Any point in a Cash buffer in Pension Drawdown Account?

Spreadsheetman

Linton wrote: »

The over-riding purpose of SWR is to avoid dying in poverty. If you die rich it has succeeeded. As a planning aid it is very useful. The mistake I think is to actauslly believe one can calculate it once prior to retirement and then keep to it regardless of what happens.
If one does use SWR, during retirement it should be sensible to recalculate it on a regular basis, say every 5 years, taking into account the fewer years one has left. This should substantially reduce the problem of excess wealth on death.
This ties in with keeping a significant though minor portion of ones assets in cash as it reduces the psychological pressure to modify expenditure at every temporary boom or bust of the market.
Personally I do not use SWR along with Guyton etal in the form often advocated for determining my actual withdrawals. Basing ones life on probabilistic simulations of the past seems highly questionable and inflexible leading perhaps to excessive caution. I find continual relatively detailed simulations of the future on based on pessimistic assumptions provides a more convincing and controllable risk management as is it enables ongoing comparison with reality.

Interesting thoughts. So how would you react to a year like 2018 where a portfolio is (say) 5% down? Then what if 2019 was 5% down? Then what if 2020 was 5% down? (could be very possible with the current UK and world situation)

Handling one bad year should be easy, skip a holiday, delay a purchase, use some cash, but what happens when a string of bad years occur? How do you react each year? Or should reviews be 3-5 yearly to smooth the result that spending decisions are made on?

MK62

Spreadsheetman wrote: »

Interesting thoughts. So how would you react to a year like 2018 where a portfolio is (say) 5% down? Then what if 2019 was 5% down? Then what if 2020 was 5% down? (could be very possible with the current UK and world situation)

Handling one bad year should be easy, skip a holiday, delay a purchase, use some cash, but what happens when a string of bad years occur? How do you react each year? Or should reviews be 3-5 yearly to smooth the result that spending decisions are made on?

You'd probably need to re-assess income level at least on a yearly basis.......having a cash buffer would mitigate a string of bad years, but eventually if the bad run persisted long enough, you'd probably be faced with selling investments at lower prices, same as anyone who relies on an investment based portfolio for income.
How would you handle the same string of bad years if you had no cash buffer at all?

In the end, planning comes down to probabilities, what-ifs and your own view of the world......plus the acceptance that there is no day-one plan which can cater for all eventualities - you have to re-assess, based on reality, at fairly regular intervals.

dunstonh

Interesting thoughts. So how would you react to a year like 2018 where a portfolio is (say) 5% down? Then what if 2019 was 5% down? Then what if 2020 was 5% down? (could be very possible with the current UK and world situation)

Expanding on what you are saying, that is nothing unique to current situation. The early millennium was a drawn-out affair which saw the FTSE fall 6.5% in 2000, -14.7% in 2001 and -23.4% in 2002.

Not all "crashes" are within a week or two. Sometimes you get the drawn out decline.

And as green-man is investing much higher than the typical retired individual, rather than -5% three years in a row, those figures could well be -6.5%, -14.7%, -23.4%.

Handling one bad year should be easy, skip a holiday, delay a purchase, use some cash, but what happens when a string of bad years occur? How do you react each year? Or should reviews be 3-5 yearly to smooth the result that spending decisions are made on?

This is where your capacity for loss comes in and the method you are using. If you have a cash buffer both within the pension and externally, you can reduce the sale of equities to little or nothing.

Reviews should be yearly. You should play scenarios out and think how they would impact on your standard of living.

Linton

Spreadsheetman wrote: »

Interesting thoughts. So how would you react to a year like 2018 where a portfolio is (say) 5% down? Then what if 2019 was 5% down? Then what if 2020 was 5% down? (could be very possible with the current UK and world situation)

Handling one bad year should be easy, skip a holiday, delay a purchase, use some cash, but what happens when a string of bad years occur? How do you react each year? Or should reviews be 3-5 yearly to smooth the result that spending decisions are made on?

My year by year plan is based on what so far have proved to be very pessimistic long term assumptions on return and inflation and is continuously updated semi-automatically in line with reality, daily for investments and weekly for expenditure/income. The plan provides for withdrawal from investments that together with various guaranteed incomes is sufficient to comfortably meet all our day to day expenditures, both basics and normal luxuries, increasing with assumed inflation. The key output is estimated wealth at death.


Provided wealth at death is comfortably high, and more than sufficent to meet care needs I have no reason to change the plan. Any potential large discretionary one-off expenditures (round the world cruises, new kitchens, new cars) are added to the plan and provided the planned wealth at death is still adequate the expenditure can go ahead.


Each year I drawdown the maximum I can whilst remaining a basic rate tax payer. The money is split between additional cash savings to cover that years expenditure and S&S ISAs. Following the drawdown the whole portfolio is rebalanced to retain the desired %split between separate growth, income and wealth preservation/cash portfolios and the desired asset allocation within each portfolio.


Should the planned wealth at death show significant falls the annual expenditure budget and discretionary expenditure can be cut. With SWR/Guyton a major fall would cause an immediate major reaction. With my strategy, since the effect of a budget cut is spread over the rest of my life the short term effect on standard of living is much lower. Also, using wealth at death as the criterion leads one to regard major falls with some equanimity.



With a detailed plan one can regard the expenditure budget as a target rather than a constraint. Any money one could spend now but doesnt represents a problem for later when ones ability to usefully spend money may be limited. I have started to make charitable donations around rebalancing time for this reason.

tacpot12

green_man wrote: »

Ok, so I’ve not run the numbers myself, but I have found the research I was after.
See here: http://investmentmoats.com/financial-independence/why-having-a-cash-buffer-does-not-increase-the-longevity-of-wealth-in-financial-independence/

The conclusion being:

Many financial planners recommend holding cash equal to 2 years’ withdrawals to draw on when your investments are down. The idea is that after a significant down year, you can live off the cash and not touch your investments, to give them some time to recover.

This sounds logical, but was not supported by the 146-year study. For example, assuming 100% in equities and a cash holding, here are the success rates for a 30-year retirement:

In every case, holding cash either had no effect or increased the risk of running out of money. I could not find a single example of a retiring year or withdrawal amount when holding any amount of cash provided a higher success rate than holding no cash.

The study showed that holding cash does not protect you. In fact, it often increases your risk of running out of money.

I am 99% certain that the study compared the success rate in retirement by using the historic returns of the two different asset classes: equities and cash, and did not apply any logic as to how income was withdrawn from the pension. So if the safe withdraw rate being tested was 4%, in year 1 it would withdraw 4% of the equities and 4% of the cash, and so on each year until the portfolio was exhausted.

Once you apply some logic to the withdrawal process, e.g. withdraw 100% cash in years when equities have crashed, I believe the cash buffer methodology stands up to scrutiny, but I have not seen analysis on this beyond whatever is on the earlyretirementnow (ERN) website.

In my own pension, I have taken a layered approach to this cash buffering. I have a cash buffer of about 12 months income, I have some funds that have been selected for their lack of correlation to equity price movement, and low-volatility. These funds can also be sold if equities have tanked. The bulk of the portfolio is designed to produce a mixture of growth and income in equal measure; even though equity values have fallen significantly this year, my pension has another £14,000 cash in it as result of income over the past year. Just less than 50% of the portfolio is invested in Investment Trusts which also results in some smoothing to the flow of income.

My safe withdrawal rate is about 6% (I have some DB pensions that kick in in my 60s), and I plan to withdraw about £18,000 from my pension over the next 12 months (in equal monthly payment). I already have £14,000 of this, and about £1000 arrives every month, so I don't expect to have to sell any equities, or even any of my low-volatility assets even though the market has fallen significantly.

Paul_Herring

tacpot12 wrote: »

I am 99% certain that the study compared the success rate in retirement by using the historic returns of the two different asset classes: equities and cash, and did not apply any logic as to how income was withdrawn from the pension.

You could always read the study (or the article that was linked here - it copies a lot from it) and reduce that 99% figure...

tacpot12

Paul_Herring wrote: »

You could always read the study (or the article that was linked here - it copies a lot from it) and reduce that 99% figure...

Yeh, you caught me being lazy. I'll have a read, and then I'll update the thread.

Linton

A large cash buffer is insurance. Like any insurance, on average you would be wealthier if you did not pay for it. However protection from the downside of a non-average situation could be more important to you than the loss of wealth.

tacpot12

Paul_Herring wrote: »

You could always read the study (or the article that was linked here - it copies a lot from it) and reduce that 99% figure...

Thanks for calling me out on this; the article DID apply logic to the sequence of withdrawals, so my assumption was wrong - as they so often are. You would think I would have learned by now!

The article absolutely proves the value of a buffer (and an update Equity Glideslope), but also shows that a CASH buffer does not increase the success rate; it actually reduces it over shorter terms, although not by much.

It goes on to analyse the reason for it, which is as that the historic return of cash is less than the historic return on equities. The author points out that in implementing the cash buffer "... you take 10% of equity and move it to cash. It is a drastic reduction in overall wealth growth rate." I would agree, if convert 10% of your equity investment to cash, you have lost the growth potential of 10% of your portfolio.

As I explained, I implemented my cash buffer slightly differently: the portfolio started as a mixture of bonds and equities, most of which produce a natural yield or income. The portfolio was implemented in this form a year before retirement, so that the cash buffer was built up prior to retiring. Clearly this will have resulted in some loss of growth in the portfolio because the income was not being reinvested, but it did not require me to sell 10% of my portfolio for cash and thus permanently lose the potential growth and income of the portfolio. I think I've lost about 3% of the growth & income potential of my portfolio by building my cash buffer in this way (and I don't have two years+ worth of cash).

Was I right to hold a cash buffer? The article suggests not, but I think we need to also appreciate that it is measuring success in terms of failures under previous scenarios. There is potential for a new scenario to occur in future. It is my personal choice to hold a cash buffer to diversify the asset classes I hold. I have some commercial property holdings in the portfolio, and have two residential properties that produce an income outside of the pension, so I clearly like the idea of diversifying to the maximum amount possible. The cash buffer also means that I reduce dealing costs as I have some flexibilty to decide when to sell which asset class and don't need to be too reactive.

I hadn't seen the article prior to this thread, so thanks to the OP for drawing our attention to it.

goRt

I'm close to the FP14 LTA so have to withdraw crystalised funds from my SIPP every year.
you need to be aware that cash held within a SIPP is pooled with all other cash held by that provider so you get a %age of one lot of 85k FSCS compensation.
ii used to be different but changed sometime in the last quarter without notice - the 400k urgent emails it sent out in December are the result of my complaint!