Inflation and retirement plans

SouthCoastBoy

Linton said:

If you dont believe you are at risk of running out of money before death whilst maintaining your desired lifestyle then why add to your stress levels and/or jeopardise that life-style in the short term to get even richer?  You may be in a position whereby you are more concerned about passing the largest inheritance you can achieve to your then 65 year old child than your own well being in the say 25 years you have left. In that case your approach could make sense.  However I guess that most people in retirement wont have that as their top priority.

Yes, this is where I am hopefully (stock market crashes always a risk etc.), with 40% cash and inflation running at around 7% for next five years I should have approx £200k (in 2020 terms) in my DC pot in 2055 when 90, so I don't need to take a big risk but feel inflation could run longer and higher so may be prudent to trim to 25% or 30% cash?  

Prism

SouthCoastBoy said:

Not an expert on the 1970s economy but I assume interest rates were closer to inflation rates than they are now? i.e. CPI is around 5000% higher than the current base rate

It was a moving target. Sometimes CPI was higher and sometimes short term (cash) interest rates. However we don't need to stick to absolute instant cash when in retirement as spending is reasonably predictable. Fixed term savings accounts can reduce the gap should interest rates lag inflation.

BritishInvestor

Linton said:

BritishInvestor said:

Linton said:

BritishInvestor said:

Linton said:

BritishInvestor said:

SouthCoastBoy said:

So inflation (CPI > 5% and RPI > 7%) has really taken grip and could have an impact on both DB pensions that have a CPI cap and also DC where money is in bonds/cash. As I have posted on here before I have 40% cash as close to retirement, but have now started to reduce that moving into some "defensive equities" (e.g. food producers, energy companies etc.) To me this is taking more risk than I wish to but feel I have no choice with the BoE appearing to have no intention to raise interest rates by a significant amount in the short term. 

I would be interested in other opinions, is anybody else concerned by the latest inflation figures and if so are they doing anything about it?

What hits retirement plans hardest is persistently high inflation and falling markets. The 1970s had this, and this is the period that has historically put retirement plans under most stress. 

Given current moderate inflation and relatively benign markets, I'm not sure there is any reason to make adjustments to retirement plans just yet. 

I'm not sure what "defensive equities" are nor how they will contribute towards a successful retirement outcome.

I am not concerned about current inflation fears and therefore not doing anything about them. My retirement portfolio was designed taking into account that inflation is always a risk.  The way to protect against inflation is to hold equity and therefore the portfolio needs to included a significant amount.  Equity should beat inflation over the long term - if it did not there would be little reason for people to make the effort to set up and invest in businesses.

However equity has the problem of volatility.  Therefore if one wants to support steady expenditure less volatile investments are required for the short term.

The main question then is what % allocations one should use.  In my view the % of  non equity should be as little as is required to meet ones expenditire requirements in the short to medium term with zero worry.  In the long term equity will do the work. The second question is what is this non-equity?   But that can be left to another posting.

One could regard short term as 5 years, medium term as 5-12 years and long term anything beyond that.  Cash is only suitable for the short term.  For safety one could decide to hold sufficient to cover required non-guaranteed income with say 5% annual inflation over that period.  This should be nowhere near 40% of total assets.  For the medium term a cautious portfolio including some equity  would be reasonable.

With that viewpoint I find it difficult to see how holding 40% cash when one is starting retirement could possibly be justified.  A much lower % could be held without any concerns about "reasonable" levels of inflation.

Answeringf British Investor's question - Defensive Equities are shares in companies whose sales/profits should be little affected by problems with the economy.  These could include utilities, household cleaning proiducts, basic foodstuffs etc.  The benefits to meeting one's retirement needs are pretty obvious.  Though there is the downside that returns tend to be lower than for more exciting investments.

"The way to protect against inflation is to hold equity and therefore the portfolio needs to included a significant amount."

Agreed

 "However equity has the problem of volatility"

That's a human problem, not a portfolio problem.

"Therefore if one wants to support steady expenditure less volatile investments are required for the short term."

But this can impact portfolio sustainability over the longer term, hence why bucketing tends to be sub-optimal from a non-emotional standpoint.

"The benefits to meeting one's retirement needs are pretty obvious."

I'm not sure I've seen the evidence TBH. 

You may be correct that bucketing is financially suboptimal in the very long term and it meets a human rather than an investment problem.  From that point of view 100% equity is the only way to invest.

However as a retiree my primary concern is not the long term, I dont have a lot of it to worry about and I only have one life so averages dont mean much,  Provided one has sufficient wealth to sustain what one considers a comfortable lifestyle the human problems are more important than the investment ones.  Dying rich is not a primary ambition for most people as opposed to having a long and healthy retirement made more likely by minimal stress.

That is where defensive investments may help.  Particularly in the medium term they could enable holding a higher % equity than one might otherwise choose.

"However as a retiree my primary concern is not the long term, I dont have a lot of it to worry about and I only have one life so averages dont mean much"

I'm not sure of your personal situation, but given that most don't know the exact date they are going to die, then surely the longer term has to be a priority, given that running out of money is a suboptimal outcome (if you live longer than expected)? 

You dont need to make provision for the possibility that you may live to 120. If you are in a position whereby alternative non-perverse investment decisions make the difference between running out of money at 90 vs running out of money at 100 then you really are in any case at serious risk from normal short term economic events.  You should have reduced your expenditure requirements well before reaching that stage.

If you dont believe you are at risk of running out of money before death whilst maintaining your desired lifestyle then why add to your stress levels and/or jeopardise that life-style in the short term to get even richer?  You may be in a position whereby you are more concerned about passing the largest inheritance you can achieve to your then 65 year old child than your own well being in the say 25 years you have left. In that case your approach could make sense.  However I guess that most people in retirement wont have that as their top priority.

I think I misunderstood your original comment  - agreed with this 

BritishInvestor

Prism said:

Audaxer said:

SouthCoastBoy said:

BritishInvestor said:

SouthCoastBoy said:

Deleted_User said:

1. Thats an awful lot of cash.  

2. You need to diversify your fixed income rather than buy a lot more stocks than you are comfortable with.

When you say diversify my fixed income I'm not sure where to go, Bonds look expensive at the moment, cash has very low interest rates. What other options are there?

What's the issue if bonds are "expensive", given their primary role is not to provide returns but instead dampening down overall portfolio volatility?

Personally I think cash is better positioned to do this at the moment. Having said that as inflation is running away, especially when considered against savings rates neither are great at the moment, hence my original post.

Cash is not great with high inflation, but I don't necessarily think 40% cash is too much for all circumstances. It really depends on your own circumstances. If for example you are lucky enough to already have a large enough portfolio in equity and bonds to give you a very safe withdrawal rate to meet your needs, I don't see much wrong with holding a large amount of cash. I know some would invest more in these circumstances, but some would see no need to invest more.

Its not great but it could be the least worst.. 40% seems high though

On an unrelated note, it's going to be interesting to see the return on US large-cap growth stocks over the next decade, especially if inflation persists.

https://www.marketwatch.com/story/8-lessons-from-80-years-of-market-history-2014-11-19

jim8888

My main focus will be that if interest rates start to climb then I'll pay off the mortgage from my cash reserves as I'm on a BoE tracker mortgage. Can you imagine the state of Britain if mortgage interest rose to even 5%? I mean, I remember when it was 14% but I'm old! What would the generation(s) who've never seen anything like that actually do? As far as I'm aware, most people still live with debt up to the eyeballs on houses, cars and  student loans (and where would they increase to?). It's one thing with the price of a pint, coffee or gallon of petrol goes up, but when a further 1% a month is added to your £200k or £300k mortgage, that's when the stress kicks in.

Prism

BritishInvestor said:

Prism said:

Audaxer said:

SouthCoastBoy said:

BritishInvestor said:

SouthCoastBoy said:

Deleted_User said:

1. Thats an awful lot of cash.  

2. You need to diversify your fixed income rather than buy a lot more stocks than you are comfortable with.

When you say diversify my fixed income I'm not sure where to go, Bonds look expensive at the moment, cash has very low interest rates. What other options are there?

What's the issue if bonds are "expensive", given their primary role is not to provide returns but instead dampening down overall portfolio volatility?

Personally I think cash is better positioned to do this at the moment. Having said that as inflation is running away, especially when considered against savings rates neither are great at the moment, hence my original post.

Cash is not great with high inflation, but I don't necessarily think 40% cash is too much for all circumstances. It really depends on your own circumstances. If for example you are lucky enough to already have a large enough portfolio in equity and bonds to give you a very safe withdrawal rate to meet your needs, I don't see much wrong with holding a large amount of cash. I know some would invest more in these circumstances, but some would see no need to invest more.

Its not great but it could be the least worst.. 40% seems high though

On an unrelated note, it's going to be interesting to see the return on US large-cap growth stocks over the next decade, especially if inflation persists.

https://www.marketwatch.com/story/8-lessons-from-80-years-of-market-history-2014-11-19

It does feel like some sort of mix of the nifty fifty with dot.com. Both the cash generative growth companies of today (Apple, Microsoft etc) and the cash light growth companies of tomorrow (Tesla, AirBnb etc) will likely go nowhere fast. Still, I'd rather be in the first group than the second while at the same time having a higher allocation outside of US growth stocks than the global index would suggest. Perfectly happy with lower returns should I be wrong.

NedS

jim8888 said:

My main focus will be that if interest rates start to climb then I'll pay off the mortgage from my cash reserves as I'm on a BoE tracker mortgage. Can you imagine the state of Britain if mortgage interest rose to even 5%? I mean, I remember when it was 14% but I'm old! What would the generation(s) who've never seen anything like that actually do? As far as I'm aware, most people still live with debt up to the eyeballs on houses, cars and  student loans (and where would they increase to?). It's one thing with the price of a pint, coffee or gallon of petrol goes up, but when a further 1% a month is added to your £200k or £300k mortgage, that's when the stress kicks in.

Yes, and throw in a housing market crash and we're back in the 90's negative equity all over again.

I work in a jobcentre and was really struck by people coming in at start of Covid having lost what they thought was a secure job with debt up to their eyeballs. Something like "How am I supposed to live on £75/week when the loan for my Audi is £400/month, my iPhone is £60/month, my Sky is £60/month, my Netflix is £15/month, I'm paying off £200/month store credit for clothes and there is £6k on my Credit Card. Good job I live with my mum who doesn't charge me any rent". Would you like a referral for help with budgeting support Sir - No thanks, I'm fine!

jamesd

SouthCoastBoy said:

...I have 40% cash as close to retirement, but have now started to reduce that moving into some "defensive equities" (e.g. food producers, energy companies etc.) To me this is taking more risk than I wish to but feel I have no choice with the BoE appearing to have no intention to raise interest rates by a significant amount in the short term. 

I would be interested in other opinions, is anybody else concerned by the latest inflation figures and if so are they doing anything about it?

Your cash level looks fine for now. That's because in low interest, low inflation times medium term bonds suffer capital losses when interest rates rise. The BoE not having raised rates yet means that there's still substantial potential for this loss. Since the bonds also don't protect against inflation much more than cash, ignoring inflation-linked bonds, you seem well positioned. I'm also using cash and other non-equity things instead of bonds at present.

If you're using safe withdrawal rates like 4% rule or Guyton-Klinger those provide for an uncapped inflation increase either always (4% rule) or usually (GK). Simply continue to follow the plan because nothing has happened that merits changing it.

bostonerimus

Again the emphasis is on the investment side of the equation rather than on spending. A retirement plan should include some form of index linked income to give a solid foundation and also a plan to cut expenses when returns are poor...and if inflation  remains high, returns aren't going to be worth as much. That should not argue for more risk as your plan should have included high inflation. So look to your index linked bonds, DB and state pensions and tighten the belt if necessary. Also all those who made extra mortgage payments prior to retirement will be happy when rates start to peak, there's a lot to be said for removing costs from your budget as you approach retirement because it removes income generation stress from your portfolio and ultimately from you.

jim8888

Bostonerimus says "There's a lot to be said for removing costs from your budget as you approach retirement because it removes income generation stress from your portfolio and ultimately from you."

I think about that quite a lot now that I've retired. I could clear quite a bit of debt, such as the mortgage and the car finance that we have. Doing that would effectively half my monthly expenditure, but then I wouldn't be earning the interest on that six figure sum, which exceeds the interest I'm paying on the finance! I think the market will inevitably crash (but when and for how long!?) and I'll still have the debt, hence the "income generation stress". I kind of suspect clearing my debt might not be the optimum financial move today, but I feel it would wipe a lot of financial stress from the back of my mind for tomorrow.