How to spread £200k over 10 years?

Triumph13

3 years and 9 months to my planned retirement date and everything is starting to get very real. I must be on to version 5,000 of the spreadsheets by now and I'm fairly happy with how everything looks despite recent market jitters. We plan to go 10 years before our DB pensions kick in with state pensions another 2 to 4 years after that. DC funds will be divided into 2 pots - one to provide an ongoing income throughout retirement and one to take the place of the DB pensions for those first 10 years.


I'm comfortable with my strategies for the first pot (almost entirely equities) and do not want to hand it over to an insurer for 10 years at great expense as part of a fixed term annuity to cover the bridging period!). I'm happy to have a lot of volatility in income from it as we should have plenty of slack so my current thinking is on the lines of withdrawing of 4% of actual portfolio value each year, subject to indexed floor and ceiling of 3% and 5% of starting value respectively. I'll couple this with a modest cash buffer, partly to smooth income, but more as a way of avoiding taking even the floor income for a year or two in a major crash.


The second pot I need (for my peace of mind) to be very low risk (say no more than 10% downside) as that is to cover core spending and I am really struggling to come up with an investment strategy for it. In my projections I've assumed growth on this pot equal to inflation so I could just start converting the funds (currently in diversified asset funds) to cash and hope to get a real interest rate of not too much below zero, but that seems a bit extreme. In 'normal' times I might have been looking at a bond ladder of gilts, but these are not normal times and I'd be better off with cash ISAs.


Is anyone else out there facing this kind of situation? I'd be very interested to know what strategies others are adopting for 'pot 2' as whilst the net is full of information on how to live off a portfolio for the whole of your retirement, there doesn't seem to be much out there to cover this kind of situation. My natural inclination is x years in cash with the balance in diversified funds, but I'm hitting the point where I have to start deciding what 'x' should be and what's my algorithm for converting funds to cash.

AlanP_2

Got slightly confused as to which pot is which, sorry, particularly where you mentioned "10 years" & "annuity" for first pot. Just to make sure I have it clear in my mind

POT1 = Lifetime retirement income at a steady(ish) rate of ~4% with a cash buffer to complement it.

POT2 = 10 year DB income replacement. This is the one you are seeking views on.

Have I got it the right way round?

Assuming it is then it could be worthwhile moving a chunk into cash now and maximising the various current account, regular saver offers on the market. As you talk about Cash ISAs you may have already utilised all / some of these up to their single & joint account limits so may not work for you and your situation.

If you haven't it should get you a 30x current inflation rate return (at 3% average interest and CPI of ~0.1%). That will change over the next few years I am sure and we are unlikely to see those sort of multiples over CPI once inflation does start ticking up.

If it was me and I was looking to reduce equity market risk over the next 3-4 years until retirement and then take a phased income I would move approx 25-35% into cash as above over the next 12 months and then focus on diversified funds as you say with another 50:50 bonds:equities split. A mix of VLS40 and VLS60 (or similar) say.

That mix should preserve the value of your pot against inflation I would think even if there is no significant growth in its value.

atush

5 years as cash, and 5 ears worth (ie half and half) into some good solid dividend paying investment trusts .

With a 5 year lag time, you could see some ups and downs but if you bank the divis that could give you a 6th year in cash in case the markets plunge during the 5 years. Which even if they do, I find that good divi paying ITs dont drop as much as the market, and recover fairly quickly. And many pay near to 4% income, and have maintained and increased their dividends thru good times and bad for decades.


I guess my point with pot 2 is, you dont have to put in in the same thing, but can merge the downside figures to get to your comfort point.

Triumph13

Alan, you you have the pots right. Unfortunately I can't do anything terribly efficient in terms of cash right now as all spare cash is being poured into the pensions and so I can't get hold of any of pot 2 until 2019 (endowment matures, wife hits 55 and we stop work) and 2021 (I hit 55). That adds the complication that anything I move early to cash gets lousy money market rates within a pension. It also means I also have some fairly complicated cashflow which I haven't been able to bring myself to fully model yet in order to make best use of ISA allowances and minimise tax on pension withdrawals when the money does become available!

Triumph13

Atush,
I like the idea of banking the dividends from 50% of the pot for 5 years to hopefully give a buffer against a nearly 20% fall (plus plenty of upside). I'm not sure about ITs though as I have a fear that these 'dividend machines' could see big falls in capital value if interest rates normalise over the intervening period so holding them for capital preservation rather than income doesn't instantly appeal. For the same reason I'm very wary of long dated bonds. I've been hanging on and hanging on for interest rates to rise and burst the bond bubble, but the prospect just keeps on receding!

Linton

Triumph13 wrote: »

Atush,
I like the idea of banking the dividends from 50% of the pot for 5 years to hopefully give a buffer against a nearly 20% fall (plus plenty of upside). I'm not sure about ITs though as I have a fear that these 'dividend machines' could see big falls in capital value if interest rates normalise over the intervening period so holding them for capital preservation rather than income doesn't instantly appeal. For the same reason I'm very wary of long dated bonds. I've been hanging on and hanging on for interest rates to rise and burst the bond bubble, but the prospect just keeps on receding!

Dividend paying ITs mostly get their money from holding dividend paying shares. Such shares are not directly affected by interest rates (unlike bonds) as their price is largely determined by the financial state and prospects of the company concerned. And the price of most ITs is largely determined by the value of the assets they hold.

So I think your fears are misplaced.

Triumph13

Linton wrote: »

Dividend paying ITs mostly get their money from holding dividend paying shares. Such shares are not directly affected by interest rates (unlike bonds) as their price is largely determined by the financial state and prospects of the company concerned. And the price of most ITs is largely determined by the value of the assets they hold.

So I think your fears are misplaced.

I'll freely admit that I don't know much about ITs, but I was working on the principle that with the scrabble for yield many of them would be trading at significant premiums over the underlying stocks and that these premiums might rapidly disappear if the yields on bonds and cash improved. I may be mixing them up with other types of fund though!

Linton

Triumph13 wrote: »

I'll freely admit that I don't know much about ITs, but I was working on the principle that with the scrabble for yield many of them would be trading at significant premiums over the underlying stocks and that these premiums might rapidly disappear if the yields on bonds and cash improved. I may be mixing them up with other types of fund though!

Two of the better known dividend paying equity ITs are Murray International (6.71%) and City of London (4.1%). Both are on less than 4% premium.

coyrls

As I've recently posted on another thread, you could create a "ladder" of fixed rate savings accounts for Pot 2, so for 10 years you could put twice the required income in 1,2,3,4 and 5 year fixed rate savings accounts, then, as each one matures, you take half as the income for the year and invest the remaining half in another 5 year fixed rate savings account. Obviously this is not inflation linked but you have a fair chance of keeping pace with inflation, I would think. Just make sure you are below the FSCS limit for each institution and it's very, very low risk.

Triumph13

coyrls wrote: »

for 10 years you could put twice the required income in 1,2,3,4 and 5 year fixed rate savings accounts, then, as each one matures, you take half as the income for the year and invest the remaining half in another 5 year fixed rate savings account.

A very elegant method of spreading the risk on interest rate movements Coyris. I like it. I just need to build in the additional complexity of moving things in and out of other investments... That and working out at which point current contributions start being made to cash funds ready to be taken out and put into ladders. Why is everything always so complicated?

coyrls

Remember to take the full 25% tax free out of your DC pension for pot 2, with the tax free interest allowance plus your personal allowance, you will get some/all of the interest tax free on your tax free lump sum and there is no tax on the capital.