Drawdown Psychology and Capital Burn

saver861

mgdavid wrote: »

It's a shame the pedantic, picky and pompous cannot find it within themselves to be a little less so at this time of year......

Says 'he'... !!!!!

The OP's dilemma is not with the numbers but in making a decision and sticking to it.

A lifetime of saving and prudence does not change overnight. It is an inherent culture. Likewise, the opposite that spend spend spend.

For those continually querying whether they will have enough would still do so even if their financial situation increased by 25% overnight. Within a few months the cyclic financial reviewing would continue the same way.

The only thing I would say is that OP seems to be somewhat dependant on there not being a market meltdown. I'd be looking to redress that such that even if there was a meltdown, it would not deflect my plans particularly one way or the other.

Triumph13

saver861 wrote: »

The only thing I would say is that OP seems to be somewhat dependant on there not being a market meltdown. I'd be looking to redress that such that even if there was a meltdown, it would not deflect my plans particularly one way or the other.

That's easier said than done! The only way to completely insulate yourself would be to keep working until 55 and then buy an indexed annuity which would be horrendously expensive.
Once everything is in place, my plans have been built to withstand a 40% downturn and still give more income than I currently spend, so I'm pretty comfortable with that. A 40% drop followed by a 'lost decade' would inconvenience me, but only to the extent of having to spend funds planned for inheritance. Once SPs come on line, we'll have more than current spending from DBs and SPs so no exposure there at all - unless you count political risk to the SP.
The bit where I do feel exposed is the two years between planned retirement date and being able to access my DC funds, but I think that's more psychological than real. I'm still tussling with the timings of converting funds into cash as it will really hurt to watch cash attract negative real returns (and charges!) for too long. I need to do more sensitivity analysis on that period.
Of course I'm also exposed to downturns in the next two and a half years, but until I hand in my notice there will at least be the safety blanket of being able to delay retirement or go part time, but if I did so following a crash it would be more from greed to buy stocks on sale that fear of them not recovering.


I think too many people overdo their safety margins by trying to build in pessimistic assumptions to every single assumption. I have just gone broadly mainstream (okay, maybe slightly cautious) on my main assumption of 3.6% net real returns then built a huge margin into the income. If markets crash, I just spend less than my grossly inflated budgeted income. If markets don't crash I spend more (Who am I kidding? If markets don't crash I'll just keep buying more stocks with the excess:o)

atush

I dont think it is too conservative to have set aside (and not emergency funds, Uni funds, or helping/replacing anything else funds) 2/3 years cash for yearly income requirements as cash funds.

So as not to have to sell ANYTHING once you retire while you wait to see how things pan out (and if the market is down, reinvest 100% of dividends and if rising, save some or all income as cash to replenish what you are spending).

Triumph13

atush wrote: »

I dont think it is too conservative to have set aside ... 2/3 years cash for yearly income requirements as cash funds.

A lot of people seem to do this as a buffer against a downturn to draw from in a slump and replenish in a boom. Whilst there is a lot to be said for it, it can sail dangerously close to trying to time the markets which is usually a good recipe for a kicking.

So as not to have to sell ANYTHING once you retire while you wait to see how things pan out

That doesn't seem to make any sense at all to me. If you are planning over a 40 year plus timescale, there is no logical reason to do something different in the first two or three years than over the next four decades. The issues facing you at the end of that first period would be no different to those at the start, apart possibly from being closer to other income streams like the SP coming on line.

(and if the market is down, reinvest 100% of dividends and if rising, save some or all income as cash to replenish what you are spending).

Do you mean that you would be investing for dividend yield rather than total returns? All the literature seems to indicate that the latter generally gives better returns long term.


In my own case, I will actually be aiming to go into retirement with 4 to 5 years income in cash or near cash, but earmarked to be spread over a 14 year period (until the last of the DBs / SPs come on line) to reduce income volatility. Pretty much everything else will be in funds where I would plan to sell acc units rather than harvest dividends.
In the case of a sudden and dramatic crash in the early pre-DB/SP phase, I may hold back on investment sales for a while and draw a little cash forward from the smoothing fund, but I would be very wary of going too far with that. My core strategy would be just to sell the same percentage of funds that I had planned and accept that that portion of my income would be lower. As I'm on a fixed percentage strategy rather than fixed income I have no sequence of returns exposure and as I'm so overprovided on income the reduction would be no particular hardship.
The whole point of my strategy is to minimise stress, not to maximise income. I don't want to be sitting there trying to second guess the markets and I especially don't want to be in a position of watching my cash reserves go down whilst desperately praying for a market recovery to replenish them as I know how much that would distress me.


Once all the DB/SP streams are on line my strategy will change somewhat in that I will then only sell funds when markets are performing well and in downturns will just live on the DB stream. I will probably just have a chart of actual vs budgeted investment value and not sell if actual is below budget.

saver861

Triumph13 wrote: »

That's easier said than done! The only way to completely insulate yourself would be to keep working until 55 and then buy an indexed annuity which would be horrendously expensive.

But what is a plan - in the theoretical sense. You may not even be able to continue working until 55 for all sorts of reasons, health, redundancy, etc. I don't think anyone can completely insulate for the future - but equally, plans with greater inherent risk versus reducing time scales may be more in the 'hope' category rather than 'plan'!

Triumph13 wrote: »

Once everything is in place, my plans have been built to withstand a 40% downturn and still give more income than I currently spend, so I'm pretty comfortable with that. A 40% drop followed by a 'lost decade' would inconvenience me, but only to the extent of having to spend funds planned for inheritance.

Sounds like a plan! If the markets fall much more than 40% then we all will have something to worry about. However, maybe you are trying to cover too many bases. In the case you say you might have to spend funds planned for inheritance. However, you also say that your kids will have inheritance from grand parents etc. Presumably they will have your property inheritance etc. Recognising a good equilibrium is also part of it.

Triumph13 wrote: »

The bit where I do feel exposed is the two years between planned retirement date and being able to access my DC funds, but I think that's more psychological than real. I'm still tussling with the timings of converting funds into cash as it will really hurt to watch cash attract negative real returns (and charges!) for too long. I need to do more sensitivity analysis on that period.

But that is again the danger of trying to squeeze the last droplets out of the funds etc. When I had an inkling that I might get the opportunity to take redundancy and early retirement, I whisked my full AVC fund into a Deposit account which was there for over two years. Last thing I wanted was to risk a crash scuppering my bigger picture plans. The markets did rise in that period and I did lose out on some growth, but no point in gaining a little at the risk of losing a lot.

You still have all the options open. My guess is this time next year, you, and everyone else, will have a much clearer picture of what the medium term future will look like. 2017 will be very informative, one way or another!

Triumph13

saver861 wrote: »

But that is again the danger of trying to squeeze the last droplets out of the funds etc. When I had an inkling that I might get the opportunity to take redundancy and early retirement, I whisked my full AVC fund into a Deposit account which was there for over two years. Last thing I wanted was to risk a crash scuppering my bigger picture plans. The markets did rise in that period and I did lose out on some growth, but no point in gaining a little at the risk of losing a lot.

The problem is that the longer the timescale you are dealing with, the more risk there is from being in cash due to inflation and the less risk from equities because of having the time to recover from downturns. If I was retiring at 63 with only 4 years until state pension then it would make no sense to use anything but cash and short dated bonds for the bridging period. When you are planning to go at 53 that would be a seriously expensive option as you not only forgo more than a decade of returns, but you have to insure against inflation risk.


To take a simplified example, let's say you wanted an even income, rising with inflation over a 14 year period. If we make reasonable assumptions of4% average real returns on investments vs -1% on cash, then you would need a 40% bigger starting fund with the cash route. Much better to go the equity route and deal with having a variable income as it happens. Long term cash is a mug's game.

saver861

Triumph13 wrote: »

The problem is that the longer the timescale you are dealing with, the more risk there is from being in cash due to inflation and the less risk from equities because of having the time to recover from downturns.

Sure. I think I was referring more to having cash at or around inflation returns. Until recently you could have stashed over £100k into current accounts at a return of 3% ish - a couple of percent above inflation for last few years. No risk - instant access!

Triumph13 wrote: »

To take a simplified example, let's say you wanted an even income, rising with inflation over a 14 year period. If we make reasonable assumptions of4% average real returns on investments vs -1% on cash, then you would need a 40% bigger starting fund with the cash route.

Unless of course there is a big bad crash in there early on. Yes 14 years is too long to tie up in cash even with slightly above inflation returns. However, 14 years when you are in early 30's is so much different to 14 years in 50's when depending on it for retirement income.

Presumably you could always call in the DB pensions at any time. Even with the actuarial reduction, it still takes around 15 years to reach the breakeven point, by which time you will have all SPs etc.

However, every situation and individual circumstances are unique. From what you say, I think you have it more than covered. If there is any downfall, it will be in trying to perfect the scenario too much.

westv

similar situation here. 1st DB kicks in 2/3 years after planned retirement date. Then more start 9/10 years after and finally the last start 15/16 years later.
The DC "filler" needs to be in something with low volatility in order to smooth income but with enough investment gain to beat inflation.

Triumph13

saver861 wrote: »

Sounds like a plan! If the markets fall much more than 40% then we all will have something to worry about. However, maybe you are trying to cover too many bases. In the case you say you might have to spend funds planned for inheritance. However, you also say that your kids will have inheritance from grand parents etc. Presumably they will have your property inheritance etc. Recognising a good equilibrium is also part of it.

A large part of what I'm hoping to achieve on the inheritance front is generation skipping. If my kids inherit from grandparents early on in life, plus having help from me along the way, then, as long as I have done a good job in bringing them up to be savers not spenders, they should hopefully be able to achieve FI by the time my wife and I are both gone. What I leave outside of pensions should then be able to be passed directly to their kids - and onwards in a self-perpetuating cycle. If I can leave a decent slug in the pension too, then it will be much easier for my kids to be able to forgo the non-pension bit. The early years of the journey to FI are the hard ones when there is mortgage debt to pay and little investment to compound. Inheriting early is therefore so much more useful than inheriting late.
And before anyone says anything, I know that my strategy to keep my putative descendants financially comfortable in perpetuity is massively in the category of 'hope' rather than 'plan' and there are a million things that could go wrong, but it makes me happier than spending the money would and that's the whole point.

saver861

Triumph13 wrote: »

A large part of what I'm hoping to achieve on the inheritance front is generation skipping. If my kids inherit from grandparents early on in life, plus having help from me along the way, then, as long as I have done a good job in bringing them up to be savers not spenders, they should hopefully be able to achieve FI by the time my wife and I are both gone.

Like I said earlier, I think the only flaw in what you are trying to do is over perfecting it.

What is FI though? Is it something that is achieved or does it have the same value if it is given/inherited?

Just the other day I was chatting to a man well into his retirement. He is very comfortable having had a successful career etc. He was saying that if he had a significant windfall from whatever source, he would like to pay off all his kids mortgages etc. However, when I put the question to him would he be really doing his kids any favours by doing so, he pondered.

Is it not the case that part of a fulfilling life is to strive! Having the zest to work for challenges etc. The man I was talking to did say then that he had not gained much materially/financially from his father due to his parents modest circumstances. Yet he himself had a successful career which provided well during his working life and now a comfortable retirement.

Triumph13 wrote: »

but it makes me happier than spending the money would and that's the whole point.

Clearly everyone has their own objectives etc. Money has differing values for different people. However, if you are having an iterative monologue about your plans to provide for your retirement and for a generation skipping inheritance, it may be worthwhile to consider taking a looser approach.