Reducing volatility risk prior to retirement

bostonerimus

Many studies (admittedly US based) have shown that keeping a high percentage of relatively risky equity funds in a retirement portfolio leads to better income producing outcomes than annuities or portfolios with high percentages of bonds. Of course you don't get the guarantee of lifetime income that an annuity gives, but right now annuities are very bad value for money so a cash buffer and a Total Return strategy seems sensible. You could also insure against longevity risk by deferring state pension.

Ballard

Cash drawdown has been mentioned and it's something that's in my mind but it's one of those things that I won't know until nearer the time. One option that I may consider would be to sacrifice a larger proportion of my salary in the year or so prior to retirement and draw that down as tax free cash upon retirement. Again, not worth planning for at this stage as I don't know what my circumstances will be or indeed whether the legislation will be the same.

bostonerimus

Deleted_User said:

Drawdown or not, poor sequence of return is a very serious risk to people immediately prior and soon after retirement.  The risk is that as portfolio is depleted during the lean years, it may never recover and the pension may run out of money too early.  

You can deal with it by having more fixed income.  That could include DB pensions, bonds or various types of annuities. 

The DB pension is becoming a rare luxury and annuities are such bad value for money now that I wouldn't look at them until relatively late in life, so cash and very short term bonds seem to be the best things to mitigate sequence of return risk.

michaels

I think holding cash is a bit of a chimera, see the analysis in the SWR website for example where in various historic periods markets have fallen and remained low for long periods after which there is also the question of how to rebuild the cash buffer.

I did a check a couple of days ago, the annuity available at age 55 gave about half the annual spending as the 3.5% 'SWR' from the same size pot - and of course with the annuity there is no flexibility nor potential inheritance - that certainty is extremely expensive but is presumably priced to reflect what the market is saying via gilts and index linked bond prices rather than annuity sellers making huge profits.

SouthCoastBoy

Personally at the moment I prefer cash to bonds. In a low inflation cycle, I don't see it as a  problem, as equities can crash and take years to recover. I prefer to miss out on growth and have the protection of a cash buffer than have all my assets in equities which could crash 60 to70%.

Having said that if inflation is here to stay and creeps up to 4 or 5% with interest rates lagging behind this then becomes an issue.

michaels

SouthCoastBoy said:

Personally at the moment I prefer cash to bonds. In a low inflation cycle, I don't see it as a  problem, as equities can crash and take years to recover. I prefer to miss out on growth and have the protection of a cash buffer than have all my assets in equities which could crash 60 to70%.

Having said that if inflation is here to stay and creeps up to 4 or 5% with interest rates lagging behind this then becomes an issue.

I think we are going to be tested in this in the next 6 months with inflation gong to close to 6% which means a real terms fall in our cash pots of the same amount

However assuming all goes to 'plan' and the end of furlough sees unemployment increasing enough to hold wages down and 'restocking' sees the end of the commodities and shipping price spikes then we should see inflation go back to 2%.

Given these expectation I don't see any interest rate response in govt or commercial bond returns so switching to bonds would not protect against this inflation loss. In fact the only protection I caa see is putting the money into equities - but then by definition it no longer serves its purpose as a moderator for equity price swings.

SouthCoastBoy

michaels said:

SouthCoastBoy said:

Personally at the moment I prefer cash to bonds. In a low inflation cycle, I don't see it as a  problem, as equities can crash and take years to recover. I prefer to miss out on growth and have the protection of a cash buffer than have all my assets in equities which could crash 60 to70%.

Having said that if inflation is here to stay and creeps up to 4 or 5% with interest rates lagging behind this then becomes an issue.

I think we are going to be tested in this in the next 6 months with inflation gong to close to 6% which means a real terms fall in our cash pots of the same amount

However assuming all goes to 'plan' and the end of furlough sees unemployment increasing enough to hold wages down and 'restocking' sees the end of the commodities and shipping price spikes then we should see inflation go back to 2%.

Given these expectation I don't see any interest rate response in govt or commercial bond returns so switching to bonds would not protect against this inflation loss. In fact the only protection I caa see is putting the money into equities - but then by definition it no longer serves its purpose as a moderator for equity price swings.

Yes I tend to agree, for me inflation is a big worry, at the moment I am sitting tight as don't see many palatable options

Thrugelmir

Ballard said:

 Looking over the last 3 years, most have gained between 20-40% so I'm happy with the performance.

Always worth remembering that long term historical averages for global equities (with income reinvested) are around 4%-5% above inflation, before fees and trading costs are taken into account. Short term high performance/returns maybe the result of any number of factors. That could very easily dissipate without prior warning. 

Ballard

Thrugelmir said:

Ballard said:

 Looking over the last 3 years, most have gained between 20-40% so I'm happy with the performance.

Always worth remembering that long term historical averages for global equities (with income reinvested) are around 4%-5% above inflation, before fees and trading costs are taken into account. Short term high performance/returns maybe the result of any number of factors. That could very easily dissipate without prior warning. 

Agreed. It's that thought that's made me wonder about de-risking. The returns over the last 12 months have been much larger but that's after COVID inspired low growth/drops immediately prior to that. It's probably the returns over the next 3 or 4 years that go a long way to deciding whether I'm retiring nearer to 60 than 65.

dunstonh

Ballard said:

Thrugelmir said:

Ballard said:

 Looking over the last 3 years, most have gained between 20-40% so I'm happy with the performance.

Always worth remembering that long term historical averages for global equities (with income reinvested) are around 4%-5% above inflation, before fees and trading costs are taken into account. Short term high performance/returns maybe the result of any number of factors. That could very easily dissipate without prior warning. 

Agreed. It's that thought that's made me wonder about de-risking. The returns over the last 12 months have been much larger but that's after COVID inspired low growth/drops immediately prior to that. It's probably the returns over the next 3 or 4 years that go a long way to deciding whether I'm retiring nearer to 60 than 65.

Returns over the last decade have been higher than the long term average and low volatility assets have performed much better than the long term average.  Mainly on part due to falling interest rates and QE.     The expectation is that low risk assets will perform worse than the long term average going forward.   However, that was the feeling 10 years ago but the rising interest rates never came.   They will at some point and QE will reduce and end at some point. Just nobody knows when and how.

The Covid recovery in the markets was largely down to government money going into companies and many companies not actually suffering financially.  Some doing better because of it.    So, it wasn't quite the perceived shock initially thought.   However, if lockdowns return this winter, don't be surprised to see markets react negatively as it would indicate that this is not as short term as hoped.

Whilst future returns are always an unknown as most events that trigger a boom or a bust are unpredictable, do be prepared for significantly lower returns in the future.    Especially at the lower risk end.