What is the optimal ratio of equities to bonds for an investment that requires a 5% annual drawdown?

Octopussy91

If I want to maintain the value of the investment (and ideally grow it), I need to aim for 5% growth before drawdown.  What ratio is most likely to deliver such growth without exposing me to costly short term losses if the market goes down in the next year or two?

george4064

Do you really expect random people on the internet to go through the time and effort to do all these calculations for you to answer this hypothetical question?

I assume you have tried calculating it yourself? If so, at least share your workings if you want anyone to comment with something meaningful.

dunstonh

What is the optimal ratio of equities to bonds for an investment that requires a 5% annual drawdown?

What ratio is most likely to deliver such growth without exposing me to costly short term losses if the market goes down in the next year or two?

It is a high drawdown rate and suggests that you are expecting capital erosion as part of your drawdown strategy.     It will also require a high ratio of equities and by default that will expose you to high short term losses.

There is no asset class that can achieve 5% pa. without short term loss potential.

Have you considered an annuity?
Do you not maintain a cash float to cover you for short term volatility?

Albermarle

 What ratio is most likely to deliver such growth without exposing me to costly short term losses if the market goes down in the next year or two?

You are searching for the Holy Grail and need to be more realistic.

A withdrawal rate around 3.5% is more realistic long term. The exact equity/bonds ratio is probably not that important as long as the equity is say minimum 50% . A cash buffer to use during times of market downturns can help as well. 

JohnWinder

There’s some ambiguity in your briefly worded enquiry, such as 5% growth before withdrawing starts or was it meant to include a withdrawal. No matter; there are lots of online resources which can simulate any old portfolio you want to imagine, and let you see how that would have fared in the past as a guide to what might happen from now on. Firecal is one such, as is cfiresim. And here’s your opening into a wealth of information: https://www.bogleheads.org/wiki/Retirement_calculators_and_spending
Let us know what you come up with, but my take on it is that a wide range of withdrawal rates have safely see investors home in retirement, and that 3.5%/year is as low you need to go to be ‘dead’ sure you won’t run out of money. More likely, you’ll get away with 5 or 6%/year.

coastline

No guide to the future but the 2000-2022 present day has been a pretty volatile period. Just as a guide the following link, although US based, is set to that period with 5% withdrawals. Three portfolios 100% equity ,60/40 bonds and 40/60. Very nervous in 2003 and even more so in 2009 where you'd be left with around 25% of your original pot. Below the Portfolio Growth chart there's an inflation tab and it gets worse when selected. 

Backtest Portfolio Asset Class Allocation (portfoliovisualizer.com)

Basically two or three bad years isn't what you want and it's not uncommon. 50 years of total annual returns here.

MSCI World - Wikipedia

Bonds have been levelling out over the last decade . Set the chart to 10 years. Performance just over 20% and inflation even more than that.

 Chart Tool | Trustnet

Again set to 10 years.

Vanguard U.K. Gilt UCITS ETF summary price and performance data – Investors Chronicle

Thrugelmir

Octopussy91 said:

If I want to maintain the value of the investment (and ideally grow it), I need to aim for 5% growth before drawdown.  What ratio is most likely to deliver such growth without exposing me to costly short term losses if the market goes down in the next year or two?

How much capital are prepared to lose? Going to require a very concentrated portfolio. 

tebbins

What are you asking for, what are you actually trying to achieve here, why do you need 5% growth, is this before or after inflation?

Octopussy91

Thanks for all the helpful responses - much appreciated.

Unfortunately the products in question are both a particular kind of offshore investment bond with withdrawals set at 5% until the death of the holder.  There is nothing I can do to reduce the withdrawal rate.  Surrender is also not an option.

The products have been in place for nearly 20 years.  One has actually performed well.  I don't think the underlying investments (a spread of about a dozen funds) have been altered much over this time.  The value has gone up about 65%, despite the 5% annual withdrawal.  The other has performed less well, and is now at about 90% of its initial value. 

I'm trying to develop a straightforward, non time-consuming fund allocation strategy for both of them and have alighted upon a combination of equities and bonds (global tracker funds for the former and government bond trackers for the latter). 

The question is, what is a sensible ratio, if I want to maintain and ideally grow the value of the capital over the long term, but avoid large dents being made in the short term.

My gut feel is that 70:30 is about right, and some initial calculations based on the last 5 years suggest it might be reasonable.  @coastline and @JohnWinder - your suggestions above look like they might help me get a better sense of this, so many thanks for them.

And thanks again for all your responses (well most of them!).

Albermarle

Octopussy91 said:

Thanks for all the helpful responses - much appreciated.

Unfortunately the products in question are both a particular kind of offshore investment bond with withdrawals set at 5% until the death of the holder.  There is nothing I can do to reduce the withdrawal rate.  Surrender is also not an option.

The products have been in place for nearly 20 years.  One has actually performed well.  I don't think the underlying investments (a spread of about a dozen funds) have been altered much over this time.  The value has gone up about 65%, despite the 5% annual withdrawal.  The other has performed less well, and is now at about 90% of its initial value. 

I'm trying to develop a straightforward, non time-consuming fund allocation strategy for both of them and have alighted upon a combination of equities and bonds (global tracker funds for the former and government bond trackers for the latter). 

The question is, what is a sensible ratio, if I want to maintain and ideally grow the value of the capital over the long term, but avoid large dents being made in the short term.

My gut feel is that 70:30 is about right, and some initial calculations based on the last 5 years suggest it might be reasonable.  @coastline and @JohnWinder - your suggestions above look like they might help me get a better sense of this, so many thanks for them.

And thanks again for all your responses (well most of them!).

If you had explained the situation properly ( like you have above ) in your first post you would have got better responses......

Are equities and bonds, the only alternatives ?. Govt bond trackers have had a poor period recently .

Prism

This is probably worth a read, covering 4% or 5% withdrawals around the world. The bottom graph suggests that 60/40 is historically optimal for a world allocation with 80/20 for UK only equity. It also suggests that historically a 5% withdrawal rate might run out after 16 years. Oh, and these examples are cash not bonds.

Does The 4% Rule Work Around The World? | RR (retirementresearcher.com)