Smoothing out early years retirement income -Guiide

DT2001

I looked at Guiide after it was recommended on an MSE thread as having a good  planning tool. It is helpful, allowing various income sources and periods of time. In addition you can tweak returns etc.  

As I had completed the worksheets I receive emails from them on various topics.

I attach the link to an article headed the same as my thread title. It is quite interesting as they are advocating a 40/60 split to include bonds maturing in the first 3 years of retirement (in effect cash). Shares are not touched until year 7. The mix changes with time increasing equity % making income volatility more likely as you age. I’m guessing that the starting pot is £500k (from the amounts drawn in bonds) and the initial drawdown is equal to 4%. After 7 years SP kicks in roughly halving the income required from the remaining pot.

It seems to me to be an overly safe approach. If you had a bond/gilts ladder to cover the 1st 7 years the rest could be held in say Investment Trusts/bonds (on a rebalancing basis 60/40 or sliding towards 75/25) reinvesting income until year 5 when the income could fill up the cash pot. Upside is greater whilst achieving the smooth early years income.

Am I missing something obvious?

https://guiidewordpress.azurewebsites.net/smoothing-out-early-years-retirement-income/?utm_source=newsletter&utm_medium=email&utm_campaign=Investment+Details

gm0

Not really missing much. 

Protection agains capital depletion from share sales in a major correction with a bad recovery shape (long) requires money market funds, short gilts, actual bonds held to term to provide essential income which is close to guaranteed. 

Which can happen any time in retirement over 40 years not just at the start.  Obviously if it depletes capital unduly at the start the impact is sustained over longer.  The amount of non-growth non-volatile stuff held once SP cuts in can be reduced - perhaps substantially for a couple - as there is now greater coverage of essential income from the guaranteed income sources - SP and DB

The investment (growth asset) part of the portfolio can be - whatever you find sufficiently racy.  100% 70/30 40/60 whatever suits you, need, heirs, attitude to volatility.  Backtesting of pension deaccumulation use (McClung etc.)  would suggest that an effective range between insufficient income and excess volatility is 40-80 equities but people have their own views on what is acceptable for very long investment horizons.

There are a hundred ways to organise the equity and bond mix, the variable income, the what gets sold first and how rebalanced discussion.  And the subset of these with reasonably defined rules are backtestable.  And detectable but small differences in the "historically" safe income yield can be found i.e. some of these academic and web ideas are indeed slightly better than others.  Or not - in an uncertain future.  Nonetheless the "demonstrably not as good as the other choice" options can probably be put aside.  As picking those would be somewhat wilful and an act of faith that a future that suits them precisely will turn up.  Accepting a variable income seems to be helpful.  GK, EM etc.

Many cohorts don't have an issue with needing the essential income cover from non-volatile assets - as it plays out for them. They don't actually need the big buffer against the possible bad sequence.  Paid the loss of potential return premium.  For no benefit on that occasion.  You don't know it was *you* until you are well into it. 

If your plans are based on last minute equity sales and something cataclysmic happens then you have little time to react and do whatever you now plan to do, cutback discretionary spending, downsize house, whatever the contingent actions are for you - or you sustain income knowing that this over depletes capital in growth assets over rapidly - which then recover to meet some long term average but you don't get it - as they are already sold.  The horror of sequence risk.

A buffered approach is easier to live with and provides time to consider calmly and to implement any lifestyle changes you choose - downsizing retirement home etc, or for the events of the world to unwind a bit further and mitigate the apparent crisis.

Some approaches maintain the protection.  Some let it burn away during early retirement (like your web link). 

You don't need a cashflow liability matched portfolio (for essential income) - until you actually do. 
And then it is too late.

Buy the ticket.  Take the ride.

Linton

mm - it would be interesting to hear the next level of detail plus what happens if a 50% equity crash occurs at an inopportune time.  

It sounds like the Guide process starts with a 40/60 balance and uses up bonds/cash until you reach 60/40 after 7 years. It would seem that you dont rebalance during this period. So rather than having a considered bond/equity mix you are effectively operating 2 separate and independent  portfolios.  Which is fine and you have no need to hide that. What is not clear to me is what happens after 7 years.  Why can you operate with a reduced safety margin at that time? What is the inflation matching strategy?

I dont see why your gilts ladder is  fundamentally different to what is proposed.  It is just a slight variation on 60% bonds using different bonds.  However if you put all the rest into income trusts to replenish the pot how do you get the growth to ensure long term inflation matching? I assume you will use a mixture of equity based and bond based income trusts to provide diversification.

Greater potential upside in retirement is not necessarily a benefit if it increases risk.  Once you have sufficient I would advocate focussing on risk reduction rather than chasing growth you may never use.

My solution is actually similar to what you are proposing though structured rather differently.  It is basically 3 completely separate portfolios (ie the overall equity/bond mix is not considered though it happens to be around 60/40).

1) Cash and very cautious investments, sufficient for say 10+ years
2) diversified Income funds
3) 100% growth equity aimed at providing long term inflation matching.

All external cash income goes into (1)  All expenditure is taken from (1).  The income from (2) automatically goes into (1).  Any excess in (1) is reinvested into (3) on a very occasional strategic basis..

If on-going total income is insufficient, money is taken from (3) and moved to (2) on a very occasional strategic basis. Or even moved to (1) for major one-offs.

So there are no special rules for particular dates, the process operates continuously.  Long term equity is largely left in peace to do its job.  Ongoing management is minimal.

JohnWinder

I can’t add much more, except this series allows one to deep dive into withdrawal portfolios and strategies: https://earlyretirementnow.com/safe-withdrawal-rate-series/

‘It sounds like the Guide process starts with a 40/60 balance and uses up bonds/cash until you reach 60/40 after 7 years. It would seem that you dont rebalance during this period. So rather than having a considered bond/equity mix you are effectively operating 2 separate and independent  portfolios.’

It has a sniff of Kitces ‘bond tent’ idea: you increase the bond component heading to retirement, then spend down the bonds during the risky SoRR period until you’re safely close enough to dying that a bad SoR won’t matter. One of many zillion approaches, but I don’t see it as two portfolios, rather one that transitions to another.

‘What is not clear to me is what happens after 7 years.  Why can you operate with a reduced safety margin at that time? What is the inflation matching strategy?’

I think the idea is that you’re over the SoRR period after 7-ish years. Maybe, depends how close to death you are. The inflation strategy is that it still holds plenty in equities, or it could be linkers.

‘basically 3 completely separate portfolios (ie the overall equity/bond mix is not considered though it happens to be around 60/40).

1. Cash and very cautious investments, sufficient for say 10+ years

If one was spending about 3%/year, considered safe, and one has 10 years in cash, then the portfolio can’t be 60/40 equities/bonds as we have to fit 30% as cash in there somewhere. It can only be 60/40 with 10 years of cash if the portfolio is hugely more than needed to live on making the cash so small a proportion as to be lost in the rounding up. No?

Linton

JohnWinder said:

I can’t add much more, except this series allows one to deep dive into withdrawal portfolios and strategies: https://earlyretirementnow.com/safe-withdrawal-rate-series/

‘It sounds like the Guide process starts with a 40/60 balance and uses up bonds/cash until you reach 60/40 after 7 years. It would seem that you dont rebalance during this period. So rather than having a considered bond/equity mix you are effectively operating 2 separate and independent  portfolios.’

It has a sniff of Kitces ‘bond tent’ idea: you increase the bond component heading to retirement, then spend down the bonds during the risky SoRR period until you’re safely close enough to dying that a bad SoR won’t matter. One of many zillion approaches, but I don’t see it as two portfolios, rather one that transitions to another.

‘What is not clear to me is what happens after 7 years.  Why can you operate with a reduced safety margin at that time? What is the inflation matching strategy?’

I think the idea is that you’re over the SoRR period after 7-ish years. Maybe, depends how close to death you are. The inflation strategy is that it still holds plenty in equities, or it could be linkers.

‘basically 3 completely separate portfolios (ie the overall equity/bond mix is not considered though it happens to be around 60/40).

1. Cash and very cautious investments, sufficient for say 10+ years

If one was spending about 3%/year, considered safe, and one has 10 years in cash, then the portfolio can’t be 60/40 equities/bonds as we have to fit 30% as cash in there somewhere. It can only be 60/40 with 10 years of cash if the portfolio is hugely more than needed to live on making the cash so small a proportion as to be lost in the rounding up. No?

No. Firstly the 10 year coverage is cash+bonds + a small amount of equity. Secondly, for these purposes cash is included with the bond allocation. With interest rates now at a sensible level most of the cash could be moved from Premium Bonds to short term gilts/money market funds.

When starting retirement 10 years is about 1/3 to 1/4 of one’s remaining planned lifespan so gets the corresponding % of the assets. Then add in some  corporate bonds in the income allocation. As the growth tranche is 100% equity the overall allocation comes to about 60/40-55/45 overall.

So it turns out I am not proposing an unusual high level allocation but rather choosing the lower level allocations to meet specific objectives and managing them appropriately. An alternative approach of basing one’s well-being for 1/3 of one’s life on 40% arbitrarily assorted bonds because it sort of feels right and 60% equity chosen purely on the basis of size/popularity of company is not something I could live with, especially during periods of economic instability.

DT2001

Linton said:

mm - it would be interesting to hear the next level of detail plus what happens if a 50% equity crash occurs at an inopportune time.  

It sounds like the Guide process starts with a 40/60 balance and uses up bonds/cash until you reach 60/40 after 7 years. It would seem that you dont rebalance during this period. So rather than having a considered bond/equity mix you are effectively operating 2 separate and independent  portfolios.  Which is fine and you have no need to hide that. What is not clear to me is what happens after 7 years.  Why can you operate with a reduced safety margin at that time? What is the inflation matching strategy?

I dont see why your gilts ladder is  fundamentally different to what is proposed.  It is just a slight variation on 60% bonds using different bonds.  However if you put all the rest into income trusts to replenish the pot how do you get the growth to ensure long term inflation matching? I assume you will use a mixture of equity based and bond based income trusts to provide diversification.

Greater potential upside in retirement is not necessarily a benefit if it increases risk.  Once you have sufficient I would advocate focussing on risk reduction rather than chasing growth you may never use.

My solution is actually similar to what you are proposing though structured rather differently.  It is basically 3 completely separate portfolios (ie the overall equity/bond mix is not considered though it happens to be around 60/40).

1) Cash and very cautious investments, sufficient for say 10+ years
2) diversified Income funds
3) 100% growth equity aimed at providing long term inflation matching.

All external cash income goes into (1)  All expenditure is taken from (1).  The income from (2) automatically goes into (1).  Any excess in (1) is reinvested into (3) on a very occasional strategic basis..

If on-going total income is insufficient, money is taken from (3) and moved to (2) on a very occasional strategic basis. Or even moved to (1) for major one-offs.

So there are no special rules for particular dates, the process operates continuously.  Long term equity is largely left in peace to do its job.  Ongoing management is minimal.

Thank you for your thoughts and explaining your strategy which I like. It is easy to understand and I assume has worked well in practice?

You have also reminded me that once you have achieved ‘sufficient’ you have the option to derisk.  With my OH continuing to work, as she enjoys it, we’ll have enough to derisk by withdrawing a lower % and tailoring our travels (which account for a high % of budget in the early years) to what income we generate. We have been self employed, with variable income, for the last 25+ years so adapt to changing circumstances whereas this might ‘frighten’ some of our employed friends.