Best allocation across Cash, Bonds & Equities?

secondincometrader

I'm in the fortunate position of having retired at 55 with a SIPP DC pension to see me through to 65, at which point my DB pensions kick in along with the state pensions to provide me will the annual sum required.  So after tax I have a DC pot of £830K split equally across Bonds, Equities & Cash (£277K in each). This needs to last me for 10 years. I've then assumed a worse case scenario that the Equities decrease by 50% and the Bonds by 20%. This leaves me with £637K, enough to cover my spend requirement.  But with the emerging view that Bonds are now just correlated to Equities and certainly shown no relay gain over the last year, I'm thinking I should just ditch the Bonds and split the money across Equities and Cash. The benefit being that the more I have in Equities the more potential upside, but I can maintain the same worse case position by using some of the Bonds money to increase the Cash allocation. Would welcome thoughts on whether this is a good approach? Many thanks.

[Deleted User]

1. Equities can fall by any percentage. 50% isn’t “worst case”. Have been known to fall by 90%.

2. What’s your minimum annual “getting by” spend?  

3. Personally, I refuse to hold any meaningful amount of cash within a pension wrapper.  That means a guaranteed loss in real terms.  It also means that you are subsidizing the brokerage. 

4. What makes you think that cash will do better than bonds?   Keep in mind that “correlations” change over time. There are different bonds which will perform differently. 

As always, you have lots of ways to skin this cat, but you are in a very strong position. A lot depends on your objectives.  Is your priority to be safe and have a guaranteed minimum of X per year over the next 10 years? Or is growth potential important to you? 

michaels

I have gone for a cash/equities mix to reduce volatility and I don't see bonds and equities as being inversely correlated at current levels..  It has cost me a painful amount of lost growth in the last 12 months but I just tell myself that it is doing what it is designed to do.

Problem is when I chose this strategy inflation was minimal making cash cheap - now of course inflation is up, heading to 4-5% so the cash will see a real terms loss of this magnitude which is expensive.

Been looking at index linked bonds where in theory the loss is fixed at about 2.5% in real terms but not sure how to best invest in them, the funds all hold a mixed duration set of linkers which means they are subject to changes in value as inflation expectations change so it is not the same as choosing an index linked bond that expires in 12 months and holding that till it expires and then buying another 12m one.

Notepad_Phil

secondincometrader said:

... I'm thinking I should just ditch the Bonds and split the money across Equities and Cash. The benefit being that the more I have in Equities the more potential upside, but I can maintain the same worse case position by using some of the Bonds money to increase the Cash allocation. ...

Well I'm in a similar position to you (retired in my mid fifties a few years ago) and that's exactly what I've done - I even based my worst case scenario on a 50% equity drop, though in my case with only a pessimistic inflation matching recovery from then on.

I too didn't like the look of bonds and decided that cash+equity was the way to go as even with such a market drop, Mrs Notepad and myself would have enough income + cash to see us out - we might need to make some cutbacks but life would still be comfortable enough.

So far we've never needed to dig into our cash position, so as we get closer to state pension age we actually are putting some of that cash back into the market as we've more than enough even if the market was to fall to less than 50% of where it was when we retired (which is a lot lower than 50% of today's market price).

A sustained rise in inflation would likely cause problems with the cash, but similar (if not worse) problems would hit bonds too, so I'm keeping an eye on what happens but at the moment I'm happy.

Note in our case we have our cash outside of the SIPP and I'm very diligent in getting the bast rates on our cash - that may not be as easy to do if it's held within a SIPP.

bostonerimus

How much annual income do you need? I would be looking at a total return portfolio with one or two year's spending in cash for emergencies and market down turns. Depending on how much you need you could be around 80/20 equities to bonds and keep the bond duration less than 10 years and use it mostly as a back up for the cash that might get a bit more return than a saving account but will be less volatile than equities. If you don't need much income you might have a lower percentage of equities and concentrate on dividends. You should not be planning on spending lots of capital even if you have other pensions starting in 10 years time as DC money will give you flexibility.

Thrugelmir

secondincometrader said:

 The benefit being that the more I have in Equities the more potential upside, 

With equities come volatility. If you've a buffer of £200k above your projected spending requirement. Why not simply derisk your portfolio. Ruffer, Personal Assets Trust, Capital Gearing Trust for example. Absolute return funds such as ones managed by BH.  Then there's a raft of infrastructure/renewable/reit funds that offer less volatile options. 

dunstonh

But with the emerging view that Bonds are now just correlated to Equities and certainly shown no relay gain over the last year, I'm thinking I should just ditch the Bonds and split the money across Equities and Cash

Bonds are not one thing.  There are certainly bonds that have the volatility of equities but there are also bonds that have nowhere near the volatility and correlation would not be similar.

What is your preference?  to meet your objectives or risk it going for a couple more percentage points on the return?

JohnWinder

You really do need to tell us about how long you think equities could remain at 50% of present levels for, and your annual spending for the next decade, which bonds you hold, what the equities are, and whatever else seems relevant to you. Otherwise the rest of us risk arguing back and forward over whether bonds are any good; mind you, some of us quite enjoy that.

Most of your assumptions are too vague for us to reflect on their validity, but I’m suspicious. Can you look through the history of a diversified stock fund and tell us the longest period that such a fund would have sustained a 50% drop in real value for? 

And do the same for a low risk diversified bond fund; I doubt you’ll find a period of the slightest concern. During three years from 2004 the US central bank rose rates from 1% up to 5% with barely a ripple in a total market bond fund.

A lot of people think under ten years is a bit of a short investing time to be having a lot of faith in stocks. Your average time frame is 1+2+3…10/10, or about 6 years. So a lot of folk would think that moving from 33% stocks to 50% in that time frame would be questionable.

Always be skeptical of ‘emerging views’; I suppose you are, since you’re asking, and I am too. No one knows what future correlations will be like so probably make your asset allocation decisions on more robust, well founded bases (like ‘stocks are for the long run’, cash for the very short…). Do note, or recall, that scores of economists en masse couldn’t even guess next years interest rate change direction, let alone its magnitude: https://www.marketwatch.com/story/yes-100-of-economists-were-dead-wrong-about-yields-2014-10-21

With ‘all cash and stocks’ you could be disadvantaged by inflation. The cash would likely never catch up, and the stocks could take more than a decade if you’re out of luck. So you kind of need to set up for a range of different future scenarios, rather than being overly influenced by one line of ‘emerging views’ it seems to me.

fineclaret

Although there is a worry that stocks will dip hugely and never come back, I tend to take a more optimistic approach. I've not been wrong yet! (though I've not died yet either; first time for everything). I have about 10% (of a 500k pot) in bonds, whose main purpose is to be liquidised during a substantial stock dip (of course, they can go down too). While markets are rising (God, how much longer?) I profit-take on the equities instead. That, plus recent reluctance to put new cash into a high market, is partly why I'm actually even a bit higher in bonds than I might have wished. Come the crash (???) I'll rebalance.

However, if I was looking at a 10 year term, I might be slightly less cavalier.

Thrugelmir

allanm02 said:

 I have about 10% (of a 500k pot) in bonds, whose main purpose is to be liquidised during a substantial stock dip (of course, they can go down too). 

Bonds is a very broad term that encompasses a variety of sub asset classes. What are you holding in your portfolio? 

fineclaret

Thrugelmir said:

allanm02 said:

 I have about 10% (of a 500k pot) in bonds, whose main purpose is to be liquidised during a substantial stock dip (of course, they can go down too). 

Bonds is a very broad term that encompasses a variety of sub asset classes. What are you holding in your portfolio? 

2 managed funds - Baillie Gifford Investment Grade and IG Long funds, plus a passive Vanguard Investment Grade index tracker. Absolutely no science went into those choices!