Is guaranteed retirement income a fixed interest asset?

DairyQueen

I am reading a US paper (bullet point on page 19)* that positions guaranteed retirement income within the ‘fixed interest/bond’ allocation of an in-retirement portfolio. It was authored in Nov '17 by Stanford academics including Wade Pfau so has some legitimacy.

This is a new concept to me and I am interested in opinions from the forum.

The paper suggests that guaranteed income is a fixed interest component of a portfolio. The authors include US state pension in this definition: ‘Once social security benefits have been optimized, the analyses can justify significant allocation of remaining savings to equities’.

(Note that for American ‘middle income retirees … social security provides 70% to 85% of total retirement income’. We can but dream)

The suggestion is that the more guaranteed income available as a proportion of income required, the lower the bond allocation within the drawdown portfolio. Or, expressed another way, a higher allocation to equities can be justified. This makes sense given dependency on drawdown reduces in proportion to the availability of other income streams sufficient to meet needs.

Theoretically, those who are able to cover all/most income requirement from other sources could go high equities (80-100%) and hold a chunk of cash sufficient to cover drawdown suspension during market crashes.

For those able to sleep when their portfolios drop 50% with an unknown period of recovery, bonds would be a redundant asset class. Conversely, those with higher drawdown dependency would need to allocate more to lower risk asset classes.

So, should the percentage of total income required from drawdown be a factor when determining the asset split in a retirement portfolio?

* Warning: This is a loooonnnng academic paper with American retirement and tax refs. However, the ideas are thought-provoking and UK-portable.

bostonerimus

You should take a holistic approach to retirement planning. That's what Wade Pfau and co-authors are doing in the paper. I have rental and pension income to cover my retirement spending and so I have a 75% equity allocation with the rest of my investments and plan to let that percentage increase as I get older and state pensions start.

The paper suggests a common US strategy and that is to delay taking the US equivalent of the State Pension as long as possible so that you can get a higher amount after age 70. UK retirees can also delay their state pension to get a larger amount, but you obviously need a way to fund the "gap years". I've done the calculations for delaying US state pension and taking it at age 65 vs age 70 I will have to live past age 83 for it to pay off, but there might be utility in just having the larger monthly payout for many people.

Albermarle

It's clear that the more your retirement income is guaranteed , the more risks you can take with the non guaranteed part ., if you were so inclined.
However as you say , even if you could survive a 50% market drop easily , it still would feel pretty bad that so much of your hard earned cash had disappeared , maybe never to fully recover in your lifetime.

So if you are a naturally cautious 40% equity type of person then you are not going to go to 100% equities in your drawdown fund , regardless of how much guaranteed income was covering your main costs .

Would be probably breaking the habit of a lifetime and sleepless nights would still be the order of the day I think.

Linton

DairyQueen wrote: »

........
So, should the percentage of total income required from drawdown be a factor when determining the asset split in a retirement portfolio?

Absolutely definitely YES. This is one of those cases where "to those that have even more shall be given". People who have little guaranteed income must be fairly cautious with their investing and will receive corresponding moderate at best long term returns. If you have significant guaranteed income you can survive the downturns entirely or mainly on your guaranteed income and can therefore go for 100% equity, with again the corresponding long term returns.

Apodemus

Makes sense to me! I should just about cover my minimum retirement needs from DB pension, State Pension and a drawdown strategy on my DC pension, so I am not looking to de-risk my other investments as much as I would if I was totally dependent on them for basic living costs.

bostonerimus

In 1997 I bought a house with a rental apartment on the ground floor and when I took a government job with a DB pension I developed a plan to retire mortgage free so that my DB pension and rental income would cover my basic expenses. I thought of my pension and rental as part of my fixed income allocation as they would provide regular income and this freed me to increase my equity allocation as I approached retirement. I still keep a couple of years spending in cash for convenience and I’m letting my equity percentage drift up northwards of 75% as I’ve stopped rebalancing. As I don't ever expect to go into drawdown for income I can be sanguine about the investment markets and their direction.

Audaxer

DairyQueen wrote: »

Theoretically, those who are able to cover all/most income requirement from other sources could go high equities (80-100%) and hold a chunk of cash sufficient to cover drawdown suspension during market crashes.

I agree, but some people could also take the opposite view that if all income required is covered by guaranteed income, there is no need to take any unnecessary risk with other savings or investments.

TBC15

So people that are relatively well off from their fixed income can take more risks with their investments?

Who saw that insight coming. Is there a Nobel for the painfully obvious?

Hal17

v2c§fbghn§jm1¬#≥¢;5^89-[p-o0]i9utr4,2 1n/^|67|"<:327

Thrugelmir

Personally I've always viewed our DB pension schemes as being the equivalent of gilts / fixed interest. Thereby allowing a little more flexibility with the investment of the DC\AVC elements.

bostonerimus

Audaxer wrote: »

I agree, but some people could also take the opposite view that if all income required is covered by guaranteed income, there is no need to take any unnecessary risk with other savings or investments.

Yes, the choices of the lucky people who find themselves in that situation are more about personal preferences and character than anything else. Are they risk takers, optimists or pessimists etc?