Any point in a Cash buffer in Pension Drawdown Account?

green_man

Triumph13 wrote: »

I think the real question isn't 'Should I have a cash buffer?' it's 'What is my tactic going to be if markets go down?' A cash buffer may be a useful way to mitigate stress, but only if you have a plan on how to use it that you are comfortable with.
In my view there are 3 basic responses to a market fall:

1. Carry on regardless and trust that all will be well / accept that there is now a higher risk of things not going well.
2. Reduce your spending.
3. Take part of your income from different sources eg cash buffers or part time work.

You need to have a plan that works with both your financial position and your personal psychology. Personally I plan to use a combination of the last two using a 1 year cash buffer to cover half of any shortfall and spending reduction the other half. That would cope with a 40% fall sustained for 5 years which is sufficient to let me sleep at night.

But have you convinced yourself that in this scenario (40% fall, 5 years) that the cash buffer approach gives an advantageous outcome once you take the whole economic cycle into account?.. I’m beginning to think the personal psychology element is in fact the overriding factor for most people.

green_man

OldMusicGuy wrote: »

What you're missing is my "bucket" strategy. I am not following the example set out in the article. I have a significant amount of money currently invested 50/50, which I think is safe for a long-term retirement. My cash buffer does not require me to reduce that to 10/40/50. I have always separated the cash out in my mind and will use that to fund early years of retirement at no risk. FWIW I actually moved 100K from cash into funds in Feb last year (two days before the correction!). Even I felt I was holding too much cash.

Now I could put all my money into more equity and bonds but as I explained, my personality type really would not like that. The downside is just too much for me to contemplate. And if it was wildly successful, I would end up with too much money anyway.

Not missing, just ignoring:D. In your situation it sounds like you are comfortable enough not to be too concerned whatever approach you took. You could go 100% equities and be quite comfortable enough to ride out a 5 year 40% drop. You current approach clearly fulfils your requirements. I’m not trying to change your mind, I just find the different approaches to similar scenarios interesting.

Linton

Looking at the article two things strike me...


1) the figures are based on a 50-50 equity/bond allocation. Then a 10% cash allocation is taken from the equity tranche reducing the overall equity % to 40%.

2) The success figures (ie not running out of money before death) seem remarkably low to me. In past discussions something approaching 95% is deemed reasonable. Would you really accept a strategy with a 1 in 5 chance of you ending your life in poverty? To be able to safely withdraw a relatively high % of your initial pot increasing with inflation you do need a substantial % in equities.



With such a high % in bonds the effects of crashes are substantially diminished. One could well believe that the further reduction in average returns by removing 20% of your equity into cash would outweigh any benefit of the relatively small amount of cash during crashes. In any case you can use bonds as your buffer with much the same effect as using cash. There seems little point in having the extra 10% cash buffer.



It seems to me that the scenario being modelled is pretty unrealistic im UK circumstances, at least with current bond returns. It would be more interesting to compare the risks of say a 80%equity/20% cash buffer portfolio vs a 100% equity one.

Audaxer

green_man wrote: »

I understand your concerns and everyone should pursue a strategy they they are comfortable with, however the research I posted before does indicate that holding cash actually increases risk in all their modelled scenarios!

OldMusicGuy is pursuing a strategy he is comfortable with. The modelled scenarios I have looked at show that holding cash may produce a drag on returns and not maximise them. However I don't think that means you are increasing risk by not holding cash. If you don't need to maximise returns, there is a benefit of holding cash as well as other defensive assets like bonds in a portfolio. If there is a poor sequence of returns in the first decade of retirement I think there would definitely be a risk of running out of money if you go 100% equities with no cash.

kidmugsy

coyrls wrote: »

The issue with (i) is that a Purchased Life Annuity is unlikely to be good value.

Compared to what? Equities that might lose two thirds of their value over the next two or three years?

coyrls wrote: »

As I understand it, the purchased annuity market is very small and people who buy purchased annuities tend to live longer than average.

I don't think our hypothetical investor would buy the PLAs unless he had objective reason to hope that he and his widow might live a long time. Though if he was in poor health he would presumably get a higher annuity rate anyway.

The point is to diversify your risks. Retirement investing isn't just about returns: risk matters hugely because your human capital - i.e. your ability to earn a living - is so depleted.

kidmugsy

Audaxer wrote: »

As the percentage is now only 5.8% just wondering how many years it would take to break even after deferring for a year?

You tell me the CPI inflation rate, and the return you might have got on the pension money if you hadn't deferred, and I'll tell you the break even time.

Audaxer

kidmugsy wrote: »

You tell me the CPI inflation rate, and the return you might have got on the pension money if you hadn't deferred, and I'll tell you the break even time.

I am planning to get the maximum SP of £8,546 per year at age 66, which will be subject to 20% tax. If I deferred it for one year, and estimate it increases by 2.5% each year with inflation, if my calculations are correct it would take me 15 years to break even. So maybe a bit less time than I thought to break even, but I don't think I'll be deferring it.

kidmugsy

Audaxer wrote: »

If I deferred it for one year, and estimate it increases by 2.5% each year with inflation, if my calculations are correct it would take me 15 years to break even. So maybe a bit less time than I thought to break even, but I don't think I'll be deferring it.

The point of buying extra state pension would be that you were frightened by the prospect of substantial inflation and therefore wanted more inflation-linked income. In that circumstance it's rather potty to model with 2.5% inflation. Surely the pensioner would be worried by a 1970s scale of inflation?

Triumph13

green_man wrote: »

But have you convinced yourself that in this scenario (40% fall, 5 years) that the cash buffer approach gives an advantageous outcome once you take the whole economic cycle into account?.. I’m beginning to think the personal psychology element is in fact the overriding factor for most people.

That depends entirely on how you define advantageous. Too many models concentrate solely on enabling the most spending possible over the course of retirement. The real aim should always be to maximise happiness. To do that you need to understand, for the individual concerned, the marginal utility of both more and less money in a given year, the anxiety levels caused by fluctuating markets and whether they think leaving money on the table at the end means they lost or they won.

Robert_McGeddon

green_man wrote: »

Indeed, if within 100% equities it should be comfortably such. Yet others say if you don’t need the growth why risk 100% equities! It’s an interesting dilemma

Equities have the potential for both income and capital growth (or loss!).There is not necessarily a direct connection - if the stock market rises or falls by, say, a third for a year or two the dividends will probably be much less volatile.. So if you're investing in shares for growth then yes, be wary of stock market crashes, If you're just in for the natural yield then I think you should be less concerned about market volatility - you're more interested in the best revenue stream you can achieve on your investments. There is still a risk on the revenue side of things of course, but that's true of all investment types. .