Preferred approach to dealing with a correction/crash

Bobziz

Hi, 

Having begun to learn the ropes of investing over the last 4 years with a relatively small amount of cash, I'm now nearing the point where I will be investing a sizable inheritance.

My question is what is your preferred approach to maintaining a sufficient income when there's a market correction/period of poor performance ?

For example, do you keep a number of years worth of expenses in cash savings or do you take income from lower risk investments, perhaps you reduce your spending, or a combination of the above ? 

Why have you chosen that strategy and has it worked well for you?

Many thanks

Alexland

I'm not in drawdown yet but if I can retire early at 55 and the portfolio needs to last a very long time then my thinking is that some would be ring fenced to cover the delay until the state pension starts and the rest would be circa 1/35ths ie just under 3% pa using a portfolio of 10% cash/mmf, 20% bonds and 70% equities. That's assuming the valuations and yield at the time are somewhere near their historic norms,

The natural yield should produce around half the required income and then I'd just sell down whatever as part of re balancing the portfolio. If there was a long crash then the 30% non-equities would cover a decade plus maybe another 5+ years from the yield but probably less as I would be rebalancing some of the 30% into the crashed equities.

That's probably a too conservative a drawdown rate so the portfolio might grow most of the time but at least I'd sleep well at night and both asset valuations and income should keep up with inflation. If that didn't seem to be working I would reduce expenditure for a while.

InvesterJones

I just make sure I don't need the assets involved in a correction before they've had time to recover, so currently it's the usual savings backup and as I approach retirement I'll move more assets into less volatile investments (before rebuilding a set of buckets of different volatilities/timeframes most likely).

Linton

My strategy aims to completely avoid the problem of dealing with crashes....

1) Take income for essential expenditure from guaranteed sources - eg SP, annuities

2) Take normal ongoing income beyond this from well diversified high dividend and interest generating investments.   The platform pays the income directly into ones current account.

3) Have a growth portfolio from which investments are sold to buy extra income generating investments to meet
inflation or other need for increased ongoing expenditure

4) Have a near-ish to cash buffer for large one-offs fed from excess income from (2) and very rarely from selling investments from the growth portfolio in a rebalance or putting money back into the growth portfolio if the buffer gets larger than necessary.  Current and savings accounts are regarded as part of the buffer.

Experience over the past 20+ years has shown that investment income is much less volatile than equity capital value.  As the growth portfolio is not required to sustain ongoing income any medium/short term volatility can be ignored.  If the crash is very long lasting, money can be taken from the buffer.

So investments are never sold to provide income and when they are sold they are used to buy other investments (ie those that generate income).  In a crash one is never selling devalued investments for cash but rather to buy different investments which will also have dropped in price.

This is complex to design as it needs the right investments in the right quantities held in the right sheltered environment for the tasks to work together but once set up continues with zero intervention except for an occasional rebalance.

.The strategy has worked well without any sleepless nights.  Though to be fair it is now a long time since we have had a decent crash to put the strategy to a real test.

Hoenir

Bobziz said:

My question is what is your preferred approach to maintaining a sufficient income when there's a market correction/period of poor performance ?

Understanding your own appetite for risk goes a long way. Together with understanding how your portfolio would perform under certain scenario's. While one cannot predict the future with any certainty. There's normally fair warning of possible outcomes that lie at some point ahead. Grey Rhino's often being dismissed as the sayings of doomsters. History does repeat iself in a similar fashion with surprising regularity. 

dunstonh

My question is what is your preferred approach to maintaining a sufficient income when there's a market correction/period of poor performance ?

a) use a yielding strategy
b) have a cash pot that can be used to see you through 3 years (bucket your portfolio into phases)
c) ensure you have sufficient secure income for your main expenditure. So, you can cut back on the spending if necessary.

Bostonerimus1

Producing consistent income through market ups and downs usually relies on having some non-correlated assets. If you have a core of equities for growth then non-correlated (at least to some extent) could be cash, interest, bonds, gold and commodities, dividends, DB pensions and SP, annuities and maybe things like rental income or even part time work. How you organize the ratios of these assets will depend on your income needs relative to you investment pot and sources of "guaranteed" retirement income. At the extremes you might just go with an all equity portfolio with a little bit of cash as a buffer and basically trust in the modeling and your withdrawal rate that your money will last or at the other extreme buy an annuity to ensure lifetime income.

Bobziz

Many thanks folks, really helpful responses as ever. Much food for thought and some light bulb moments for me.

My situation is as follows:

Ambition to retire at 60 in 7 years with an annual income of £45k and maintain enough capital to provide a reasonable inheritance.
£20k DB uncapped index linked from 60 Inc reduction.
Full SP forecast at 67.
Further DB pension as above of £8.5k from 65.
£400k in DC's, cash, s&s ISA and a GIA.

My limited  4 years investment experience has taught me that my tolerance for risk is low to medium. The opposite of what I thought at the start of my journey. I have no inclination, interest, need or the ability to beat the market, so my strong preference is for passive investments. The one exception to this might be wealth preservers such as CGT.

Question, what kind of return is reasonable from a yielding strategy? And is the preferred approach to this to use a mix of bond ladders and dividend heroes ?

Thank you..

JohnWinder

strong preference is for passive investments. The one exception to this might be wealth preservers such as CGT.

I understand the preference for passive investments, so I don't understand why you'd make an exception for CGT or the like. Welcome your thoughts.

PS You'll find more than you could ever imagine about dealing with the problem you've started with at this website: https://earlyretirementnow.com/safe-withdrawal-rate-series/

Bobziz

Thanks @JohnWinder I've held CGT for a few years and I guess I see it as a bond+ fund. I like the transparency around why the managers do the things they do and the honesty about when they get things wrong. The objective aligns with my own i.e. to preserve and over time grow, without aiming to shoot the light out. They also have skin in the game.

The perception seems to be that it's not done well recently but I guess it depends what you compare it to. VGOV for example has fared much worse, but it is obviously purely a bond fund. I appreciate that past performance is just that, but it also has a long track record of meeting it's objectives. 

I'm open to persuasion, although I'd prefer not to focus on CGT in this thread as the forum has been there and done that so many times. 

Thanks for the link, I'll have a read.

Alexland

Bobziz said:

Question, what kind of return is reasonable from a yielding strategy? And is the preferred approach to this to use a mix of bond ladders and dividend heroes ?

Yield will very much depend on where asset valuations are at the point you start the drawdown.

Being a 'dividend hero' sounds great but it just means they have managed to increase their dividend YoY (by sometimes selling down assets which sounds better with the accounting terminology of 'revenue reserve') and the status is regardless of if the income and NAV has kept up with inflation.

Inflation is much harder to achieve so the board and managers prefer not to talk about it but worth you thinking about before putting your future income needs into such a strategy. They just like to pat themselves on the back for delivering a dividend increase however small.

I once asked the former chair of a divi hero UK income trust if it was a board objective that the income keeps up with inflation over the long term and he seemed to have never considered it before and the answer was no they just increase it by what they can afford each year. So while you might feel reassured you are paying to outsource your income needs the responsibility is still on you to maintain spending power.

Bobziz said:

Thanks @JohnWinder I've held CGT for a few years and I guess I see it as a bond+ fund. I like the transparency around why the managers do the things they do and the honesty about when they get things wrong. The objective aligns with my own i.e. to preserve and over time grow, without aiming to shoot the light out. They also have skin in the game.

I do wonder to what extent wealth preservation trusts were a popular topic a few years ago because investors couldn't bring themselves to directly buy the underlying bonds given the valuation issues at the time. To my mind they just seem to be a rather active form of a multi asset fund delivered in an IT wrapper.