Foolishness of the 4% rule

Linton

Deleted_User said:

Linton said:

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

In practice its the other way around. People tend to take out annuities if they are healthy.  A healthy 65 year old has an excellent chance of living past 100. The pool of people taking annuities is self-selected to have better than average mortality rates. 

Individual “Return” is unknown and unpredictable.  Its the wrong way of thinking about annuities.  What is your return on car insurance? House insurance?  What annuity does in real world is permit someone with a decent amount of money and long life expectancy to spend a lot more safely as a portion of asset allocation. 

Your comparison of annuities with car and house insurance does not seem appropriate to me.  With either you are paying a relatively small amount of money to protect yourself from effectively unlimited costs.   The peace of mind gained justifies the cost.  With an annuity the cost is a high % of any benefit you get. 

ISTM that inflation linked annuities could be worth considering as they do protect you against unlimited "costs".  Without inflation linking the risk of your future income being totally inadequate through inflation could well exceed the investment risk of cautious drawdown especially with a time outlook of 20+ years.

According to UK official statistics the chance of living to 100 is not "excellent", but simply rather better than you may have thought.  ONS cohort data from 2014 suggests the chance of someone aged 65 today living to 100 was estimated at about 8.5% but I believe values have decreased since then.

1. I think the benefit of annuity to someone risking outliving his assets is huge.  Full dependence on the state or kids or having to die a little earlier because of money issues seems like more of a threat than having to pay for a new car out of pocket. 

2. You could also have a ladder of flat annuities to deal with your inflation concerns, if you are unprepared to rely on asset allocation for hedging inflation risks. 

3. 8.5% is a very high probability for nasty scenarios described in 1. But if you are a well off healthy 65 year old on an investment/pensions board, your chances of living longer are noticeably higher.  

Your picture of someone suddenly running out of money at a particular age seems unreasonable to me.  Anyone in comtrol of their assets and spending would have known of the situation years in advance and should have been able to reduce expenditure at that time.  After all you are talking now about well-off people, not people who can barely manage.

Any of your dire outcomes could arise from inflation even if you had a fixed annuity as you suggest, in fact especially if you have a fixed annuity since other investments than simple bonds should provide a level of long term inflation protection.  Of course if you had the extra money to hedge the long term inflation risk you would be OK.  But then why buy an annuity?  Just keep a suitably large cash or cautiously invested buffer.  

On life expectancies - if you are a well off healthy 65 year old you will probably live to 85.  If you live to 85 the chance of reaching 100 is 14% so noticeably higher but still pretty unlikely.  It is only when you reach 97 does the chance of reaching 100 exceed 50%.  That age is surely well beyond the benefits of being well off and more down to pure luck.

MK62

The ONS are saying that for 65yo UK male, today, the estimated chance of living to 100 is a little over 3%.

Thrugelmir

Deleted_User said:

Linton said:

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

In practice its the other way around. People tend to take out annuities if they are healthy.  A healthy 65 year old has an excellent chance of living past 100. The pool of people taking annuities is self-selected to have better than average mortality rates. 

Individual “Return” is unknown and unpredictable.  Its the wrong way of thinking about annuities.  What is your return on car insurance? House insurance?  What annuity does in real world is permit someone with a decent amount of money and long life expectancy to spend a lot more safely as a portion of asset allocation. 

Your comparison of annuities with car and house insurance does not seem appropriate to me.  With either you are paying a relatively small amount of money to protect yourself from effectively unlimited costs.   The peace of mind gained justifies the cost.  With an annuity the cost is a high % of any benefit you get. 

ISTM that inflation linked annuities could be worth considering as they do protect you against unlimited "costs".  Without inflation linking the risk of your future income being totally inadequate through inflation could well exceed the investment risk of cautious drawdown especially with a time outlook of 20+ years.

According to UK official statistics the chance of living to 100 is not "excellent", but simply rather better than you may have thought.  ONS cohort data from 2014 suggests the chance of someone aged 65 today living to 100 was estimated at about 8.5% but I believe values have decreased since then.

But if you are a well off healthy 65 year old on an investment/pensions board, your chances of living longer are noticeably higher.  

Healthy one minute . Gone the next.  We all live each day hanging by a thread. Like is no different to the stock market. You can minimise the risks but you can never eradicate them. As somethings are out of our individual control. 

bostonerimus

itwasntme001 said:

bostonerimus said:

Well it isn't as bad as 2009 and the last decade was ok. I did some rebalancing through that P/E spike and fall and things were ok. I won't do that this time though, I'll let it all ride and my bond allocation is now less than 20% so I expect some "fun". If you worry about P/E ratios then time the market or decouple your essential income from markets as much as you can so you can stop worrying about them. 

But is your "bond" allocation really less than 20% when you take into account your DB pension, state pension, BTL income etc?

Context matters.  I know you say decouple your essential income, which is what you have presumably have done, but then saying "less than 20% bond allocation" is a bit misleading.

Good point, the portfolio needs to be looked at holistically. So there's $280k in the DB pension and $150k (back in 1997) in the rental, practically nothing in NICs as the vast majority are Class 2 and a whole lot in US Social Security contributions. If we ignore the UK and US SPs and inflate the rental value to today and combine it with the CETV of the DB pension and my bonds it comes to around 30% of my portfolio, leaving 5% in cash and 65% in equities. The UK and US SPs will provide a very comfortable guaranteed income at age 67, the DB pension is coming in now, the rental is a nice income diversifier and also an asset I can sell if needed and so I feel ok with a high equity percentage with the rest of my money as I have a 0% withdrawal rate. In fact I am on a "rising glide path" for equity allocation as I have stopped rebalancing and I'm just letting the equities grow and I've seen my bond allocation drop in the 7 years since I retired.

Linton

MK62 said:

The ONS are saying that for 65yo UK male, today, the estimated chance of living to 100 is a little over 3%.

It depends. There are several diffierent measures.  In particular you can look at the ages of people who are dying now and make an estimate.  That is where many life expectancy calculations come from.  Or you can make estimates based on knowledge that the 65 year olds now are more healthy then their equivalents decades ago - they are less likely to have smoked, less likely to have worked in life shortening jobs (eg mining or outside manual labour).  Then you can also try to take into account the improvements in medical treatments.  Someone dying early now may be doing so having contracted cancer years ago.  If they got the same disease today perhaps death could have been delayed.  And it may be assumed that medical improvements will continue.

I used an earlier version of the most optimistic data now available from: https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/lifeexpectancies/adhocs/10975numberssurvivingatexactagelxandcohortlifeexpectancyex2018basedprojectionuk1951to2068

MK62

I'm sure there are several measures, and even more ways to calculate....I did say "estimated"....

https://www.ons.gov.uk/peoplepopulationandcommunity/healthandsocialcare/healthandlifeexpectancies/articles/lifeexpectancycalculator/2019-06-07

I think the 3.3% figure was actually for a 60yo.......for a 65yo it's actually 2.9%........but whatever the actual figure, it's quite small, relatively speaking.

IIRC the ONS figure there is the percentage of survivors.......ie, 97.1% of all the 65yo's today will fail to reach 100yo (not that I'm wishing the grim reaper on any 65 year olds).......of course, that is an estimate, has to be, but it's as good an estimate as we are likely to be able to get today.

Thrugelmir

Two of my friends both fit and healthy , and well under 60. In the past have caught pneumonia. Both went into ICU. One lasted 4 just days and unfortunately passed away. The other spent nearly 6 weeks on life support before finally pulling through. Although recovered. The experience has shorterned her life expectancy by around a decade. Statistics are meaningless. It's the hand you've been dealt personally that matters. 

MK62

True in the end, but as you don't know what that hand is, you have to make some assumptions when doing a plan for the future.......of course those assumptions could be wrong (in fact there's more than a fair chance they will be), so you alter the plan as the future is revealed.....pretty much all you can do really.

bostonerimus

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

A healthy 65 year old has an excellent chance of living past 100. 

Ah, this is obviously some strange use of the phrase "excellent chance of living past 100"  that I wasn't previously aware of.

Sorry couldn't resist a HHGTTG paraphrase.

[Deleted User]

bostonerimus said:

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

A healthy 65 year old has an excellent chance of living past 100. 

Ah, this is obviously some strange use of the phrase "excellent chance of living past 100"  that I wasn't previously aware of.

A 5% chance of outliving money and dying in poverty is way too high in my book. A healthy and relatively. wealthy 65 year old has a much, much higher probability  of getting to 100.  The table below gives 10% for a healthy 65 yo male in the US. US is a bit behind other developed countries on longevity.  Its higher if you also screen by wealth and for a female.  And mortality stats trend to longivity.  I am 51.  For all we know, in 15 years time a quarter of well of 65 year olds will live past 100. 

The beauty of an annuity is that its a win-win-win.  If your house burns down its not exactly a “win” even if insurance pays out.  Here you get to live longer AND you get to collect.  And if thing do go wrong and you die early its still a financial win because you can afford to invest the balance of your portfolio more aggressively and spend more money safely before you die.