pays 5.8% plus CPI inflation. The expected outcome is barely under-performing investments in the UK stock market, without having the investment risk. And that's before costs, which means it probably actually beats the market. That makes it very useful as a risk reduction tool.

Where did your 3% above inflation value come from? Did you perhaps assume that the 5.8% wasn't inflation-linked?