How do professionals manage sequence of return risk?

tacpot12

Does anyone know how professional pension managers manage sequence of return risk?

Given that the future returns and volatility of returns is uncertain, how do professionals decide on a safe withdrawal rate?

Anyone know?

Dox

There are various approaches - no one magic answer, sadly. If you just google on your question, you'll get plenty of options.

tacpot12

I've read much of the theory, but was hoping someone might have some knowledge of how the professions actually manage pension portfolios where the client has a specific income requirement.

Thrugelmir

Any such plan would need to be tailored to fit your personal circumstances. As would factor in your other sources of income. There is no one size fits all.

Dox

tacpot12 wrote: »

I've read much of the theory, but was hoping someone might have some knowledge of how the professions actually manage pension portfolios where the client has a specific income requirement.

It has to be done individually, a key issue being the client's attitude to risk. No professional will guarantee that any portfolio will deliver a specific outcome - it just depends what sort of risk the client is prepared to take, as well as how much risk.

ams25

As stated, it varies so much... Variables being your attitude to risk, whether you have an income floor (secure income from pensions, annuities etc) and what proportion of expenses that accounts for, how flexible you are prepared to be (cutting back in a severe down market), the size of portfolio vs income required etc etc. Plenty of material to read....but case studies on what folk actually do is less easy to find. I'd be interested to read more too.

My personal approach (c. 2 years into retirement) is to have at least 2 years in cash and a further 3-5 years in less volatile investments (bonds etc). I'm working on withdrawing c.3% from my portfolio as a safe withdrawal rate (based on allowing for a 40+ year retirement, fees and wishing to leave a legacy). My equity allocation is c. 50% now but I will increase that over time to at least 60%. This is based on plenty of experts, retirement planners etc advocating this approach...and fits with my attitude to risk, personal circumstances and income requirement. I take a total return view but dividends/interest yield covers a decent chunk of the withdrawal amount.

You will find many saying keep c.75% in equities throughout and ride out the downturns. And while that may over the long term give (slightly) higher returns I would not want to be 2 or 3 years into retirement and have my portfolio go down by the best part of 50%. What aids restful sleep matters to me.

bostonerimus

tacpot12 wrote: »

Does anyone know how professional pension managers manage sequence of return risk?

Given that the future returns and volatility of returns is uncertain, how do professionals decide on a safe withdrawal rate?

Anyone know?

There's a lot of academic research on this topic and both professionals and DIYers can use the basic tools of asset allocation, product selection and withdrawal rates to manage drawdown. But perhaps the most critical factor is only controlled by you and that's your budget - what you spend and how you adjust it through out your retirement.

Of course if you can afford to buy an annuity, that's the easiest and safest way to manage risk.

tacpot12

Thanks for all the responses so far. I know I can't afford an annuity, but I do have a very good handle on my non-discretionary living expenses.

I also have other forms of income to factor into my own personal calculation, including a couple of small DB pensions that I can take at age 63 and 65.

I've gone with an roughly 80/20 equity/bonds split as my attitude to risk and volatility is quite aggressive, and I am planning for a 45 year retirement! :-)

I was wonder if any advisors/pension managers have developed models to identify an initial safe withdrawal rate for each model portfolio or client risk profile. Or a model that takes the other income streams into account.

coyrls

You could take a look at these books:

https://www.amazon.co.uk/gp/product/1985721643/ref=oh_aui_detailpage_o01_s00?ie=UTF8&psc=1
https://www.amazon.co.uk/gp/product/0997403403/ref=oh_aui_detailpage_o07_s00?ie=UTF8&psc=1

kidmugsy

I find Dirk Cotton's blog very good.
http://www.theretirementcafe.com

ams25

tacpot12 wrote: »

I was wonder if any advisors/pension managers have developed models to identify an initial safe withdrawal rate for each model portfolio or client risk profile. Or a model that takes the other income streams into account.

check out Wade Pfau's book https://www.amazon.co.uk/How-Much-Spend-Retirement-Investment-Based/dp/1945640022. He covers this in great detail.

My approach is to work out what the SP and my DB will provide in 7 and 14 years, bridge those gaps with cash amounts so I have the ongoing amount needed from my investments...then use a suitable withdrawal amount.

Say I have 10k from db and state pensions in 5 years.
I have total expenses of 20k pa
So I need approx 50k (5x10) to bridge the gap with the DB and SP.
I need a starting 10k pa from investments from now
If I had a 300k remaining portfolio (excluding the 50k) then 3% would cover it fairly safely
If I had 200k then 5% is needed...which is more agressive and would need careful management (ie you would have to cut expenses or find new income) in a severe and prolonged down market.

Simplified example but by splitting out your income streams you can derive the required withdrawal approach.