How to calculate the worth of a fixed income product?

DT2001

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Then you can go for the riskiest to meet other objectives as income is only part of the whole (Inheritence?) or all income generating funds to use IHT excess income relief.

If you include your DB/SP into your 60/40 allocation and interest rates change and therefore ‘necessitate’ an adjustment it could work against you overall goals.

Linton says he does not ignore guaranteed income when designing retirement portfolio.He does this by removing it from the calculation of income required. So maybe the OP can advise if our discussion helps - does he start with his number, take off the DB/SP and then calculate the pot required (25 times income for rough target). 

[Deleted User]

Linton said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

Linton - How would you treat it?

The idea of allocating a value is presumably to see where you are in relation to a perceived end goal, which is measured in terms of a multiple of your number. Using Mordko’s 25 x is, I think quite reasonable but
I wouldn’t value a DB/SP in allocating assets directly but it would influence the strategy for the rest of the portfolio and therefore the balance. (I agree with Mordko it is part of your FI).
As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

If for example someone has a £200K pot and needs to drawdown £5K/year to supplement guaranteed income to meet their desired standard of living it is irrelevent whether that guaranteed income is £10K/year or £50K/year. 

My approach is to start from what one wants to achieve....

Put aside £25K as cash to ensure any short term disruption to payment would be covered.  Put £25K in Wealth Preservation funds to cover the medium term.  The rest can now be invested according to one's long term objectives.  That could be high risk equity if one wanted to die rich.  On the other hand it could be lower risk investments with the sole aim of matching inflation and topping up the cash buffer as required.  If one has no real use for all one's current excess wealth, why try to get more?

In neither case would I consider whether I "should" be in x% equity because a US investment guru says so.  There is no x that is right for all people at all times.  All that matters is investing appropriately to meet your objectives whilst avoiding sleepless nights..

The following two scenarios are not the same:
1. Person A with a 50k/y DB income looking to add 10k/y from his 250k DC pot.
2. Person B with a 10k/y DB income looking to add 10k/y from his 250k DC pot.

Person A can withstand market fluctuations far better than person B.  He can therefore put a much higher proportion of his 250k pot into an asset which fluctuates more but has higher expected returns.  Its just common sense. 

In general it’s important to consider your income streams holistically.   Between me and my wife we have 10 investment accounts and 7 sources of DB income streams. The whole thing is managed as a single portfolio. Which is straightforward.  Regardless of which pot has available cash, I know exactly which asset type and sector to invest in.   If we were to take each individual pot and start looking how to generate X thousand per year from each pot separately, we would create a mess. 

[Deleted User]

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Let’s say you bought an annuity with half of your money.  Does it mean that the invested portion of your portfolio needs to be split between FI and Equity in the same proportion as before the purchase?

Linton

Deleted_User said:

Linton said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

Linton - How would you treat it?

The idea of allocating a value is presumably to see where you are in relation to a perceived end goal, which is measured in terms of a multiple of your number. Using Mordko’s 25 x is, I think quite reasonable but
I wouldn’t value a DB/SP in allocating assets directly but it would influence the strategy for the rest of the portfolio and therefore the balance. (I agree with Mordko it is part of your FI).
As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

If for example someone has a £200K pot and needs to drawdown £5K/year to supplement guaranteed income to meet their desired standard of living it is irrelevent whether that guaranteed income is £10K/year or £50K/year. 

My approach is to start from what one wants to achieve....

Put aside £25K as cash to ensure any short term disruption to payment would be covered.  Put £25K in Wealth Preservation funds to cover the medium term.  The rest can now be invested according to one's long term objectives.  That could be high risk equity if one wanted to die rich.  On the other hand it could be lower risk investments with the sole aim of matching inflation and topping up the cash buffer as required.  If one has no real use for all one's current excess wealth, why try to get more?

In neither case would I consider whether I "should" be in x% equity because a US investment guru says so.  There is no x that is right for all people at all times.  All that matters is investing appropriately to meet your objectives whilst avoiding sleepless nights..

The following two scenarios are not the same:
1. Person A with a 50k/y DB income looking to add 10k/y from his 250k DC pot.
2. Person B with a 10k/y DB income looking to add 10k/y from his 250k DC pot.

Person A can withstand market fluctuations far better than person B.  He can therefore put a much higher proportion of his 250k pot into an asset which fluctuates more but has higher expected returns.  Its just common sense. 

In general it’s important to consider your income streams holistically.   Between me and my wife we have 10 investment accounts and 7 sources of DB income streams. The whole thing is managed as a single portfolio. Which is straightforward.  Regardless of which pot has available cash, I know exactly which asset type and sector to invest in.   If we were to take each individual pot and start looking how to generate X thousand per year from each pot separately, we would create a mess. 

If as I suggested in the example at least 10 years non-guaranteed income is covered by zero or low volatility investments I find it difficult to see that market fluctuations are an issue.  

Regarding multiple investment accounts, yes I agree it makes no sense to manage those individually.  That is why I manage my portfolio(s) across multiple acounts and place new investments into whichever account has the cash.  However that does not require bundling in pseudo-bonds to represent DB pensions.  After all these cant be managed anyway.

Linton

Deleted_User said:

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Let’s say you bought an annuity with half of your money.  Does it mean that the invested portion of your portfolio needs to be split between FI and Equity in the same proportion as before the purchase?

Possibly, possibly not.  If say the annuity also represented 50% of your income then if the allocation was right prior to the purchase it is probably right afterwards.  If on the other hand the annuity provided a lower return compared with the previous investment income then you would be drawing down a higher % of your assets and so would need to reconsider your allocations.

It certainly doesnt follow that if you were previously 50% equity, 50% bonds you should switch to 100% equity since the bond tranche is now occupied by your annuity.

[Deleted User]

Linton said:

Deleted_User said:

Linton said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

Linton - How would you treat it?

The idea of allocating a value is presumably to see where you are in relation to a perceived end goal, which is measured in terms of a multiple of your number. Using Mordko’s 25 x is, I think quite reasonable but
I wouldn’t value a DB/SP in allocating assets directly but it would influence the strategy for the rest of the portfolio and therefore the balance. (I agree with Mordko it is part of your FI).
As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

If for example someone has a £200K pot and needs to drawdown £5K/year to supplement guaranteed income to meet their desired standard of living it is irrelevent whether that guaranteed income is £10K/year or £50K/year. 

My approach is to start from what one wants to achieve....

Put aside £25K as cash to ensure any short term disruption to payment would be covered.  Put £25K in Wealth Preservation funds to cover the medium term.  The rest can now be invested according to one's long term objectives.  That could be high risk equity if one wanted to die rich.  On the other hand it could be lower risk investments with the sole aim of matching inflation and topping up the cash buffer as required.  If one has no real use for all one's current excess wealth, why try to get more?

In neither case would I consider whether I "should" be in x% equity because a US investment guru says so.  There is no x that is right for all people at all times.  All that matters is investing appropriately to meet your objectives whilst avoiding sleepless nights..

The following two scenarios are not the same:
1. Person A with a 50k/y DB income looking to add 10k/y from his 250k DC pot.
2. Person B with a 10k/y DB income looking to add 10k/y from his 250k DC pot.

Person A can withstand market fluctuations far better than person B.  He can therefore put a much higher proportion of his 250k pot into an asset which fluctuates more but has higher expected returns.  Its just common sense. 

In general it’s important to consider your income streams holistically.   Between me and my wife we have 10 investment accounts and 7 sources of DB income streams. The whole thing is managed as a single portfolio. Which is straightforward.  Regardless of which pot has available cash, I know exactly which asset type and sector to invest in.   If we were to take each individual pot and start looking how to generate X thousand per year from each pot separately, we would create a mess. 

If as I suggested in the example at least 10 years non-guaranteed income is covered by zero or low volatility investments I find it difficult to see that market fluctuations are an issue. 

So, you’d have A and B put 100k into cash and keep taking inflation corrected 10k from the investment and adding it to the 10 year cash provision annually.  And the non-cash investment would be in stocks in both cases? 

I think it’s inappropriate for person A because most of his income is provided for by DB. In a downturn he can easily tighten the belt. He would have a better chance of generating 4%/year long term on his liquid assets if he had them in stocks, except for (lets say) 5 years’ worth of expenditure.  And I bet he wouldn’t object too hard if his pot ends up bigger after 10 years.

And person B really can’t afford market fluctuations. Much harder to reduce expenditure if you are relying on invested pot to generate half of your income.  And the pot has no margin for error.  For him this portfolio would be way too risky.  He should consider buying an annuity with his 250k.  

Considering all sources of income together helps you come up with a better answer. And DB pension is fixed income. Many other types of FI are illiquid.  

MK62

DT2001 said:

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Then you can go for the riskiest to meet other objectives as income is only part of the whole (Inheritence?) or all income generating funds to use IHT excess income relief.

If you include your DB/SP into your 60/40 allocation and interest rates change and therefore ‘necessitate’ an adjustment it could work against you overall goals.

Linton says he does not ignore guaranteed income when designing retirement portfolio.He does this by removing it from the calculation of income required. So maybe the OP can advise if our discussion helps - does he start with his number, take off the DB/SP and then calculate the pot required (25 times income for rough target). 

.....but 100% equity is not guaranteed to offer a higher value portfolio.......it may be more likely to, but in drawdown any fall in portfolio value can be a disaster, far more so than any equivalent rise can be a godsend.

Risk is risk.......and while it has paid off in the last 7 or 8 years, there are periods where anyone drawing down on a 100% equity portfolio would not have been so fortunate.

I suppose this is really about maximising returns vs minimising risk, and that depends on your personal opinion and situation.

[Deleted User]

Linton said:

Deleted_User said:

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Let’s say you bought an annuity with half of your money.  Does it mean that the invested portion of your portfolio needs to be split between FI and Equity in the same proportion as before the purchase?

It certainly doesnt follow that if you were previously 50% equity, 50% bonds you should switch to 100% equity since the bond tranche is now occupied by your annuity.

So you are considering annuity as part of your FI. How is DB income different? 

And if the bond tranche is occupied by annuity, why not switch to 100% equity for the rest (except a small cash buffer)? I am confused. 

MK62

Deleted_User said:

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Let’s say you bought an annuity with half of your money.  Does it mean that the invested portion of your portfolio needs to be split between FI and Equity in the same proportion as before the purchase?

No, and nobody has said that.......but neither would this then automatically dictate 100% equity either.

You may be likely to have a higher equity content than before though, granted........

You could reverse that though and ask if someone is meeting their income objectives with a 60/40 portfolio, should they move to 100% equities purely on the basis it might give them a higher value portfolio to pass on?

[Deleted User]

MK62 said:

Deleted_User said:

MK62 said:

DT2001 said:

60/40 was just an example. It should be “whatever is appropriate” for you.  My point is that DB income is a type of FI and should be counted as such towards your desired allocation. Ignoring it introduces massive distortions. 

I dont say ignore guaranteed income when designing your retirement portfolio, quite the reverse.  It's just that you dont need to convert it via a dodgy calculation into a hypothetical bond in order to do this.  

As Linton points out if the amount required was low then a perceived lower risk (higher bond allocation) strategy could be used without any distortion when interest rates changed. BUT if you only needed a say 1 or 2% withdrawal rate a 100% equity portfolio would (on historical data) be risk free. 

......but on the same basis, so would a 60/40 portfolio...or an 80/20...or a 30/70....all would have met your income objective!

Let’s say you bought an annuity with half of your money.  Does it mean that the invested portion of your portfolio needs to be split between FI and Equity in the same proportion as before the purchase?

No, and nobody has said that.......but neither would this then automatically dictate 100% equity either.

You may be likely to have a higher equity content than before though, granted........

You could reverse that though and ask if someone is meeting their income objectives with a 60/40 portfolio, should they move to 100% equities purely on the basis it might give them a higher value portfolio to pass on?

That’s a separate issue.  There are long and short term risks. If you can handle short term risks (eg because you have a salary and are far from retirement) then equities are a better vehicle because bonds are riskier in the long term. 
But you don’t have 100% equity if most of your income needs come from DB sources.