Exploring drawdown options - take from cash vs equities first?

gm0

I would recommend you look at a few of the better researched (i.e. tested via international backtesting and MonteCarlo simulation) methods for extraction and rebalancing and then pick ONE of them to take the current conditions emotional charge and market timing temptation out of annual income and rebalancing i.e. a plan to stick to that has known testing behaviour in a wide range of previous market condtions.  Resetting the plan to year 0 every year and chopping and changing may work brilliantly or tragically badly but you definitely lose the benefit of any evidence of it's past long term behaviour.

The usual web and book recommendations apply to playing around with this to the level of detail you need to explore to get comfortable - ERN series. McClung (Living off your money - 360 pages pretty much entirely on the interaction of portfolio shapes and extraction + rebalancing methods with sustainable draw in DC drawdown), Monevator summary pages etc.

jamesd

Here's part of a withdrawal policy statement from Jon Guyton that implements the Portfolio Management Rule from the Guyton-Klinger rules and which has been thoroughly tested when building them:

"All interest and dividend distributions are taken in Cash and held in your investment account(s).

Withdrawals: Capital gain distributions are reinvested in IRA accounts [UK:pension] and held in Cash for after-tax accounts [UK:ISA].

Following years with positive returns that cause an equity category to exceed its target allocation, the excess amount is sold and reinvested in Cash or Fixed Income to fund future WDs.

Yearly WDs are funded from equities when markets are favorable and from fixed income when they are not, using this priority: 1) Cash; 2) Selling Fixed Income assets; 3) Selling Equity assets in descending order of the prior year’s performance. No WDs are funded by selling an Equity asset after a negative return year as long as Cash or Fixed Income assets are able to

fund that year’s WD amount."

So:

a. first use income units so you get cash distributions instead of the reinvestment from accumulation units.

b. once a year use the fixed interest bonds (or cash as well if being used as a bond substitute) to work out the desired equity level. If equities have both gone up and exceed this, sell the excess and keep the cash for later withdrawals. Both because otherwise you'd sell equities after a bond drop that exceeded an equity drop and this rule is trying to take out bull market equity gains.

c. after doing b take your income from the cash pool, if not enough sell fixed interest, if still not enough, sell equities.


Regrettably, ERN falsely claimed to use the Guyton-Klinger rules and have refused to correct their major mistakes after requests from many people. The result was a performance mess as they created their own poor rules instead of using the real set.  Wade Pfau produced graphs showing how something closer to real Guyton-Klinger works, though he also didn't use the Portfolio Management Rule, and also explains two of the changes from Guyton to Guyton-Klinger.

Linton

gm0 said:

I would recommend you look at a few of the better researched (i.e. tested via international backtesting and MonteCarlo simulation) methods for extraction and rebalancing and then pick ONE of them to take the current conditions emotional charge and market timing temptation out of annual income and rebalancing i.e. a plan to stick to that has known testing behaviour in a wide range of previous market condtions.  Resetting the plan to year 0 every year and chopping and changing may work brilliantly or tragically badly but you definitely lose the benefit of any evidence of it's past long term behaviour.

The usual web and book recommendations apply to playing around with this to the level of detail you need to explore to get comfortable - ERN series. McClung (Living off your money - 360 pages pretty much entirely on the interaction of portfolio shapes and extraction + rebalancing methods with sustainable draw in DC drawdown), Monevator summary pages etc.

The problem is that none of the backtesting data includes close to zero bond rates. For much of the past 100 years bonds provided useful returns reducing the impact of crashes. Removing emotion is certainly a good thing, but calmly driving around with your eyes closed is not to be recommended.

Linton

jamesd said:

Here's part of a withdrawal policy statement from Jon Guyton that implements the Portfolio Management Rule from the Guyton-Klinger rules and which has been thoroughly tested when building them:

"All interest and dividend distributions are taken in Cash and held in your investment account(s).

Withdrawals: Capital gain distributions are reinvested in IRA accounts [UK:pension] and held in Cash for after-tax accounts [UK:ISA].

Following years with positive returns that cause an equity category to exceed its target allocation, the excess amount is sold and reinvested in Cash or Fixed Income to fund future WDs.

Yearly WDs are funded from equities when markets are favorable and from fixed income when they are not, using this priority: 1) Cash; 2) Selling Fixed Income assets; 3) Selling Equity assets in descending order of the prior year’s performance. No WDs are funded by selling an Equity asset after a negative return year as long as Cash or Fixed Income assets are able to

fund that year’s WD amount."

So:

a. first use income units so you get cash distributions instead of the reinvestment from accumulation units.

b. once a year use the fixed interest bonds (or cash as well if being used as a bond substitute) to work out the desired equity level. If equities have both gone up and exceed this, sell the excess and keep the cash for later withdrawals. Both because otherwise you'd sell equities after a bond drop that exceeded an equity drop and this rule is trying to take out bull market equity gains.

c. after doing b take your income from the cash pool, if not enough sell fixed interest, if still not enough, sell equities.


Regrettably, ERN falsely claimed to use the Guyton-Klinger rules and have refused to correct their major mistakes after requests from many people. The result was a performance mess as they created their own poor rules instead of using the real set.  Wade Pfau produced graphs showing how something closer to real Guyton-Klinger works, though he also didn't use the Portfolio Management Rule, and also explains two of the changes from Guyton to Guyton-Klinger.

I agree with this general strategy and use it myself (with tweaks).  Interestingly it does support the use of some income funds despite the preference on this forum for a "total return" strategy.

In practice I wouldnt necessarily sell all the excess equity as it seems sensible to constrain the total amount in cash because of  inflation risk.  So equity is used for money for which there is no specific use.

Once you get to (c) part 3 surely you are well on your way to disaster.

pip895

I keep 1 Years withdrawals as cash in my drawdown account - once the cash reserves slip below 6 months (this can take considerably longer than 6 months because of income receipts) I top them up again by withdrawing from whichever fund is edging above its allocation level.   

In a prolonged and significant downturn I would stop SIPP withdrawals and live on external cash reserves until they get below the 6month level (currently at 2years).  Only then would I restart withdrawals from my SIPP.  There is no point in holding cash reserves, if you have no plan to ever use them..

I cant help thinking that for most of us getting to hung up on using true Guyton-Klinger or some other method is a little pointless as we all have slightly different circumstances.  In my case I have other income that at least uses up my NRB so stopping SIPP payments doesn't waste that and we also have a sizable discretionary spending budget which could easily be cut..  If cutting your SIPP amount would mean being unable to heat your home then ultimately you are going to have to take a higher risk with your fund.

mark13

I have a years living expenses in a savings account. I also have a couple of years living expenses in a S&S ISA, any profit I will move that to cash and it will sit in my ISA until needed or indeed if there is a pullback, to reinvest it. My ISA is made up of trusts and dividend stocks. My Pension is part crystallized and invested similar to my ISA but I do hold £24K in cash so that I can draw £12k per year. 

NedS

MarkCarnage said:

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

This is what I was getting at with the suggestion to look wider than conventional bonds....thinking wealth preservation funds, like PAT, CGT, Ruffer etc.....the current strategy from central banks to cap nominal bond yields in a period of rising inflation certainly doesn't encourage me to hold much in the way of conventional bonds in a portfolio. 

And what percentage of bonds do you think these Wealth Preservation Funds hold? CGT, PNL, Troy Trojan all hold 40% plus in bonds. You don't want much in the way of bonds but are happy to buy funds holding 40% in bonds?

I'm not denying these funds have performed excellently over the last 10-20 years WRT their remit (with equity and bond bull markets, it's hard not to), but there is no magic here, and if you don't like the look of bonds, and equities are too high risk, where else are you going to put your cash? These funds aren't going to hold more than a small percentage in gold or property etc, so you are either taking on a lot more risk that you expected if they are heavy on equity, or you are buying these funds to avoid bond exposure and they have the high bond exposure you are trying to avoid. If bond markets take a tumble along with equity as many predict, then these wealth preservation funds may not perform as well as they have over the last period.

MarkCarnage

NedS said:

MarkCarnage said:

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

This is what I was getting at with the suggestion to look wider than conventional bonds....thinking wealth preservation funds, like PAT, CGT, Ruffer etc.....the current strategy from central banks to cap nominal bond yields in a period of rising inflation certainly doesn't encourage me to hold much in the way of conventional bonds in a portfolio. 

And what percentage of bonds do you think these Wealth Preservation Funds hold? CGT, PNL, Troy Trojan all hold 40% plus in bonds. You don't want much in the way of bonds but are happy to buy funds holding 40% in bonds?

I'm not denying these funds have performed excellently over the last 10-20 years WRT their remit (with equity and bond bull markets, it's hard not to), but there is no magic here, and if you don't like the look of bonds, and equities are too high risk, where else are you going to put your cash? These funds aren't going to hold more than a small percentage in gold or property etc, so you are either taking on a lot more risk that you expected if they are heavy on equity, or you are buying these funds to avoid bond exposure and they have the high bond exposure you are trying to avoid. If bond markets take a tumble along with equity as many predict, then these wealth preservation funds may not perform as well as they have over the last period.

Their bond exposure is overwhelmingly index linked. PNL hold c20% in UK T Bills, which is quasi cash with very short duration, and without any default risk (unless you believe HMG will default of course).  All bond exposure is US TIPS.  CGT has a small UK conventional gilt exposure c.14%, with duration unspecified, and linkers exposure of more than twice that. Ruffer has only 3% in short dated gilts, and over 30% in linkers. 

I wouldn't be holding them if they had heavy exposure to conventional bonds. 

They also have the ability to vary their asset allocation and have historically made some quite significant changes. Yes, that takes us back to the active v passive debate, but I don't think they are relying on the same asset allocation that helped give them decent returns in the bond bull market. 

I also hold a global index linked sovereign bond fund (as well as a lot of equities). Nothing in conventionals. 

EDIT: To note that some of the WP funds also have not insignificant exposure to gold, and also in some cases derivative protections against rising rates. 

jamesd

Linton said:

The problem is that none of the backtesting data includes close to zero bond rates. For much of the past 100 years bonds provided useful returns reducing the impact of crashes. Removing emotion is certainly a good thing, but calmly driving around with your eyes closed is not to be recommended.

There were some such periods in the US data. That's why I've been able to write about cash being shown to be a better choice during low interest rates, low inflation times. People backtested it with the historic data for those periods.

Linton said:

jamesd said:

...
a. first use income units so you get cash distributions instead of the reinvestment from accumulation units.

I agree with this general strategy and use it myself (with tweaks).  Interestingly it does support the use of some income funds despite the preference on this forum for a "total return" strategy.

In practice I wouldnt necessarily sell all the excess equity as it seems sensible to constrain the total amount in cash because of  inflation risk.  So equity is used for money for which there is no specific use.

Once you get to (c) part 3 surely you are well on your way to disaster.

That's income units, not income funds. So the income units of a growth or total return fund qualify for that. The withdrawal policy doesn't say anything about growth or income investments themselves.

In not selling the equity you'd be making a mistake, I think. You're in a bull run or at least bull market situation and what comes next, eventually, is a crash or correction. But you are allowed to buy fixed interest with the excess, it doesn't have to be all or even at all kept in cash.

One of the reasons why GK does so well is that it has the rising equity glidepath property, meaning gradually less in equities as you get older. So eventually reaching 3c is likely. For at least many early years if a person does follow the sell equities to rebalance approach they are going to be topping up the cash/bonds and delaying selling the bonds portion.

bostonerimus

OP you're really just dealing with cashflow. I'd keep a couple of year's cash in savings and then have maybe a year's spending in your regular bank account and spend from that. You could then replenish once a quarter by selling some stocks (in good times) or taking dividends. If times are bad you'd use the cash from your saving account or bonds.