How to calculate the worth of a fixed income product?

cfw1994

mark55man said:

However as I  also have some inheritance ambitions (ie to leave some not to get some) I need to balance the extent I drain the DC - plus if my DB + SP gets too big, whilst still at Basic rate tax, I would have less slack for drawing down DC funds at BRT.     

Just on this small point of inheritance ambitions.....our goals are more focussed on helping our offspring (early 20s) sooner rather than later.    Helping set up  (modest!) LISA, ISA and pensions, we have trickled money in for a few years now: hopefully that will give them a better understanding of investing, as well as the possibility for the “power of compounding” to help them in the years ahead before we pass away!

It appears all too often that inheritance these days is often handed to those who least need it.  

We will likely inherit a 6-figure sum in the next 1-15 years....but I’m already giving up my day job this spring.  Sure, we have the option to help our offspring with it (& will), but the topic of inheritance is complex!

DT2001

cfw1994 said:

mark55man said:

However as I  also have some inheritance ambitions (ie to leave some not to get some) I need to balance the extent I drain the DC - plus if my DB + SP gets too big, whilst still at Basic rate tax, I would have less slack for drawing down DC funds at BRT.     

Just on this small point of inheritance ambitions.....our goals are more focussed on helping our offspring (early 20s) sooner rather than later.    Helping set up  (modest!) LISA, ISA and pensions, we have trickled money in for a few years now: hopefully that will give them a better understanding of investing, as well as the possibility for the “power of compounding” to help them in the years ahead before we pass away!

It appears all too often that inheritance these days is often handed to those who least need it.  

We will likely inherit a 6-figure sum in the next 1-15 years....but I’m already giving up my day job this spring.  Sure, we have the option to help our offspring with it (& will), but the topic of inheritance is complex!

Totally agree with trying to help now and also educate so our children so they have more informed choices. One grandparent put a lump sum soon after birth into a pension for each of ours and the growth both overall and annual variations is clear. Hopefully this will promote long term savings plans to utilise the good times and prepare for the poorer investment periods.
Inheritence is complex - unknown timings - the desire to be ‘fair’ - tax planning - getting your parents to spend rather than save “we want to leave something for you” etc

Linton

DT2001 said:

 Linton said
 In retirement you need a very different mindset to that whilst working.  Retirement investing puts particular emphasis on the medium term, a timeframe that I do not believe is covered adequately in the literature.  For a start as far as I am concerned 20 years is in the far distant possibly unattainable future.  It doesnt matter if investments are down from their current value as long as there is more than enough to support our current standard of living for the rest of our days and provide for the occasional extravagence.  More income would not improve our lifestyle.

What provision, if any, have you made for care costs?
For my mother we’ve utilised the equity released by downsizing and I see that as a reasonable strategy. If you can squeeze a little more income/growth from your portfolio with a minimal increase in volatility should you do so?

Can you explain compartmentalising assets for an objective or give an example as I am unsure of how the approach works. Thank you

Care fees: I do not use SWRs.  Instead  financial management is based on a year by year model assuming 3% inflation and 4% investment return.  The maximum steady ongoing inflation-linked annual expenditure is calculated to provide a fixed sum more than enough for a few years care home fees for both of us at the end of the plan period.  As long as our ongoing expenditure is below this maximum all is well.

As the maximum  expenditure from the plan has grown over time and is now much greater than actual I am derisking by moving excess returns from the Growth Portfolio into the Wealth Preservation/Cash portfolio.   Excess money in the WP/Cash portfolio is available for major extravagences.   My intention is to continue doing this as we get older.  There is no point in taking extra risk for more return than can be reasonably used in our lifetimes.  However should our expenditure approach the maximum then it may be necessary to move wealth the other way.

This nicely shows the advantages that having separate compartments, portfolios, tranches or whatever you want to call them, can bring. The allocation to growth can be reduced by a specified % and the money freed up used for other purposes.  In this case it was to increase the pool of relatively safe assets.  It could alternatively have been moved to the Income Portfolio to increase dividend/interest income by a known amount,  or of course some chosen mixture of the two.

At the other extreme adopting the view that the only investment decision one needs to make is the value of xx in VLSxx would have made this level of control much more difficult.  You simply dont get the number of levers you need to manage your investments to meet your needs.  The main lever would be to adjust expenditure, something I never want to be forced to do. 

[Deleted User]

I do think the bucket strategy is flawed.  Like this guy explains https://www.forbes.com/sites/robertberger/2020/08/02/the-bucket-strategy-is-broken-heres-a-better-way/?sh=5b49573d1b33

There are lots of little reasons why its not ideal, but fundamentally it ends up in day to day decision making by a human.  And that invariably  ends up costing us in the long run.  We can always make up a million of seemingly sound reasons to make changes.  Usually we are just justifying to ourselves what we emotionally want to do anyway.  And the problem gets worse over time as our decision making deteriorates with age. 

TVAS

Don't say fixed it is not fixed. It is however guaranteed. So 10k p.a. RPI increases and 2/3ds spouse you would need a fund of at least 350k and maybe more so a minimum factor of 35 x the annual pension at least because it will be increasing and will provide for a spouse on your death as well as the guarantee these are the reasons why a DB pension is so important and should be valued. State pension lower factor only because spouse may or may not inherit some of it.

[Deleted User]

I think the value of DB is very “case by case”.  A lot depends on how you generate income outside of your DB pension.  If its sitting in a cash account then x35 isn’t enough.  If its in an equity portfolio then I’d say a factor of 35 is too high based on long term returns we’ve seen. It also depends on the benefits within the DB pension. Spousal benefit within DB pensions is important but isn’t an advantage when comparing to liquid investments which are inherited anyway. 

Linton

Deleted_User said:

I do think the bucket strategy is flawed.  Like this guy explains https://www.forbes.com/sites/robertberger/2020/08/02/the-bucket-strategy-is-broken-heres-a-better-way/?sh=5b49573d1b33

There are lots of little reasons why its not ideal, but fundamentally it ends up in day to day decision making by a human.  And that invariably  ends up costing us in the long run.  We can always make up a million of seemingly sound reasons to make changes.  Usually we are just justifying to ourselves what we emotionally want to do anyway.  And the problem gets worse over time as our decision making deteriorates with age. 

Your citation seems to be about the waterfall model rather than basing one's investment allocations on objectives. Perhaps the following will help explain the strategy:
 https://www.manulifeprivatewealth.com/ca/en/viewpoints/investor-education/what-is-goals-based-investing-and-how-does-it-work
https://wealthmanagement.bnpparibas/en/expert-voices/goal-based-investing-or-when-the-end-justifies-the-means.html

Of course we could always discuss the issues directly rather than by lobbing quotes that support our respective points of view at each other.

Linton

Deleted_User said:

I do think the bucket strategy is flawed.  Like this guy explains https://www.forbes.com/sites/robertberger/2020/08/02/the-bucket-strategy-is-broken-heres-a-better-way/?sh=5b49573d1b33

There are lots of little reasons why its not ideal, but fundamentally it ends up in day to day decision making by a human.  And that invariably  ends up costing us in the long run.  We can always make up a million of seemingly sound reasons to make changes.  Usually we are just justifying to ourselves what we emotionally want to do anyway.  And the problem gets worse over time as our decision making deteriorates with age. 

I came up with my approach myself but now find others thought of it first!
Something more academic:
Click on "download this paper"
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1702387 
It is described in terms of an advisor working with a client, but it  provides a good description of the approach.

MK62

Costabit said:

I am having a bit of a mind block on this as am unsure how to include my fixed income products (final salary pension and state pension) in my overall asset allocation alongside SIPPs ISAs cash etc.

If I have a £10K per annum pension which I am drawing on now, with RPI increases and 2/3rds widow benefits, what £ figure could you allocate to this?

And the same with a full state pension which I will get in 4 years, what £ figure would you give this?

I realise that it is not a definite finite science but am really not getting how to calculate this, is there a way of doing it that anybody knows.

Grateful for any thoughts.

Back on topic........

Personally I wouldn't assign a fixed £ value, any more than I'd do that with a salary.

They are income streams.......use them to decide how much income you need to take from your other assets (SIPPs ISAs cash etc)

EG......if your current income requirement is £25k pa........then you need to supply £15k pa from your other assets for 4 years, until your SP kicks in (c£9.2k pa)......after which your requirement will be £5.8k pa. (all in today's money.....you'd adjust each year for inflation).

In reality, you'd need to jiggle those figures a little bit, as they are gross.......your net income is the real target, so you'd have to take income tax into account as well, in your overall planning.

DT2001

Linton said:

Can you explain compartmentalising assets for an objective or give an example as I am unsure of how the approach works. Thank you

Care fees: I do not use SWRs.  Instead  financial management is based on a year by year model assuming 3% inflation and 4% investment return.  The maximum steady ongoing inflation-linked annual expenditure is calculated to provide a fixed sum more than enough for a few years care home fees for both of us at the end of the plan period.  As long as our ongoing expenditure is below this maximum all is well.

As the maximum  expenditure from the plan has grown over time and is now much greater than actual I am derisking by moving excess returns from the Growth Portfolio into the Wealth Preservation/Cash portfolio.   Excess money in the WP/Cash portfolio is available for major extravagences.   My intention is to continue doing this as we get older.  There is no point in taking extra risk for more return than can be reasonably used in our lifetimes.  However should our expenditure approach the maximum then it may be necessary to move wealth the other way.

This nicely shows the advantages that having separate compartments, portfolios, tranches or whatever you want to call them, can bring. The allocation to growth can be reduced by a specified % and the money freed up used for other purposes.  In this case it was to increase the pool of relatively safe assets.  It could alternatively have been moved to the Income Portfolio to increase dividend/interest income by a known amount,  or of course some chosen mixture of the two.

At the other extreme adopting the view that the only investment decision one needs to make is the value of xx in VLSxx would have made this level of control much more difficult.  You simply dont get the number of levers you need to manage your investments to meet your needs.  The main lever would be to adjust expenditure, something I never want to be forced to do. 

Thank you for the explanation. The link you provided later on helped me better understand, I hope, the logic. I can see it's merits - the purpose is achieving an income goal first and foremost with lower risk followed by wealth preservation/growth? Just to check can you comment on the example below
number £50k
DB £20k  
Create à portfolio to produce an ongoing £30k + CPI assuming growth at say CPI + 1%
Balance in a portfolio to preserve/grow wealth
Then at SPA move funds from income/growth portfolio to wealth preservation portfolio.
You could also create a portfolio to utilise IHT relief via excess income.

Each pot has its own asset mix and has doesn’t influence any of the others?

Does this presume someone has a larger pot than they need at the start of retirement or is it an adjustment one makes if your income/growth pot exceeds expectations after a few years?

The OP doesn’t then need to place a value on any DB/SP just use MK62’s idea above?