Pension Funds and De-Risking

bostonerimus

I worry about how risk is calibrated in a world where stocks markets are so volatile and bond funds are subject to rising interest rates. I decided I wanted to have a foundation minimum income made up of SP and other "non-market" sources. So I gave up on using what could be described as "safer" or "more conservative" stocks and bonds to de-risk my retirement and decided to annuitize a portion of my DC pot and also have some in a rental property. Annuities, SP and DB pensions can still be hit by inflation and rentals can stand empty, but hopefully combining them with a DC pot invested in the markets will provide the diversity to weather a range of situations.

Controlling spending is also a very important tool to de-risk your retirement.

Steve_s1

Diversification makes a lot of sense. I’m also considering a small rental property to generate some modest income, alongside the pension. I hear what you say about controlling spending too…luckily I don’t need to drive a smart new car or take exotic holidays to enjoy life…a take-away and a pint once a week is my little luxury! 😉 Thanks for the comments.

jim8888

zagfles said:

jim8888 said:

Trying to predict the markets is why (in my 1st year of retirement) I took out 3 year's worth of annual expenses in cash. My intention is each year to cash in another year's worth of expenses so that I'll always have a 3 year cash buffer if the markets tank. The rest of my SIPP is in a Vanguard 80/20 LS fund. It took me ages to decide on this approach. It's not without risk, but so far I'm as comfortable with it as I think I could be with any other. 

The thing about this sort of "cash buffer" approach is you have to make short term market timing decisions as to when to use it. What does "tanking" mean? For instance, what would you have do if the markets behaved as from 2000 onwards? Between 2000 and 2003 they mostly "tanked", so would you have spent the cash buffer over those 3 years? If you had, you'd have run out in 2003, at a market low, and be forced to sell equities in a massive dip. Similar story if you started in 2007. It works fine if the dip is very short term like the 2020 COVID dip, but many aren't.

Personally I'm looking at a more structured approach like Prime Harvesting, discussed here recently, it's a similar principle but more structured (ie based on rules rather that subjective assessments) and a much longer term approach.

That's interesting I might have a look at Prime Harvesting. (I searched the forum but couldn't find one that simply explained the concept - is there a good "Beginners Guide" link someone could post?)
I would like to refine my strategy for the reasons Zagfles has outlined, but it was so complex trying to work out a withdrawal strategy when initially I just wanted to keep things simple that I took a bit of a sledgehammer approach. I recognise that arbitrarily picking (say) April each year to cash in a year's worth of expenses, regardless of the market at the time, might not be sensible. At the other end of the extreme, I could "spend a month's cash and sell the equivalent in equities" and that way keep my buffer fund topped up. I have to say that trying to keep things simple gets increasingly complicated 

dunstonh

jim8888 said:

zagfles said:

jim8888 said:

Trying to predict the markets is why (in my 1st year of retirement) I took out 3 year's worth of annual expenses in cash. My intention is each year to cash in another year's worth of expenses so that I'll always have a 3 year cash buffer if the markets tank. The rest of my SIPP is in a Vanguard 80/20 LS fund. It took me ages to decide on this approach. It's not without risk, but so far I'm as comfortable with it as I think I could be with any other. 

The thing about this sort of "cash buffer" approach is you have to make short term market timing decisions as to when to use it. What does "tanking" mean? For instance, what would you have do if the markets behaved as from 2000 onwards? Between 2000 and 2003 they mostly "tanked", so would you have spent the cash buffer over those 3 years? If you had, you'd have run out in 2003, at a market low, and be forced to sell equities in a massive dip. Similar story if you started in 2007. It works fine if the dip is very short term like the 2020 COVID dip, but many aren't.

Personally I'm looking at a more structured approach like Prime Harvesting, discussed here recently, it's a similar principle but more structured (ie based on rules rather that subjective assessments) and a much longer term approach.

That's interesting I might have a look at Prime Harvesting. (I searched the forum but couldn't find one that simply explained the concept - is there a good "Beginners Guide" link someone could post?)
I would like to refine my strategy for the reasons Zagfles has outlined, but it was so complex trying to work out a withdrawal strategy when initially I just wanted to keep things simple that I took a bit of a sledgehammer approach. I recognise that arbitrarily picking (say) April each year to cash in a year's worth of expenses, regardless of the market at the time, might not be sensible. At the other end of the extreme, I could "spend a month's cash and sell the equivalent in equities" and that way keep my buffer fund topped up. I have to say that trying to keep things simple gets increasingly complicated 

Drawing it in April each year is also timing.     If you are silly enough to say that keeping a cash float for any period is timing.

95% of market falls recover within 3 years (actually much less than that).   So, a cash buffer avoids sales of units in the vast majority of negative periods.   You cannot cover all eventualities but you can take reasonable steps.

Take the period between 2000 and 2003.  A three year float would not have avoided the eventual sale of units but instead of selling units each year between 2000 and 2003, you would only have had to sell units after 2003 as the three-year buffer would have been in place from unit sales/income prior to the fall.      When markets are lower, you don't have to replenish the buffer for a 3 year period.  You can do it for one year.  And then revert to three years once higher.

Malthusian

You wouldn't have switched withdrawals to your cash buffer in 2000 as it was just a sideways year - markets went up and markets went down. Effectively it was still the top of the market.

You might have done it in 2001 depending on timing - a mere 10% correction turned into a full-blown crash after 9/11.

And you would certainly have started draining the cash buffer by 2002. (If you don't start spending the cash buffer when markets are 25% down, what's it there for?)

After 2003 markets started going back up. So in the worst case scenario you would have run out of your cash buffer in 2004, a year after the bottom of the market. Markets wouldn't be back to their peak until 2006 so you would still be cashing in investments below their peak for a good few years, but hey, at least the markets were going back up. And if you didn't hold 100% equities your bond holdings would probably have held their value as equities fell, so you would have those to draw from as well.

Naturally all of this is only true with the benefit of hindsight, and the experience of draining a 3 year cash buffer as markets fell might have felt much more scary at the time. But there's only so much you can do. You could always hold 5 years' spending in cash if it doesn't compromise your lifestyle too much.

bostonerimus

jim8888 said:

zagfles said:

jim8888 said:

Trying to predict the markets is why (in my 1st year of retirement) I took out 3 year's worth of annual expenses in cash. My intention is each year to cash in another year's worth of expenses so that I'll always have a 3 year cash buffer if the markets tank. The rest of my SIPP is in a Vanguard 80/20 LS fund. It took me ages to decide on this approach. It's not without risk, but so far I'm as comfortable with it as I think I could be with any other. 

The thing about this sort of "cash buffer" approach is you have to make short term market timing decisions as to when to use it. What does "tanking" mean? For instance, what would you have do if the markets behaved as from 2000 onwards? Between 2000 and 2003 they mostly "tanked", so would you have spent the cash buffer over those 3 years? If you had, you'd have run out in 2003, at a market low, and be forced to sell equities in a massive dip. Similar story if you started in 2007. It works fine if the dip is very short term like the 2020 COVID dip, but many aren't.

Personally I'm looking at a more structured approach like Prime Harvesting, discussed here recently, it's a similar principle but more structured (ie based on rules rather that subjective assessments) and a much longer term approach.

That's interesting I might have a look at Prime Harvesting. (I searched the forum but couldn't find one that simply explained the concept - is there a good "Beginners Guide" link someone could post?)
I would like to refine my strategy for the reasons Zagfles has outlined, but it was so complex trying to work out a withdrawal strategy when initially I just wanted to keep things simple that I took a bit of a sledgehammer approach. I recognise that arbitrarily picking (say) April each year to cash in a year's worth of expenses, regardless of the market at the time, might not be sensible. At the other end of the extreme, I could "spend a month's cash and sell the equivalent in equities" and that way keep my buffer fund topped up. I have to say that trying to keep things simple gets increasingly complicated 

There are a few withdrawal strategies you can implement like the old Bengen 4%, Guyton-Klinger and now Prime Harvesting. They are all good ways to sell books and magazine articles. I think any of them will get you through retirement ok if future markets have similar statistics to past markets and the performance of each will come down the the details of market variability and the way the retiree actually implements the methods. The error many people make is believing that they can work out an optimum retirement solution when they can only guess at the future statistics of the markets. That doesn't mean that it's silly to research the methods or implement one of them as that process will give you an understanding of the problem and a structure to work within, but it will never remove risk or the possibility of failure. The best way to do that is to have an index linked DB pension or annuity.

NedS

jim8888 said:

That's interesting I might have a look at Prime Harvesting. (I searched the forum but couldn't find one that simply explained the concept - is there a good "Beginners Guide" link someone could post?)
I would like to refine my strategy for the reasons Zagfles has outlined, but it was so complex trying to work out a withdrawal strategy when initially I just wanted to keep things simple that I took a bit of a sledgehammer approach. I recognise that arbitrarily picking (say) April each year to cash in a year's worth of expenses, regardless of the market at the time, might not be sensible. At the other end of the extreme, I could "spend a month's cash and sell the equivalent in equities" and that way keep my buffer fund topped up. I have to say that trying to keep things simple gets increasingly complicated 

See Chapter 3 of Living Off Your Money by McClung, freely available here (a great read):

http://livingoffyourmoney.com/wp-content/uploads/2016/05/LivingOffYourOwnMoney_eBook_FirstThreeChapters.pdf

k6chris

dunstonh said:

95% of market falls recover within 3 years (actually much less than that).   So, a cash buffer avoids sales of units in the vast majority of negative periods.   You cannot cover all eventualities but you can take reasonable steps.

Genuine question, how and when do you replace that cash buffer? Thanks.

dunstonh

k6chris said:

dunstonh said:

95% of market falls recover within 3 years (actually much less than that).   So, a cash buffer avoids sales of units in the vast majority of negative periods.   You cannot cover all eventualities but you can take reasonable steps.

Genuine question, how and when do you replace that cash buffer? Thanks.

You are not looking to time the market as to when it is best to sell.    You are just looking to avoid the worst periods.    If your value is much the same as last year or a bit lower or higher then you refloat.  If it's a lot lower then consider deferring.   It's not about avoiding minor volatility.  It's avoiding the sell during the big ones.

The same can apply if you hold larger cash amounts outside of your pension in that you turn off the pension income and use your external cash instead rather than sell units in extreme negative periods.

Prism

k6chris said:

dunstonh said:

95% of market falls recover within 3 years (actually much less than that).   So, a cash buffer avoids sales of units in the vast majority of negative periods.   You cannot cover all eventualities but you can take reasonable steps.

Genuine question, how and when do you replace that cash buffer? Thanks.

I did a simulation of a cash buffer with the 2000 crash and it was almost impossible to replace it at any time within the first 15 years. In fact the cash buffer with a high allocation of equities didn't really work at all as you ended up holding onto all of those equites to the very bottom in 2003, at which point the buffer was gone and then you started selling equites as they began to rise (just when it would have been ideal to hold onto them). Then 2008 hit and there was no cash buffer and this was the real crash.

All that time I imagine someone would have been constantly questioning their choices on what to use that year - cash or equities. Who knew that the best approach would have been to sell equities in 2000, 2001 and 2002 because it was in fact going to go even lower.

Of course someone with a 'proper' retirement allocation of bonds and equities wouldn likely have never needed the cash buffer as they would have sold some bonds.