Don't cash in your final salary pension

kidmugsy

jamesd wrote: »

Before treating that as credible you should know that John Ralfe is the guy who got fired after he moved the Boots pension scheme out of equities into bonds.

I don't know why Boots sacked Ralfe, but if my memory is right his decision was a great success at the time, and his logic in its favour was persuasive.

But enough of ad hom to-and-fro, how about engaging with his "acid test"?. Would you like to refute it, jamesd?

"If holding equities for the long-term really does mean you will always “win”, with little risk, why don’t investment firms offer funds with guaranteed equity outperformance, and charge a modest fee to reflect the (supposedly) modest risk?"

jamesd

kidmugsy wrote: »

I don't know why Boots sacked Ralfe, but if my memory is right his decision was a great success at the time, and his logic in its favour was persuasive.

But enough of ad hom to-and-fro, how about engaging with his "acid test"?. Would you like to refute it, jamesd?

"If holding equities for the long-term really does mean you will always “win”, with little risk, why don’t investment firms offer funds with guaranteed equity outperformance, and charge a modest fee to reflect the (supposedly) modest risk?"

I already did refute it indirectly. It's the same bogus argument as the one about buying options. Like the option seller the fund managers will take a big loss during a brief drop in value as everyone sells to exploit their guarantee then buy on the open market. A retiree needing income doesn't need that never lower guarantee because they never need to spend the whole of their retirement pot at one moment. It's a straw man argument. The risk to the manager isn't small, the risk to the retiree is.

But let's pretend that a fund manager tries it. It has the word guarantee and so they must ensure that they deliver. How can they deliver? They have to protect against say a 50% market drop. One way would be to buy twice as many shares. Where's that money coming from? Not the investors and the fund manager is hardly going to offer to put in as much of their money as the investor at no charge, they could just invest it themselves and keep the profit instead. Or they could buy the options. It's that option buying straw man, by proxy. But who's going to pay for the options? It can't be the investors, they have been told they will get the equity returns. Again it has to come from the pocket of the fund house, given away free by them since it isnt cheap. They aren't in the business of providing free money, they could just invest it themselves without the inconvenience of selling anything.

As he said in the story, the point of doing it was to allow Boots to borrow more to do a £300 million share buyback and the pension switch was the financial engineering trick he used to do it. Persuasive logic for employees and others with shares and share options who could make a profit on the deal. Then he was fired, by 2004 the scheme had started to switch back into equities and commercial property and was in sufficient trouble by 2007 that it was an impediment to the 2007 takeover, requiring a £418 million cash injection to deal with the shortfall. £300 million of share buybacks then a £350 million underfunding six years later wasn't exactly a success story, except for Ralfe making his name well known and the shareholders who benefitted from the buybacks.

jamesd

BobQ wrote: »

While there are arguments either way on this one, there is something simple about having a DB, inflation linked for life, without having to spend a lot of time thinking/worrying/predicting what global stockmarkets will do to your future income.

The alternative is to rely on what the annuity market happens to offer or to manage or pay someone else to manage your investments. Most people are not confident enough to do this themselves and while it might make sense when you are 65 it might be less sensible as you get older.

Most people can do things like defer their state pension, at twice the income for their money as an annuity at around state pension age, and buy annuities as they get old enough or unhealthy enough for the expected return of that to beat remaining invested. It's the sort of thing that I expect to do and tell others to do.

Not that it's exactly hard to buy tracker funds and hold and once a year follow the steps in the Guyton Klinger drawdown method. Nor is it hard to once a year do what Guyton's sequence of return reduction method says.

Annuities are a poor alternative to DB. The problem is risk transfer. If a DB scheme does badly, perhaps under-funded or perhaps happening to have lots of demand during a long sustained period of low returns it has recourse to the employer to guarantee the payments. An annuity has to provide the same certainty but without recourse to an employer. It does that by offering lower income than the DB for the purchase price because it has to find the money to fund the guarantee somehow.

That's part of why drawdown can offer twice the initial income for the money. It doesn't need the guarantee because the retiree can say how low they will let their income drop, perhaps to the annuity level, instead of paying for a very expensive no drop even in the worst conditions guarantee. If they happen to be unlucky they get that low level eventually but if not they end up well ahead.

Of course annuities aren't always bad. If life expectancy is reduced they can pay more with a guarantee than DB, which uses scheme member average rather than individual life expectancy.

BobQ wrote: »

If I had the choice of a stress free DB income or accepting the uncertainty of the stockmarket I know what I would chose.

Or you could do some of each. Say state pension deferral and early annuity to guarantee your base needs and takedown with a few rules to work though once a year, hen gradual switching into annuities as you get older or sicker. It's not a one choice only world, you can pick blended solutions as well and each person gets to pick the blend between higher but not guaranteed or lower but guaranteed income that suits them.

jamesd

kidmugsy wrote: »

I suspect that you don't realise that that is untrue.

That would be because it's true, not untrue. Like bonds, investing in equities has always produced a return, in all markets globally at any time and for any holding period.

That return hasn't always been positive but it has been a return.

But of course I'm being pedantic. I know that you both meant positive return even though neither of you wrote that. It was just amusing to see the combination of him making an assertion that was guaranteed to be true and you asserting that it wasn't.

kidmugsy wrote: »

What is roughly true is something like "investing in equities for the 80 years before the last 20 years always produced a return in the long run as long as you invested in the right countries and bought and sold at the right times."

How do you propose to select your countries in advance, and to identify the times to buy and sell? Do you plan simply to buy "now"? And sell as and when you need the money? Do you realise that the latter decision is not the same thing as holding shares for the long term? Do you plan to invest in the countries where the stock markets did well in the past? Why are you confident that they'll do well in the future?

I expect that he was thinking of the countries covered in the Equity Gilt Study and others which show that the expected chance of equity returns beating bonds has historically increased the longer you hold the investments.

But that is not certainty and it differs for different countries, as do safe withdrawal income levels and optimal bond-equity mixtures for residents of each country who only invest in that country's markets.

For all of the equity markets studied, a couple of dozen including all of the big ones, it's been found that future returns are inversely correlated with the ten year cyclically adjusted price/earnings ratio. A person wishing to exploit that knowledge might choose to invest more heavily in markets at favourable PE10 than unfavourable, or to follow Guyton's same country approach that changes equity holding percentage based on PE10 of that market.

A sensible British person might also do well to recognise that if in normal good health state pension deferral around state pension age offers higher returns than the SWR for the UK so it would be sensible to defer. Similarly they might recognise that there comes a point where age or health causes annuity returns to exceed the SWR (those not factoring in life expectancy, some do) and as that happens some switching to annuities makes sense, absent inheritance motive.

chiefie

If someone has more than one DB pension and does the maths on all of them then there may well be an argument to transfer if their goal is early retirement or to reduce their hours. This is hardly ever taken into account in the press, it's always black and white yet many people nowadays have numerous jobs and different pension schemes.

The other issue is that the press always take into account average life expectancy after 65. What about enjoying life before 65, early retired but with a reduced income. It's a bit like comparing someone who likes Caribbean holidays but will only get them after 65 (when they are more likely to have worse health) than someone who likes going to benidor every year from 55. They may well love that - everyone is not the same ��

Finst

John Ralfe is a very interesting character with very bold and controversial (some would say crazy) views. Having heard him speak a couple of times I can say that he is also exceptionally good at putting across his point of view.


Always worth listening to, not necessarily worth following! Though in this particular case, I tend to agree that cashing in a DB pension isn't usually a good idea (not always, though).

Triumph13

BobQ wrote: »

While there are arguments either way on this one, there is something simple about having a DB, inflation linked for life, without having to spend a lot of time thinking/worrying/predicting what global stockmarkets will do to your future income.

The alternative is to rely on what the annuity market happens to offer or to manage or pay someone else to manage your investments. Most people are not confident enough to do this themselves and while it might make sense when you are 65 it might be less sensible as you get older.

If I had the choice of a stress free DB income or accepting the uncertainty of the stockmarket I know what I would chose.

Whilst I'd agree with James's technical arguments for why DBs give better returns than annuities, I think it's also interesting to note the role played in these arguments by loss aversion - the human tendency to place more weight on potential losses than potential gains. Thus people with a DB will tend to want to cling on to it rather than risk the vagaries of the market, but people with a DC won't want to take out an annuity in case they don't live long enough to make it worthwhile.

jamesd

Yes, loss aversion and also just risk aversion and unfamiliarity are factors.

For DC and annuity it's not just the not live long enough issue, it's also the half the likely income one. Throwing away half of your money to get certainty should be a tough sell.

Malthusian

The reason you can't buy a guaranteed stockmarket-linked investment for a modest fee is the same reason you can't buy a new Lamborghini for £5,000, because it doesn't cost a modest fee. There are however numerous products which offer guaranteed stockmarket-linked investment for eye-watering fees, so I'm not sure what he's on about.

For example, MetLife offer ISAs and pensions with guarantees - e.g. to pay at least the original investment at a specified future date, or on death. However in addition to having restrictions on the amount you can have invested in equities, you can expect to pay charges in the region of 3% per annum. Or you could invest in structured deposits linked to the FTSE 100, but again the charges (though implicit) can be very high, typically all investment growth over a certain cap and all dividends.

Even though a diverse portfolio of equities will outperform cash over the long term - not a crystal ball prediction but an economic law of physics - we don't know exactly how long the long term is. I could very easily design an investment product that would guarantee you performance in excess of cash, and for a modest fee as well. This is how it would work - it would ban you from withdrawing any money whatsoever if the portfolio is currently worth less than cash. Ever. No exceptions, if the markets are down and you want to get your money out, you'd have to wait however long it took for them to recover (which they would, as the only investment options would be sensibly diversified global portfolios). Simple. No-one would ever lose money in the MalthusianLife Guaranteed Lock-In Bond.

Of course, the reason I'm not doing this is because the product is utterly useless. Sometimes people have a good reason for wanting to withdraw money even when the investment is currently underwater. My artificial ban on withdrawing money when the investments are down offers investors no benefit whatsoever - since they could choose for themselves not to withdraw money when the investments are down if they don't need it. Moreover, I don't actually have any reason to charge a "modest fee" for my artificial no-loss lock-in, because if someone encashes their investment when the markets are down it costs me no more or less than if someone encashes their investment when the markets are up. So no-one has any reason to buy the MalthusianLife Guaranteed LockIn Bond - everyone will just buy a normal investment product that allows access at any time.

Triumph13

Malthusian wrote: »

So no-one has any reason to buy the MalthusianLife Guaranteed LockIn Bond - everyone will just buy a normal investment product that allows access at any time.

That depends how good your marketing department is!