What is my real asset allocation?

GazzaBloom

How would you interpret the following situation?

Pre State Pensions...If 18% of expected initial retirement annual spend is coming from a fixed income source of a defined benefit pension and the combined invested defined contribution pensions/ISAs is invested 85% equity index funds and 15% cash/money market funds and the plan is to to draw down proportionally to make up the difference and rebalance annually, is it fair to view the "real" asset allocation not 85/15 but in fact 67/33 equity (risk-on) / fixed income (risk-off)?

dunstonh

I would ignore the secure income in respect of asset allocation as you are using your risk based assets to cover the shortfall in secure income to meet your expenditure.

Pat38493

dunstonh said:

I would ignore the secure income in respect of asset allocation as you are using your risk based assets to cover the shortfall in secure income to meet your expenditure.

There is an argument to take the opposite view because the DB pension is equivalent to having a sum of money invested directly in inflation linked bonds?  I think you can argue it both ways.

What's clear to me is that simulation results are much worse over an entire retirement timeline, if you have front loaded bridging strategy leading up to SPA, and you simulate putting your DB into payment late compared to immediately, so it seems clear that the DB acts as a kind of partial protection against the worst sequence risk.

Possibly the answer to the question depends on your risk attitude!

Bostonerimus1

I'd take your secure income, ie DB pensions and SP, off your retirement income needs and then invest your remaining assets to meet that net income requirement. So take them out of the equation. This can lead to a bit of a paradox if the next income you need to cover with DC, ISA and general invested assets is small: you might say "I have my income covered so I don't need to take any risk and I can invest conservatively" or you might say "I have my income covered so I can take lots of risk and invest aggressively". Your asset allocation could be 10/90 or 90/10 and work just fine, it ends up being more a reflection of your personality than your financial circumstances.

GazzaBloom

Interesting isn't it? There are different lenses we can look through.

Linton

What benefit do you gain by representng your combined DB and DC package by a single % allocation? What do you do with that nuumber?  In my view your DB pension is a totally different beast and it is meaningless to regard it as a sort of bond. 

Just decide what separate jobs you want done by your assets and hence the investment type and quantity to do them.  If there is anything left over you can cosider whether there are more tasks for your investments.  If not invest your free wealth in the way that comes most naturally to you.

That will give you a % allocation based on needs rather than being chosen arbitrarily

Bostonerimus1

I think of my DB pension and SP as "wages" and don't include them in my assets, even though there is an early death benefit with the DB pension, but that is irrelevant to my immediate finances. 

JohnWinder

There is an argument to take the opposite view because the DB pension is equivalent to having a sum of money invested directly in inflation linked bonds?

Yes, but weakened to the extent that the bonds will run out at some time before you die whereas the SP won’t; or the bonds won’t run out because there’s enough for 100 years, and now we’re talking about an asset allocation of 5/95 which sounds strange.

GazzaBloom

OK, give me some rope here, try this view. these numbers are made up for the sake of example, with inflation and state pensions disregarded for simplicity for now:

You are looking to fund a 30 year retirement

 DB pension £6K x 30 = £180,000

 You have DC and ISA assets totalling £550,000 split 85/15 stocks (risk on) and cash (risk off)

 So, you could look at this:

£467,500 stocks, £82,500 cash, £180,000 fixed income as a total starting pot of £730,000. Imagine the DB pension is like taking an annuity that pays £6K a year at the start of retirement with some of the starting pot.

 So with that view, you could look at this as 64% stocks, 11% cash and 25% fixed income as a starting portfolio to fund the planned 30 years retirement.

This all started when I was discussing asset allocation with someone recently and I took the view in the conversation that the DB pension is disregarded and wasn't particularly relevant, as is suggested by some replies above.

But, it is relevant and will have an important part to play, even at the seemingly low £6K a year (inflation linked) 

Linton

Do you treat your SP in the same way as your DB pension? If not, why not? Both are guaranteed and will increase with inflation. One downside of treating either or both as an annuity bought at retirement is that a change in annuity rates prior to retirement changes your assumed asset allocation when in reality the cost and benefit of the income streams do not change.

You can treat anything in any way you want. How does doing it in one way rather than another affect your subsequent actions? If it doesn’t why bother?

GazzaBloom

Linton said:

Do you treat your SP in the same way as your DB pension? If not, why not? Both are guaranteed and will increase with inflation. One downside of treating either or both as an annuity bought at retirement is that a change in annuity rates prior to retirement changes your assumed asset allocation when in reality the cost and benefit of the income streams do not change.

You can treat anything in any way you want. How does doing it in one way rather than another affect your subsequent actions? If it doesn’t why bother?

Agreed, it's just a bit of light musing, to while away boring hours at work, not a life of death debate. My plans are set and I'm progressing to plan.