UK Gilts (eg TR32) vs Bond Funds for Retirement Portfolio Balance (7-Year Horizon, Retiring at 57)

Bostonerimus1

For the folks who value convenience over the construction and management of an individual bond ladder you can give up a few 1/10ths of a percent and buy NS&I Guaranteed Growth or Income bonds.

JamTomorrow

Secret2ndAccount said:

You could go 1/3 equities, 1/3 TR32 and 1/3 T32. I'm not saying it's the best solution. Choosing the best solution requires:
1.  Deciding what you mean by best;
2.  Predicting the future

In the end, what you want is something that helps you sleep at night. For someone in your position I would suggest that annuities are a no brainer, but that's at today's prices. You can't buy them in advance, and who knows what they will offer in 7 yrs time.

Agree, what I am looking for is some peace of mind over the next 7 years and not stealing defeat from the jaws of victory by having an equity 30%+ correction hit in the few years leading up to my work optional date in Sep 2032.

But, I'm also concerned about inflation reducing my purchasing power in real terms (now considering IL GILTS based on earlier suggestion) and being a little bit greedy in that I don't want to miss out completely on equity upside.

My initital concern was that direct holdings in bonds, although they provide certainty, do not provide the same ballast/counter correlation to equities in the case of a 30%+ correction and I still think that is true unless corrected.  The guaranteed 4% return does not offset the equity fall in the same way a 30 year bond would (assuming a 30% fall in equities results in a reduction in interest rates).  Therefore I am thinking a small holding in a ~30 year bond could provide that ballast in case of equity fall and long term income by holding to maturity if rates do not fall (but they must right over 30 years - surely UK Gov cant refinance at 5.5% for the next 30 years).

So my thinking is now evolving towards something like :

Bonds - All direct UK holdings rather than funds and held in SIPP 
20% TR32 - Paying an effective 4.2% if held to maturity as planned (in Jun 2032); the 4.2% coupon each year used for rebalancing
20% TR31 IL - Real Yield of 0.865% plus inflation if held to maturity as planned (in Aug 2031)
This 40% guaranteed return holding would have sufficient funds to purchase an annuity in Sep 2032 if rates are still favourable; if not I will need to reasses how to reinvest the principal at that time
10% T56 - 30 year GILT until I am about 80 at 5.375% coupon - 5.474% YTM
Coupon each year to be used for rebalancing, provides ballast against fall in equities to reduce impact of equity decline on total holdings

50% Global Equities - VWRP held in remainder of SIPP balance plus all of ISA - Still not sure here, is it better to hold the equities in ISA or SIPP Balance - my logic is I may purchase annuity out of the Bonds cash return in 7 years time so best to hold them in my SIPP
Low cost exposure to global equities for potential upside; in case of say 30% fall in global equities my guess is the bonds held to maturity would increase in value reducing the downturn in my portfolio to say 10% or less; I should then be primed in that downturn to rebalance back to 50% bonds/equities by selling out of bonds and buying into VWRP

This feels a fairly simple and straightforward allocation to implement and manage with rebalancing only really needed in the event of an equity crash or UK Gov getting the bond yield under control (when I would rebalance out of increased value of 30 year bond and into equities - i will continue to hold the 40% allocation in the 2 other bonds all the way to maturity)

Importantly I think this allocation will let me sleep easily over the next years knowing I have certainty on cash flows for 50% of my portfolio and I think that can beat inflation - with some IL GILTS to help that.  I can sustain a 30% equity fall the month before my retirement and still be at peace retiring as planned

I don't mind if this means I am missing on a few extra % of long term gain as I don't need that.

Please thrown stones and this and criticise if you see a blindspot I have missed.  Thank you.

JamTomorrow

Bostonerimus1 said:

For the folks who value convenience over the construction and management of an individual bond ladder you can give up a few 1/10ths of a percent and buy NS&I Guaranteed Growth or Income bonds.

Thanks, but I am looking for something to allocate to from my SIPP and ISA holdings.

JamTomorrow

OldScientist said:

A couple of comments - the horizon of 7 years takes you to retirement, but not beyond. With an individual bond held to maturity you run interest rate risk at maturity if it is to be reinvested.

In retirement, for many people income is the most important consideration (legacy may also be important). Guaranteed income (i.e., not dependent on market conditions) can come from SP, DB pensions, annuities, and collapsing gilt ladders.

The last of these can be built before retirement. For example, using the gilt ladder tool at https://lategenxer.streamlit.app/Gilt_Ladder it would appear that a 40 year ladder (i.e., taking you to 97) with a 7 year delay in starting that will provide an inflation adjusted £10k per year can currently be built for about £250k. While this is complex to construct, it is relatively easy to use in retirement (coupons and maturing bonds end up in your pension account).

An alternative, as already mentioned, is to purchase an annuity at retirement. Since, AFAIK, deferred annuities are not currently available in the UK, in order to lock in the current good rates, inflation linked gilt funds or individual gilts that match the duration of the annuity (roughly half the life expectancy at purchase) plus the delay until purchase will ensure the income at purchase is roughly the same as now (yields and payout rates going down will lead to price rises in the gilts held and vice versa).

Yes, on the first point I will need to decide what to do with the 40% bond allocation that has matured.  If Annuity rates are similar or better to now then a large chunk of this could be allocated to an annuity.  If the economy is under control and interest rates have fallen I agree I will be in a dilemma if only low rate return available.  I don't really know what my strategy should then be in that scenario in 7 years time.  Maybe hold in low rate money market fonds or recycle in to short duration IL GILTS so that my capital keeps pace with inflation as I don't feel I need to chase return, just preserve it in real terms.

I'm not sure I understand your insights on locking in good rates.  Let's say I expect to live to 90 so if I buy say £300k of an individual GILT with 23 year duration ((90-57)/2)+7 that would lock in current yield rates? 

Using TG49 as an example with current YTM of 5.4% and lets say the rate drops by 1% in one years time (and then hold for the next 6 years), then the price of that bond should increase by ~22% (22 years left x 1% movement), so my TG49 bond holding would increase to ~£360k.  Therefore when I come to buy an annuity in 7 years time I now have £360k, rather than £300k, and that additional £60k of capital should directionally be suifficient to offset the reduction in annuities from a ~1% reduction in the yield curve?  I think I now see what you are saying but can you confirm if I have got that right.

That does feel like some kind of financial alchemy but I can see how that could be a strategy to largely lock in todays annuity rates if you are certain you are going to buy an annuity in 7 years time.  It's when you learn things like this that I love this site   Thank you.

Peter_F

Without wishing to derail the discussion I would suggest that perhaps you are focusing on the wrong issue.
I am assuming that retiring at age 57 it is your intention to use income drawdown at least initially to fund your retirement income. Let's assume that you do this for at least 10 years until age 67 that gives you a 17 year investment period from today
On that basis most people would opt for a portfolio that is weighted towards equities but with a significant bond portfolio to dampen volatility and provide regular income. Historically many people would adopt a 60:40 portfolio. Whether you use gilt/bond funds or individual gilts/bonds really won't make that much difference. The most important aspect of your portfolio is the overall weighting towards equities and bonds. 

Equity markets can always suffer corrections of 30% or more. Generally they are short lived but not always. A 60:40 portfolio might limit the fall to 20%. If so this should not overly impact your retirement plans providing you take sensible short term steps.
Reduce your withdrawals in the early years and perhaps supplement your income with some part time work.
If you are going to use income withdrawal over a long time period, you need to be comfortable with your portfolio fluctuating significantly in value. If you aren't then an annuity provides a sensible reliable income stream.

For a successful retirement, I would encourage you to focus more on longer term planning rather than just the next 7 years.

OldScientist

JamTomorrow said:

OldScientist said:

A couple of comments - the horizon of 7 years takes you to retirement, but not beyond. With an individual bond held to maturity you run interest rate risk at maturity if it is to be reinvested.

In retirement, for many people income is the most important consideration (legacy may also be important). Guaranteed income (i.e., not dependent on market conditions) can come from SP, DB pensions, annuities, and collapsing gilt ladders.

The last of these can be built before retirement. For example, using the gilt ladder tool at https://lategenxer.streamlit.app/Gilt_Ladder it would appear that a 40 year ladder (i.e., taking you to 97) with a 7 year delay in starting that will provide an inflation adjusted £10k per year can currently be built for about £250k. While this is complex to construct, it is relatively easy to use in retirement (coupons and maturing bonds end up in your pension account).

An alternative, as already mentioned, is to purchase an annuity at retirement. Since, AFAIK, deferred annuities are not currently available in the UK, in order to lock in the current good rates, inflation linked gilt funds or individual gilts that match the duration of the annuity (roughly half the life expectancy at purchase) plus the delay until purchase will ensure the income at purchase is roughly the same as now (yields and payout rates going down will lead to price rises in the gilts held and vice versa).

Yes, on the first point I will need to decide what to do with the 40% bond allocation that has matured.  If Annuity rates are similar or better to now then a large chunk of this could be allocated to an annuity.  If the economy is under control and interest rates have fallen I agree I will be in a dilemma if only low rate return available.  I don't really know what my strategy should then be in that scenario in 7 years time.  Maybe hold in low rate money market fonds or recycle in to short duration IL GILTS so that my capital keeps pace with inflation as I don't feel I need to chase return, just preserve it in real terms.

I'm not sure I understand your insights on locking in good rates.  Let's say I expect to live to 90 so if I buy say £300k of an individual GILT with 23 year duration ((90-57)/2)+7 that would lock in current yield rates? 

Using TG49 as an example with current YTM of 5.4% and lets say the rate drops by 1% in one years time (and then hold for the next 6 years), then the price of that bond should increase by ~22% (22 years left x 1% movement), so my TG49 bond holding would increase to ~£360k.  Therefore when I come to buy an annuity in 7 years time I now have £360k, rather than £300k, and that additional £60k of capital should directionally be suifficient to offset the reduction in annuities from a ~1% reduction in the yield curve?  I think I now see what you are saying but can you confirm if I have got that right.

That does feel like some kind of financial alchemy but I can see how that could be a strategy to largely lock in todays annuity rates if you are certain you are going to buy an annuity in 7 years time.  It's when you learn things like this that I love this site   Thank you.

Yes, your understanding is correct. If the duration of the annuity and the fixed income holdings are perfectly matched then the rise in price of the gilt should exactly compensate for the fall in payout rate of the annuity. In practice, matching the duration exactly is unlikely to be achieved, but the tracking error (in terms of income purchased) will be smaller than with no matching (so it is a matter of reducing interest rate risk rather than eliminating it).

While it does seem like alchemy, what this method tries to do is to hold a collection of fixed income that has similar properties to that held by the insurance company (their actual underlying holdings are unknown and will vary from company to company). In order to achieve a better match it is usual to hold two or three gilts at a range of maturities (rather than just one) since these will then capture changes across the yield curve (e.g., as we have seen recently, yields of longer gilts have risen far more than those of shorter gilts).

It is unfortunate that deferred income annuities are not currently available in the UK (they are available in the US where they are sometimes used as longevity insurance) since this would remove the need to mess about with matching!

JamTomorrow

OldScientist said:

Yes, your understanding is correct. If the duration of the annuity and the fixed income holdings are perfectly matched then the rise in price of the gilt should exactly compensate for the fall in payout rate of the annuity. In practice, matching the duration exactly is unlikely to be achieved, but the tracking error (in terms of income purchased) will be smaller than with no matching (so it is a matter of reducing interest rate risk rather than eliminating it).

While it does seem like alchemy, what this method tries to do is to hold a collection of fixed income that has similar properties to that held by the insurance company (their actual underlying holdings are unknown and will vary from company to company). In order to achieve a better match it is usual to hold two or three gilts at a range of maturities (rather than just one) since these will then capture changes across the yield curve (e.g., as we have seen recently, yields of longer gilts have risen far more than those of shorter gilts).

It is unfortunate that deferred income annuities are not currently available in the UK (they are available in the US where they are sometimes used as longevity insurance) since this would remove the need to mess about with matching!

Thanks again, your insight is brilliant and feels like an "aha" moment! It reminds me of when I realised that concentrating my workplace pension contributions into fewer months, rather than spreading them evenly over 12 months, significantly reduced my National Insurance (NI) contributions for the same pension outcome.  Something that is straightforward to do but never seems to make mainstream financial guidance.

It also resonates with a past strategy where I used a Contract for Difference (CFD) to hedge a 3-year Save As You Earn (SAYE) scheme. I was confident the share price had more downside risk by the time my SAYE matured in a year, so the CFD effectively locked in the current price for a small cost.

Similarly, I’m surprised no financial institutions are offering a product to lock in today’s record-high annuity rates for a modest fee, especially for those nearing retirement. After reading your post, I’m keen to explore this approach further and allocate part of my pension portfolio to UK Gilts that align with my investment horizon.  Sorry, but a few questions:

1. Is a single Gilt too simplistic or directionally fit for purpose? I assume your suggestion to use 2–3 funds is to hedge against changes in the yield curve, which could make a single Gilt less effective. Is that the risk?
2. Resources for further research? Are there any recommended books, articles, or websites where I can dive deeper into using Gilts to lock in annuity rates?  
3. Tools for Gilt selection? Are there any existing tools that take inputs like age, years to retirement, and desired annuity investment (e.g., £300k) to recommend specific UK Gilts? If not, I’ll consider building something like this using Google’s Gemini Canvas or similar platforms?

JamTomorrow

Peter_F said:

Without wishing to derail the discussion I would suggest that perhaps you are focusing on the wrong issue.
I am assuming that retiring at age 57 it is your intention to use income drawdown at least initially to fund your retirement income. Let's assume that you do this for at least 10 years until age 67 that gives you a 17 year investment period from today
On that basis most people would opt for a portfolio that is weighted towards equities but with a significant bond portfolio to dampen volatility and provide regular income. Historically many people would adopt a 60:40 portfolio. Whether you use gilt/bond funds or individual gilts/bonds really won't make that much difference. The most important aspect of your portfolio is the overall weighting towards equities and bonds. 

Equity markets can always suffer corrections of 30% or more. Generally they are short lived but not always. A 60:40 portfolio might limit the fall to 20%. If so this should not overly impact your retirement plans providing you take sensible short term steps.
Reduce your withdrawals in the early years and perhaps supplement your income with some part time work.
If you are going to use income withdrawal over a long time period, you need to be comfortable with your portfolio fluctuating significantly in value. If you aren't then an annuity provides a sensible reliable income stream.

For a successful retirement, I would encourage you to focus more on longer term planning rather than just the next 7 years.

No, please derail.  That's what I would like as I know I can over complicate or over think the situation and want full consideration before I make some sizeable financial decisions.  The back and forth here helps me thinkin of new things or realise I was being stupid or overthinking.

My thought process at the moment feels more smilar to someone paying off their mortgage that has a lower interest rate that what they could achieve from investing in bonds.  Not a great financial decision, but the calm mind that comes from knowing you have no mortgage on your family home is worth the financial cost to many (not me in this scenario but I can understand it).

Me and my Wife are in agood position from a retirement planning perspective, we have a lifestyle we could afford with what we have accumulated already, based on a portfolio that is more heavily equity weighted.  However, we still have 7 years to go until I am 57 and can access the pension where most of our retiremetn funds are tied up.  A lot can happen in those 7 years and I want more (but not complete) certainty that what we have now is going to be at that or a little higher.

What I like about what I am exploring now is locking in annuity rates with around £300k of our money to buy an annuity in 7 years time.  The remainder will be split between global equities and bonds.  However I feel like I want to hold direct bonds rather and bond funds from the certainty that comes with holding to maturity.

If there was a 30% equity fall then my bonds held to maturity would dampen that reduction.  Howver if I held bond fund(s) then I see less certainty in that providing the ballast I am looking for as there is either a stagflation risk with UK GILTS or added complexity from holding global bonds.  It feels less certain and more complex that holding bonds directly with good YTM but completely get I could be over thinking this.

JamTomorrow

Comments and insights here have been really helpful and my thoughts have developed further.  I guess I have not thought this through before at this level of detail because GILT rates have not been this high in a  period where I have seriously been thinking about retirement, I now have sufficient funds for the lifestyle we want, and it is within touching distance (well  7 years away).

My thoughts have now developed to this approach/strategy which I think is sound but appreciate thoughts here.

Developing strategy :

1. £300k into single GILT which is earmarked to buy ~£12.5k of income from an annuity at 57 for me and my Wife - if annuity rates drop the value of this GILT will have increased in 7 years so I will have more, say £350k, to buy the same annual income annuity even though rates have dropped

2. ~£270k into Gilt ladder to fund ages 57-67 until get SP : Using GILT ladder tool https://lategenxer.streamlit.app/Gilt_Ladder  I believe this tells me I can guarantee a £40k per year income from 2032-2042 (Ages 57-67) with £270k

This gives a total Income of ~£52k/year from 57-67

3. From 67+ Have 2x State Pension plus £12.5k annuity so £35k-£40k/year

Alongside this the remainder of our portfolio can be 100% Global equities as now I have certainty of a suitable income from 57 to 67 so have at least 17 years until we need to access this part of our portfolio.  This portfolio allocation can be used to fund any emergency expenditure or top up annual income if inflation significantly erodes purchasing power.

Main flaw/uncertainty in this inflation risk.  Also this would need to be refined on how to split these investments between my ISA and SIPP holdings and also make sure we use both mine and my Wife’s personal allowances effectively.

Is this a reasonable approach and is it worth constructing through discussions with a Financial Planner as they can perfect on asset allocation across SIPP and ISAs and also ensure correctly structured to across mine and my Wife’s allowances.

Thank you.

Peter_F

If you are attracted now by the potential returns from Gilts and the guaranteed income offered by annuities, then at age 50, the best option may be to put a decent % of your pension portfolio into longer term Gilts. 30 year gilts have recently been offering yields of 5.6%. Given that a 60 year old could secure a level annuity of 6% pa, 5.6%  guaranteed return for a 50 year  for the next 30 years looks pretty good imo. Whilst the capital value will fluctuate, the overall returns are guaranteed if held to maturity. Shorter term gilts can also be used but yields are obviously lower.

Once you have achieved the level of capital that you are comfortable with for retirement, it is wise to consider whether you can consolidate those gains by reducing the equity component of your portfolio.

Personally when withdrawing monies from a SIPP, I do not care how the monies have been generated i.e. through income or capital growth. All I care about is the value of the pot now and its value in the future.

The key thing to focus on is what proportion of your assets do you want in equities and how much in Gilts/Bonds.
Everything else is really immaterial at this stage (7 years away from drawing benefits).