Pension Funds and De-Risking

zagfles

Notepad_Phil said:

Linton said:

I dont look at the cash and equity together and worry about the overall risk.  The cash, for these purposes, is considered risk free so no worries and the growth equity volatility can be completely ignored since those investments dont need to be touched for at least 10 years, by which time who knows what sort of world we will be living in.  So no worries there either.

But doesn't that mean that you are looking at both the cash and equity together?

You're happy to have ten years of cash or 'near' cash because you have the investments, and vice versa you're happy to have the growth equity because you've got the cash.

I'm similar to you in having many years of cash but only because I've got the backing of 100% equities in my investments that will hopefully take care of the longer term.

The other thing to remember is that cash is hardly "risk free", inflation is currently 6.2% (CPI) or 8.2% (RPI) and predicted to rise, while interest rates are under 2%. So cash is currently losing about 5%pa. There are fears that high inflation could lead to a wages/prices inflationary spiral meaning inflation could get even higher.

We've lived in a low inflation environment over the last few decades which may have caused people to forget about the risk of inflation, in the 1970's it peaked at over 25%, and one decade's inflation reduced the value of cash by 71%.  £1 in 1970 bought the same as £3.47 in 1980.  

bostonerimus

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

Prism said:

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.

Yes I did similar myself, downloaded some historical SORs and using a "cash buffer" made hardly any difference to outcomes, however the criteria was tweaked. Maybe someone here who favours it/uses it can point us at an analysis of using a cash buffer strategy and how it would have fared in a wide variety of historical and international markets, together with rules and critera for using it/refloating it?

Here is such a study, make of it what you will.

https://www.financialplanningassociation.org/article/journal/SEP13-benefits-cash-reserve-strategy-retirement-distribution-planning

Interesting but it's US based and the main advantage of using the cash buffer seems to be transaction costs and taxes, something unlikely to be make a significant difference in the UK using funds in pensions and cash unwrapped/in ISAs. In fact I would guess taxes are likely be be higher in the UK using a cash buffer as the best interest rates for cash are unwrapped. When these are ignored, they come to the same conclusion I did, hardly any difference.

I think you are not reading the results correctly. There is a marginal benefit (~1% more successful outcomes) to not having a cash buffer in a no tax and no transaction cost scenario. The cash buffer wins out with transaction costs and taxation. In the UK there will be tax on pension withdrawals and many people will have transaction costs, but once you get into the details of taxation comparisons do become difficult. The utility and practicality of cash in the bank makes it a good thing for everyone to have. When you are working it's good practice to have an emergency cash buffer of maybe a year's spending and I don't see any reason to have less than that when retired and I would tilt towards more.

The danger in retirement is that people are pushed towards more risk and more aggressive investment strategies in order to compensate for a small pension pot relative to their perceived income needs. This is a big downside to the liberalization of retirement finances in the UK.

Indeed I did - so the cash buffer shows a worse result without accounting for what seems to be US specific taxes and transaction costs!

I can't see why in the UK there'd be any difference in transaction costs and taxes whether you use a cash buffer or not. Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons.

The comparison is between having a cash buffer and not. If you ignore taxes and costs cash there's a marginal (1%) benefit to not having a cash buffer. If you add in tax and costs then cash wins. You will have to look at the specific case for the UK, but If you draw from a cash account there will be no tax and If you draw from a tax deferred account there will be tax to pay in that year. There will be nuances like ISAs in the UK and ROTHs in the US and this is just one study. But I don't hold 2 year's of cash because of some strategic retirement goal, it's purely tactical to pay bills and cover large expenses without the faff (that's Wade Faff) of selling stuff.

The point we're discussing is holding a cash buffer for strategic purposes, which varies according to market conditions (ie can be depleted during "downturns"). Not practical purposes. Of course everyone will have some cash for practical purposes.

...and the US study shows that when you have to pay taxes and costs and run a Monte Carlo using historical data the cash wins out and in the unrealistic scenario of no tax or costs cash vs no cash are almost the same. But we should never forget that mathematical modeling should not be used in isolation and that practicalities are critical in the real world outside of algorithms. The US study might be full of confirmation bias, but does it support the prevailing dogma of having a cash buffer as part of the portfolio. An equivalent UK study would be interesting.

As I've said, I can't see why taxes or costs would be lower with the cash buffer strategy in the UK. There might be a reason for it the US, but I'm not really interested in US taxes or costs. So I think the study ignoring taxes/costs is more relevant for the UK.

If you can't see why you would have a higher tax burden in a year when withdrawing from a deferred tax account than from cash in the bank then I won't bother to explain.

The essential equivalence of cash vs no cash in the "no tax or costs" scenario is a great argument for having cash because you also have the extra practical utility.

Nebulous2

zagfles said:

Notepad_Phil said:

Linton said:

I dont look at the cash and equity together and worry about the overall risk.  The cash, for these purposes, is considered risk free so no worries and the growth equity volatility can be completely ignored since those investments dont need to be touched for at least 10 years, by which time who knows what sort of world we will be living in.  So no worries there either.

But doesn't that mean that you are looking at both the cash and equity together?

You're happy to have ten years of cash or 'near' cash because you have the investments, and vice versa you're happy to have the growth equity because you've got the cash.

I'm similar to you in having many years of cash but only because I've got the backing of 100% equities in my investments that will hopefully take care of the longer term.

The other thing to remember is that cash is hardly "risk free", inflation is currently 6.2% (CPI) or 8.2% (RPI) and predicted to rise, while interest rates are under 2%. So cash is currently losing about 5%pa. There are fears that high inflation could lead to a wages/prices inflationary spiral meaning inflation could get even higher.

We've lived in a low inflation environment over the last few decades which may have caused people to forget about the risk of inflation, in the 1970's it peaked at over 25%, and one decade's inflation reduced the value of cash by 71%.  £1 in 1970 bought the same as £3.47 in 1980.  

Our local Facebook page has just flung up a bar price list from 1971. A pint of beer was 10p. A nip of whisky or vodka was 16p. I started drinking in late 1979 / early 1980 and a pint was 32p, with a nip at 25p. (I guess the tax must have dropped on the spirits) 

Wages rose dramatically however, and so did house prices. People who remained in work, with debt such as mortgages, did pretty well out of the 70s. People with cash and no mortgages didn't do so well, nor did people who lost their jobs with the deindustrialisation. 

Thrugelmir

Notepad_Phil said:

Linton said:

I dont look at the cash and equity together and worry about the overall risk.  The cash, for these purposes, is considered risk free so no worries and the growth equity volatility can be completely ignored since those investments dont need to be touched for at least 10 years, by which time who knows what sort of world we will be living in.  So no worries there either.

But doesn't that mean that you are looking at both the cash and equity together?

You're happy to have ten years of cash or 'near' cash because you have the investments, and vice versa you're happy to have the growth equity because you've got the cash.

I'm similar to you in having many years of cash but only because I've got the backing of 100% equities in my investments that will hopefully take care of the longer term.

Cash may suffer from the ravages of inflation while equities suffer from the negative Goldilocks policies of the Central Banks. There's considerable levels of hidden indebtedness out in the wider world that's going to surface. Biden is suffering in the polls. Mid term elections are in November. MMT has indeed stoked inflation to seriously high levels and political pressure on the Fed is going to be intense. 

zagfles

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

Prism said:

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.

Yes I did similar myself, downloaded some historical SORs and using a "cash buffer" made hardly any difference to outcomes, however the criteria was tweaked. Maybe someone here who favours it/uses it can point us at an analysis of using a cash buffer strategy and how it would have fared in a wide variety of historical and international markets, together with rules and critera for using it/refloating it?

Here is such a study, make of it what you will.

https://www.financialplanningassociation.org/article/journal/SEP13-benefits-cash-reserve-strategy-retirement-distribution-planning

Interesting but it's US based and the main advantage of using the cash buffer seems to be transaction costs and taxes, something unlikely to be make a significant difference in the UK using funds in pensions and cash unwrapped/in ISAs. In fact I would guess taxes are likely be be higher in the UK using a cash buffer as the best interest rates for cash are unwrapped. When these are ignored, they come to the same conclusion I did, hardly any difference.

I think you are not reading the results correctly. There is a marginal benefit (~1% more successful outcomes) to not having a cash buffer in a no tax and no transaction cost scenario. The cash buffer wins out with transaction costs and taxation. In the UK there will be tax on pension withdrawals and many people will have transaction costs, but once you get into the details of taxation comparisons do become difficult. The utility and practicality of cash in the bank makes it a good thing for everyone to have. When you are working it's good practice to have an emergency cash buffer of maybe a year's spending and I don't see any reason to have less than that when retired and I would tilt towards more.

The danger in retirement is that people are pushed towards more risk and more aggressive investment strategies in order to compensate for a small pension pot relative to their perceived income needs. This is a big downside to the liberalization of retirement finances in the UK.

Indeed I did - so the cash buffer shows a worse result without accounting for what seems to be US specific taxes and transaction costs!

I can't see why in the UK there'd be any difference in transaction costs and taxes whether you use a cash buffer or not. Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons.

The comparison is between having a cash buffer and not. If you ignore taxes and costs cash there's a marginal (1%) benefit to not having a cash buffer. If you add in tax and costs then cash wins. You will have to look at the specific case for the UK, but If you draw from a cash account there will be no tax and If you draw from a tax deferred account there will be tax to pay in that year. There will be nuances like ISAs in the UK and ROTHs in the US and this is just one study. But I don't hold 2 year's of cash because of some strategic retirement goal, it's purely tactical to pay bills and cover large expenses without the faff (that's Wade Faff) of selling stuff.

The point we're discussing is holding a cash buffer for strategic purposes, which varies according to market conditions (ie can be depleted during "downturns"). Not practical purposes. Of course everyone will have some cash for practical purposes.

...and the US study shows that when you have to pay taxes and costs and run a Monte Carlo using historical data the cash wins out and in the unrealistic scenario of no tax or costs cash vs no cash are almost the same. But we should never forget that mathematical modeling should not be used in isolation and that practicalities are critical in the real world outside of algorithms. The US study might be full of confirmation bias, but does it support the prevailing dogma of having a cash buffer as part of the portfolio. An equivalent UK study would be interesting.

As I've said, I can't see why taxes or costs would be lower with the cash buffer strategy in the UK. There might be a reason for it the US, but I'm not really interested in US taxes or costs. So I think the study ignoring taxes/costs is more relevant for the UK.

If you can't see why you would have a higher tax burden in a year when withdrawing from a deferred tax account than from cash in the bank then I won't bother to explain.

Read what I wrote above. "Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons"

"If eg you have all equities in the pension and all cash outside, and you want to spend cash rather than equities but want to draw from the pension to use up the PA, you could cash in some equities in the pension to release drawdown cash, and at the same time buy the same equities outside the pension, eg in an ISA. So you're spending cash and maintaining equities at the same level, while still drawing your PA from the pension."

And vv obviously.

You choose which account you draw from (ie pension/ISA/unwrapped) for tax reasons. Then if necessary you rebalance according to your asset allocation strategy. You shouldn't let tax drive your asset allocation strategy, there is rarely any need to.

gm0

This is not just an "on average" across all sequences - loss of investment returns of cash and inflation erosion consideration.

If you encounter the very bad single sequence for you, i.e. your cohort start date, your WR% of pot vs the MSWR, the sequence of returns for your choice of invested portfolio, inflation impact (on cash and portfolio) and it goes wrong on that "one path"

Your *single* path among many possible as encountered - now it is "hypothetically" one of the worst - how do you support essential income and yet avoid or minimise the later retirement impact of early depletion.

There are various options

An arbitrary cash buffer of 2-4 years essential income can indeed protect from equities "overselling" while it delivers essential income.  Does it cope with all possible lenghts and shapes of correction - no.  Should you hold such a buffer to cope with all - likely no as impossible for most.   But does it help to cope with many historic corrections - yes. 

Most importantly it provides an extended period to think it through and calmly plan other next steps to conditions at the time.

Without suspending growth asset sales for drawdown in a major correction equity units could well be gone at 20-30p on the £ and a steep recovery in value later doesn't save *you* as the retirement is now badly compromised by the units leaving the plan early.

Lowering income from drawdown with a variable income method can help risk manage and also extend the usefulness of a given size cash buffer

Bring forward timing of any reitirement property downsizing could lower outgoings and also release capital for income substitution (viewed as a contingency plan).  Even if that transaction took a year to do - the cash buffer has bought the time to do it.

The arrival of SP (or other GI pensions income) for self and spouse will reduce the "required income" from drawdown in your sixties so the period from early retirement to there is the most difficult but it doesn't last a full 40 year plan for most retirees with SP enitlements

I agree all paths analysis may show that cash vs no cash is close to moot or there is a minor difference overall on average. Very well.  That may be so.

But that doesn't make it work any better for the single retiree described here.

zagfles

Nebulous2 said:

zagfles said:

Notepad_Phil said:

Linton said:

I dont look at the cash and equity together and worry about the overall risk.  The cash, for these purposes, is considered risk free so no worries and the growth equity volatility can be completely ignored since those investments dont need to be touched for at least 10 years, by which time who knows what sort of world we will be living in.  So no worries there either.

But doesn't that mean that you are looking at both the cash and equity together?

You're happy to have ten years of cash or 'near' cash because you have the investments, and vice versa you're happy to have the growth equity because you've got the cash.

I'm similar to you in having many years of cash but only because I've got the backing of 100% equities in my investments that will hopefully take care of the longer term.

The other thing to remember is that cash is hardly "risk free", inflation is currently 6.2% (CPI) or 8.2% (RPI) and predicted to rise, while interest rates are under 2%. So cash is currently losing about 5%pa. There are fears that high inflation could lead to a wages/prices inflationary spiral meaning inflation could get even higher.

We've lived in a low inflation environment over the last few decades which may have caused people to forget about the risk of inflation, in the 1970's it peaked at over 25%, and one decade's inflation reduced the value of cash by 71%.  £1 in 1970 bought the same as £3.47 in 1980.  

Our local Facebook page has just flung up a bar price list from 1971. A pint of beer was 10p. A nip of whisky or vodka was 16p. I started drinking in late 1979 / early 1980 and a pint was 32p, with a nip at 25p. (I guess the tax must have dropped on the spirits) 

Wages rose dramatically however, and so did house prices. People who remained in work, with debt such as mortgages, did pretty well out of the 70s. People with cash and no mortgages didn't do so well, nor did people who lost their jobs with the deindustrialisation. 

And many people with pensions were screwed, people go on about how wonderful DB pensions were but they forget that there was no statutory inflation protection until the 90's IIRC. Some schemes provided inflation increases but many didn't, some companies used their pension scheme as "golden handcuffs" as the pension would become worthless if they moved jobs before retirement, as it wouldn't rise with inflation.

Even now, most DB pensions have inflation capped increases, eg at 3% or 5%, so with inflation at 8% their supposedly safe DB pension is going down by 3-5% a year.

bostonerimus

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

Prism said:

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.

Yes I did similar myself, downloaded some historical SORs and using a "cash buffer" made hardly any difference to outcomes, however the criteria was tweaked. Maybe someone here who favours it/uses it can point us at an analysis of using a cash buffer strategy and how it would have fared in a wide variety of historical and international markets, together with rules and critera for using it/refloating it?

Here is such a study, make of it what you will.

https://www.financialplanningassociation.org/article/journal/SEP13-benefits-cash-reserve-strategy-retirement-distribution-planning

Interesting but it's US based and the main advantage of using the cash buffer seems to be transaction costs and taxes, something unlikely to be make a significant difference in the UK using funds in pensions and cash unwrapped/in ISAs. In fact I would guess taxes are likely be be higher in the UK using a cash buffer as the best interest rates for cash are unwrapped. When these are ignored, they come to the same conclusion I did, hardly any difference.

I think you are not reading the results correctly. There is a marginal benefit (~1% more successful outcomes) to not having a cash buffer in a no tax and no transaction cost scenario. The cash buffer wins out with transaction costs and taxation. In the UK there will be tax on pension withdrawals and many people will have transaction costs, but once you get into the details of taxation comparisons do become difficult. The utility and practicality of cash in the bank makes it a good thing for everyone to have. When you are working it's good practice to have an emergency cash buffer of maybe a year's spending and I don't see any reason to have less than that when retired and I would tilt towards more.

The danger in retirement is that people are pushed towards more risk and more aggressive investment strategies in order to compensate for a small pension pot relative to their perceived income needs. This is a big downside to the liberalization of retirement finances in the UK.

Indeed I did - so the cash buffer shows a worse result without accounting for what seems to be US specific taxes and transaction costs!

I can't see why in the UK there'd be any difference in transaction costs and taxes whether you use a cash buffer or not. Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons.

The comparison is between having a cash buffer and not. If you ignore taxes and costs cash there's a marginal (1%) benefit to not having a cash buffer. If you add in tax and costs then cash wins. You will have to look at the specific case for the UK, but If you draw from a cash account there will be no tax and If you draw from a tax deferred account there will be tax to pay in that year. There will be nuances like ISAs in the UK and ROTHs in the US and this is just one study. But I don't hold 2 year's of cash because of some strategic retirement goal, it's purely tactical to pay bills and cover large expenses without the faff (that's Wade Faff) of selling stuff.

The point we're discussing is holding a cash buffer for strategic purposes, which varies according to market conditions (ie can be depleted during "downturns"). Not practical purposes. Of course everyone will have some cash for practical purposes.

...and the US study shows that when you have to pay taxes and costs and run a Monte Carlo using historical data the cash wins out and in the unrealistic scenario of no tax or costs cash vs no cash are almost the same. But we should never forget that mathematical modeling should not be used in isolation and that practicalities are critical in the real world outside of algorithms. The US study might be full of confirmation bias, but does it support the prevailing dogma of having a cash buffer as part of the portfolio. An equivalent UK study would be interesting.

As I've said, I can't see why taxes or costs would be lower with the cash buffer strategy in the UK. There might be a reason for it the US, but I'm not really interested in US taxes or costs. So I think the study ignoring taxes/costs is more relevant for the UK.

If you can't see why you would have a higher tax burden in a year when withdrawing from a deferred tax account than from cash in the bank then I won't bother to explain.

Read what I wrote above. "Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons"

"If eg you have all equities in the pension and all cash outside, and you want to spend cash rather than equities but want to draw from the pension to use up the PA, you could cash in some equities in the pension to release drawdown cash, and at the same time buy the same equities outside the pension, eg in an ISA. So you're spending cash and maintaining equities at the same level, while still drawing your PA from the pension."

And vv obviously.

You choose which account you draw from (ie pension/ISA/unwrapped) for tax reasons. Then if necessary you rebalance according to your asset allocation strategy. You shouldn't let tax drive your asset allocation strategy, there is rarely any need to.

There are an infinite number of scenarios. The US study by necessity took a limited number and ran Monte Carlo simulations and looked at the results. The US also has a PA and the equivalent of the ISA so while the exact numbers might be different the same strategies are used. I would be interested to see the results of a UK study, but your reply shows the utility of a cash buffer in the bank.

bostonerimus

zagfles said:

Nebulous2 said:

zagfles said:

Notepad_Phil said:

Linton said:

I dont look at the cash and equity together and worry about the overall risk.  The cash, for these purposes, is considered risk free so no worries and the growth equity volatility can be completely ignored since those investments dont need to be touched for at least 10 years, by which time who knows what sort of world we will be living in.  So no worries there either.

But doesn't that mean that you are looking at both the cash and equity together?

You're happy to have ten years of cash or 'near' cash because you have the investments, and vice versa you're happy to have the growth equity because you've got the cash.

I'm similar to you in having many years of cash but only because I've got the backing of 100% equities in my investments that will hopefully take care of the longer term.

The other thing to remember is that cash is hardly "risk free", inflation is currently 6.2% (CPI) or 8.2% (RPI) and predicted to rise, while interest rates are under 2%. So cash is currently losing about 5%pa. There are fears that high inflation could lead to a wages/prices inflationary spiral meaning inflation could get even higher.

We've lived in a low inflation environment over the last few decades which may have caused people to forget about the risk of inflation, in the 1970's it peaked at over 25%, and one decade's inflation reduced the value of cash by 71%.  £1 in 1970 bought the same as £3.47 in 1980.  

Our local Facebook page has just flung up a bar price list from 1971. A pint of beer was 10p. A nip of whisky or vodka was 16p. I started drinking in late 1979 / early 1980 and a pint was 32p, with a nip at 25p. (I guess the tax must have dropped on the spirits) 

Wages rose dramatically however, and so did house prices. People who remained in work, with debt such as mortgages, did pretty well out of the 70s. People with cash and no mortgages didn't do so well, nor did people who lost their jobs with the deindustrialisation. 

And many people with pensions were screwed, people go on about how wonderful DB pensions were but they forget that there was no statutory inflation protection until the 90's IIRC. Some schemes provided inflation increases but many didn't, some companies used their pension scheme as "golden handcuffs" as the pension would become worthless if they moved jobs before retirement, as it wouldn't rise with inflation.

Even now, most DB pensions have inflation capped increases, eg at 3% or 5%, so with inflation at 8% their supposedly safe DB pension is going down by 3-5% a year.

If you don't have one, would you like a DB pension as part of your retirement portfolio?

zagfles

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

bostonerimus said:

zagfles said:

Prism said:

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.

Yes I did similar myself, downloaded some historical SORs and using a "cash buffer" made hardly any difference to outcomes, however the criteria was tweaked. Maybe someone here who favours it/uses it can point us at an analysis of using a cash buffer strategy and how it would have fared in a wide variety of historical and international markets, together with rules and critera for using it/refloating it?

Here is such a study, make of it what you will.

https://www.financialplanningassociation.org/article/journal/SEP13-benefits-cash-reserve-strategy-retirement-distribution-planning

Interesting but it's US based and the main advantage of using the cash buffer seems to be transaction costs and taxes, something unlikely to be make a significant difference in the UK using funds in pensions and cash unwrapped/in ISAs. In fact I would guess taxes are likely be be higher in the UK using a cash buffer as the best interest rates for cash are unwrapped. When these are ignored, they come to the same conclusion I did, hardly any difference.

I think you are not reading the results correctly. There is a marginal benefit (~1% more successful outcomes) to not having a cash buffer in a no tax and no transaction cost scenario. The cash buffer wins out with transaction costs and taxation. In the UK there will be tax on pension withdrawals and many people will have transaction costs, but once you get into the details of taxation comparisons do become difficult. The utility and practicality of cash in the bank makes it a good thing for everyone to have. When you are working it's good practice to have an emergency cash buffer of maybe a year's spending and I don't see any reason to have less than that when retired and I would tilt towards more.

The danger in retirement is that people are pushed towards more risk and more aggressive investment strategies in order to compensate for a small pension pot relative to their perceived income needs. This is a big downside to the liberalization of retirement finances in the UK.

Indeed I did - so the cash buffer shows a worse result without accounting for what seems to be US specific taxes and transaction costs!

I can't see why in the UK there'd be any difference in transaction costs and taxes whether you use a cash buffer or not. Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons.

The comparison is between having a cash buffer and not. If you ignore taxes and costs cash there's a marginal (1%) benefit to not having a cash buffer. If you add in tax and costs then cash wins. You will have to look at the specific case for the UK, but If you draw from a cash account there will be no tax and If you draw from a tax deferred account there will be tax to pay in that year. There will be nuances like ISAs in the UK and ROTHs in the US and this is just one study. But I don't hold 2 year's of cash because of some strategic retirement goal, it's purely tactical to pay bills and cover large expenses without the faff (that's Wade Faff) of selling stuff.

The point we're discussing is holding a cash buffer for strategic purposes, which varies according to market conditions (ie can be depleted during "downturns"). Not practical purposes. Of course everyone will have some cash for practical purposes.

...and the US study shows that when you have to pay taxes and costs and run a Monte Carlo using historical data the cash wins out and in the unrealistic scenario of no tax or costs cash vs no cash are almost the same. But we should never forget that mathematical modeling should not be used in isolation and that practicalities are critical in the real world outside of algorithms. The US study might be full of confirmation bias, but does it support the prevailing dogma of having a cash buffer as part of the portfolio. An equivalent UK study would be interesting.

As I've said, I can't see why taxes or costs would be lower with the cash buffer strategy in the UK. There might be a reason for it the US, but I'm not really interested in US taxes or costs. So I think the study ignoring taxes/costs is more relevant for the UK.

If you can't see why you would have a higher tax burden in a year when withdrawing from a deferred tax account than from cash in the bank then I won't bother to explain.

Read what I wrote above. "Obviously assuming you redistribute in the way I mentioned earlier if eg you want to draw from the pension wrapper for tax reasons but want to spend from cash for asset balancing reasons"

"If eg you have all equities in the pension and all cash outside, and you want to spend cash rather than equities but want to draw from the pension to use up the PA, you could cash in some equities in the pension to release drawdown cash, and at the same time buy the same equities outside the pension, eg in an ISA. So you're spending cash and maintaining equities at the same level, while still drawing your PA from the pension."

And vv obviously.

You choose which account you draw from (ie pension/ISA/unwrapped) for tax reasons. Then if necessary you rebalance according to your asset allocation strategy. You shouldn't let tax drive your asset allocation strategy, there is rarely any need to.

There are an infinite number of scenarios. The US study by necessity took a limited number and ran Monte Carlo simulations and looked at the results. The US also has a PA and the equivalent of the ISA so while the exact numbers might be different the same strategies are used. I would be interested to see the results of a UK study, but your reply shows the utility of a cash buffer in the bank.

Well obviously having cash in the bank is useful. It's a different issue to whether it's an idea to have a variable "cash buffer" to use in times of market downturn. I think we're done with this discussion.