How do professionals manage sequence of return risk?

Audaxer

bostonerimus wrote: »

I never understood this logic as it argues that more spending is better and I've always found that enough will suffice, which I think is why I now have way more than I need. I want to leave lots of money to my heirs and to some charities so that what I've worked for will be useful after I die.

I agree with you that more spending doesn't necessarily improve the quality of life. Peace of mind knowing you have more than enough probably improves quality of live even more.

Paul_Herring

bostonerimus wrote: »

If you use a success rate that's too high you waste money, dying with money you could have spent to improve your quality of life.

I never understood this logic as it argues that more spending is better and I've always found that enough will suffice, which I think is why I now have way more than I need. I want to leave lots of money to my heirs and to some charities so that what I've worked for will be useful after I die.

The logic presumes that the quality of life is not as good as it could have been had a lower rate been used.

You're presuming the quality of life is "good enough," and that the higher rate is sufficient for it.

Both are right - depending on circumstances

bostonerimus

Paul_Herring wrote: »

The logic presumes that the quality of life is not as good as it could have been had a lower rate been used.

There is obviously some baseline income that you need to be comfortable, but above that I think that any perceived improvement in quality of life is pretty delusional. Of course this is a very personal view. So IMHO the most important factor in retirement income planning is how much you spend. You must have a plan to modulate spending and other than inflation that modulation should only be negative.

I'm lucky (or you might call it planning ahead and being frugal while I worked) in that I have far more than I need and I mitigated retirement income risk by essentially buying an annuity just before I retired and owning an apartment that gives me monthly rent. Those more than cover my basic expenses. So I have largely decoupled my income from stock and bond fund returns. If you can't live off the lower income that guaranteed investments usually give then you will have to have more risk in your retirement portfolio.

ams25

I quite like the endowment or hybrid model for withdrawal as described in Wade Pfau's book (referenced earlier in this thread) where you take a withdrawal based on 50% of an inflation adjusted (increasing) 4% (or 3% or whatever) and 50% based on an actual 4% (or 3% etc) of the portfolio remaining. So it gives you a mix of spending growth on the inflation adjusted starting amount but links to your actual portfolio value whether higher or lower. Enhances what you can take out while reducing the risk of running out of money and reducing sequence of returns risk. Much simpler than some other rules based approaches but much of the benefit.

So 100k portfolio and 4% withdrawal, 2.5% inflation rate
Year 1 portfolio value 100k 4% or 4k withdrawal
Year 2 portfolio falls to 80k so withdrawal is 4% on 100k + inflation /2 (£2050) and 4% on 80k/2 (£1600)
So 2050 + 1600 = 3650

One approach proposed by the professionals as preferable to the standard 4% rule...

ams25

just discovered it this website which might interest followers of this topic. so much to read and learn out there...

https://howmuchcaniaffordtospendinretirement.blogspot.co.uk/2018/03/developing-sustainable-spending-plan.html

link may not work... if so google "How Much Can I Afford to Spend in Retirement?" and you should find this site.

looks super geeky.. but hey....

jamesd

k6chris wrote: »

I’m not sure that the correlation between money and quality of life is equally linear in both directions? Not having enough money for a comfortable existence strikes me as being a far more penal outcome than the risk of a potential underspend??

I'm sure it's very non-linear, yet it's not just higher income, it can be retiring earlier or saving less. Being too cautious can cost years of working during what could be the healthiest and most enjoyable years of retirement.

Thrugelmir wrote: »

Where can I obtain my date of future death from?

You can't until it's unpleasantly close. That's why sensible life expectancy, provision for the unlikely very long life and regular reviewing should be done. And each individual will have their own balance of the various factors.

jamesd

bostonerimus wrote: »

I never understood this logic as it argues that more spending is better and I've always found that enough will suffice, which I think is why I now have way more than I need. I want to leave lots of money to my heirs and to some charities so that what I've worked for will be useful after I die.

It's not just more money, it can be the same money and retiring earlier. Living on less is doable but we can't get extra years in retirement except by making some decision about what's enough.

I'm also at way more than I need, having changed my objectives.

kidmugsy

Wade Pfau suggested:

1. Spend conservatively.
2. Maintain spending flexibility.
3. Reduce volatility, including using derivatives to cut downside risks.
4. Use buffer assets so that you can avoid selling at a loss e.g. set up a line of credit on a "reverse mortgage" [i.e. equity release].

"... you should look to hold bonds to maturity or use risk-pooling like ... annuities"

Aleph Blog suggested that you embrace some illiquidity e.g. "you take some money that you would otherwise allocate to bonds and buy a life annuity".

For other investments he suggest you avoid illiquidity on the grounds that the premium yield for illiquidity will be too low.

These are American writers. In the US "reverse mortgages" seem to be widely available on good terms but inflation-linked annuities seem to be (almost?) unavailable.

tacpot12

Thank you everyone for your comments.

Reflecting on my question and having looked at annuity rates, it appears that annuity providers manage sequence of return risk by paying derisory rates! The best annuity (linked to CPI) plus my other income streams still wouldn't cover my minimumn income requirements.

My main concern has to be the potential to run out of money....

This is also my primary concern, but I also wany to maximising my withdrawls to get the most out of my retirement. Balancing these two needs is what is driving my research into the management of sequence of return risk.

I'm currently expecting to manage the risk using different 'buckets' containing assets with different volatility, and adjusting the withdrawal rate based on the Shiller PE (Cyclically adjusted price-to-earnings ratio or CAPE).

I still need to investigate the effect mentioned earlier where most equity growth comes from reinvesting the income.

I'm not married, but I do live with a partner and our finances are very intertwined. However, she has a public sector pension that will meet all of her basic income requirements. We also have a rental property that we own as joint tenants - currently we split the rent but if I die she will own the property outright and will receive all the rent. I have asked that my SIPP be split between my children and my partner on my death, so in this respect she is also affected by the sequence of return risk; but not for the income but for the residual. Even then, the residual will just improve her quality of life, not be a fundamental necessity for survival.

Thanks everyone

kidmugsy

tacpot12 wrote: »

it appears that annuity providers manage sequence of return risk by paying derisory rates!

I despair sometimes: does nobody who posts here understand any ruddy economics?

Would you care to explain how an insurance company could pay out a high inflation-linked annuity while its offsetting investment needs to be in inflation-linked gilts which offer a negative (i.e. NEGATIVE) inflation-linked return?