Would this strategy of 100% equities work?

Euro_Skank

​​T​hank you, all, very much. Some very valid points which will give me plenty to think about. I regularly watch James Shack and sometimes Pension Craft, but don't recall seeing those ones - so thanks! 

My portfolio is currently sitting around £675,00 (£200K in ISAs, £170K in a SIPP, the remainder (£305K) is in general investment accounts). My annual living expenses will be around £29K after tax so it's about 4.3%. So my index funds are definitely not play money although I can really live frugally if need be  - not sure my flexibility would be 50% though. I have no debt, no dependents (unless a neighbour's cat counts) and a couple of paid-off flats. 

My strategy would be to take approximately 3.5% during bull markets and then in the event of a market downturn (ie 20% market drop) to start pulling from my cash reserves...topping up the cash pot when the market recovers. Currently I have little desire to save more than about two years' cash for living expenses (that article by The Accumulator nearly made me consider living out of a van).

The first year I plan to cash in an ISA. I may also get a tax refund large enough to enjoy the second year before having to sell off maybe another ISA. 

Therefore, I will certainly research or glady take advice on how to (rapidly) glide path as quickly and as tax efficiently as possible into more bonds. Although when I used Pickafund (thanks to a Pete Matthews' vid) to try and research the best bond fund, its performance looked dismal; from what I could see it had actually lost money every year for the last five years! Feel free to recommend one though. 

Thanks! Sir Humphrey was my favourite character of that show. Fond memories watching it with my dad when I was a kid. 

Happy Friday! 

horace972897

Eyeful mentions using Income guard rails - this sounds like a sensible plan but how to you account for the portfolio naturally reducing due to the actual withdrawals? It sounds like the income guard rails plan needs the portfolio to always try to stay near it's initial value or there is a slow reducing of withdrawals over time (unless the markets do spectacularly)

MEM62

I was lucky in that, when interest rates peaked in 2023, I was in the late stages of planning my retirement.  I therefore, as suggested by my IFA, put the first five years of retirement income in fixed interest deposits.  By the time that comes to an end I will have my state pension and a small DB pension in payment that covers all the basic living costs.  Whilst I will keep something in cash (those motorcycles won't buy themselves ) I am happy to be heavily weighted in equities.  Never considered myself to particularly be a risk taker but I am cool with the strategy.   

phlebas192

My view is that having significant equities requires a strong mitigation strategy. Whilst working that can simply be that you would retire later and, for that reason, I reckon that most people should have more equities than generally recommended before retirement - the biggest risk for most isn't a sudden fall in values, but not ever achieving the desired level in the first place. The obvious exception is where someone has more or less achieved their aim and intends to buy an annuity, in which case they should switch to gilts in the years preceeding retirement. Post retirement it really depends on what resources you have to mitigate the risk since the employment option quickly disappears.

We were essentially 100% equities right up to when my wife retired (I had already done so, but she was always the main earner). 3 years later and we are still at 83% equities even after putting a large part of her TFLS into cash and with a strategy to gradually reduce equities. But our mitigation is that we now have over 10 years worth of expenditure in cash & gilts on top of my DB pension which is at the 'keep the lights on' level that by itself will pay for essential bills and groceries. So we can easily ride out even a significant downturn. But, importantly, on top of that about 70% of our equities are in investment trusts with long track records of paying out increasing dividends and they produce an income stream comfortably in excess of our needs. There's no guarantee that they will continue to do so but they have a strong incentive to do so and it would take something worse than the 2008 global financial crash for there to be enough of a reduction in overall income from that source to even require drawing on our cash reserves. 

Or to put it more succinctly, we've essentially won the game and are now playing on easy mode so can afford to take risks. Can you? What is your mitigation if things go really bad? Index funds generally don't pay out all that much income and they will cut it in line with the market in any downturn so it cannot be relied upon. 22 months may sound like a lot but the reality is that the next crash can always be worse than the previous one(s). Don't think about the average, but about the worst case and then allow some more for it being even worse just because it might. You won't get a second chance at this so the 'average' is a really poor indicator of the risk involved.

TheTelltaleChart

Well, you say you're hoping to draw 4.3% to spend from investments, but that seems pessimistic, because it's ignoring 2 things:

a) "a couple of paid-off flats" (is that in addition to your own home?) which presumably produce some income, and could be sold to generate more capital (to invest or spend);

b) State Pension. Are you on course for the new full rate, of c. £12k, which would reduce your required draw from investments from £29k i.e. 4.3%, to £17k i.e. 2.5%. Are you planning to retire before State Pension age? (It will still help, even if you are.)

Even ignoring those points, a 4.3% draw rate is a little high, but may be OK if you're prepared to be flexible in spending. But it would be much safer with a significant part of the portfolio in bonds. And effectively moving to 100% equities if a bear market lasts 22 months sounds both risky and very uncomfortable: ramping up the risk when everything seems to be going to pot.

Some cash reserve does make sense. However, it's generally less stressful to work by spending investment income in the first place, only topping it up from your cash reserve if it isn't enough for your expenditure (or adding the excess to your cash reserve if it's more than enough). That means that a "22 months" cash reserve will actually last a lot longer than 22 months. Then you can occasionally adjust the cash reserve back to its target size by selling/buying some investments.

Bonds will easily produce more income than equities, so more of your spending can be covered directly by investment income. Do not pay too much attention to recent past performance of bond funds, because they went through an exceptionally bad (worst for 100 years or something) period, which effectively corrected for earlier excessively high bond prices. Look at their current yield (i.e. the income they paid out in the last year), and at their yield to redemption (YTM); when the latter is lower than the current yield, there is a heightened risk of future capital losses — that was the position a few years ago, but generally not now.

Cus

TheTelltaleChart said:

Well, you say you're hoping to draw 4.3% to spend from investments, but that seems pessimistic, because it's ignoring 2 things:

a) "a couple of paid-off flats" (is that in addition to your own home?) which presumably produce some income, and could be sold to generate more capital (to invest or spend);

b) State Pension. Are you on course for the new full rate, of c. £12k, which would reduce your required draw from investments from £29k i.e. 4.3%, to £17k i.e. 2.5%. Are you planning to retire before State Pension age? (It will still help, even if you are.)

Even ignoring those points, a 4.3% draw rate is a little high, but may be OK if you're prepared to be flexible in spending. But it would be much safer with a significant part of the portfolio in bonds. And effectively moving to 100% equities if a bear market lasts 22 months sounds both risky and very uncomfortable: ramping up the risk when everything seems to be going to pot.

Some cash reserve does make sense. However, it's generally less stressful to work by spending investment income in the first place, only topping it up from your cash reserve if it isn't enough for your expenditure (or adding the excess to your cash reserve if it's more than enough). That means that a "22 months" cash reserve will actually last a lot longer than 22 months. Then you can occasionally adjust the cash reserve back to its target size by selling/buying some investments.

Bonds will easily produce more income than equities, so more of your spending can be covered directly by investment income. Do not pay too much attention to recent past performance of bond funds, because they went through an exceptionally bad (worst for 100 years or something) period, which effectively corrected for earlier excessively high bond prices. Look at their current yield (i.e. the income they paid out in the last year), and at their yield to redemption (YTM); when the latter is lower than the current yield, there is a heightened risk of future capital losses — that was the position a few years ago, but generally not now.

Lots of common sense, but fyi SWR rates are lower if you have a lot of bonds in the portfolio versus equities.  And do bonds easily produce more income than say dividend paying equities?

TheTelltaleChart

Cus said:

Lots of common sense, but fyi SWR rates are lower if you have a lot of bonds in the portfolio versus equities.

Yes, it's the Goldilocks Principle: you want some bonds but not too many.

I suspect that SWR studies may somewhat undervalue the value bonds bring to a portfolio, because their "success" rates include cases when you were perilously close to running out of money, and in reality would have had to change course (e.g. by reducing spending), because you didn't know equities were about to bounce back or you were about to snuff it. I'd like to see some SWR studies looking at the probability of necessary course changes, not just at binary success or failure.

And do bonds easily produce more income than say dividend paying equities?

Easily, in the sense that if you pick your equities and bonds without targeting a high income, bonds will yield a fair bit more. I am not advocating including bonds because of their higher income, but because of the greater stability they bring to the portfolio's returns, including its income.

Equity income funds / investment trusts (i.e. equities targeting a high income) might pay a similar income to bonds not targetting any income level. Though the income from the bonds is more stable: it's a contractual obligation for the bond issuers; unlike dividends, which companies are free to cut.

OldScientist

Cus said:

TheTelltaleChart said:

Well, you say you're hoping to draw 4.3% to spend from investments, but that seems pessimistic, because it's ignoring 2 things:

a) "a couple of paid-off flats" (is that in addition to your own home?) which presumably produce some income, and could be sold to generate more capital (to invest or spend);

b) State Pension. Are you on course for the new full rate, of c. £12k, which would reduce your required draw from investments from £29k i.e. 4.3%, to £17k i.e. 2.5%. Are you planning to retire before State Pension age? (It will still help, even if you are.)

Even ignoring those points, a 4.3% draw rate is a little high, but may be OK if you're prepared to be flexible in spending. But it would be much safer with a significant part of the portfolio in bonds. And effectively moving to 100% equities if a bear market lasts 22 months sounds both risky and very uncomfortable: ramping up the risk when everything seems to be going to pot.

Some cash reserve does make sense. However, it's generally less stressful to work by spending investment income in the first place, only topping it up from your cash reserve if it isn't enough for your expenditure (or adding the excess to your cash reserve if it's more than enough). That means that a "22 months" cash reserve will actually last a lot longer than 22 months. Then you can occasionally adjust the cash reserve back to its target size by selling/buying some investments.

Bonds will easily produce more income than equities, so more of your spending can be covered directly by investment income. Do not pay too much attention to recent past performance of bond funds, because they went through an exceptionally bad (worst for 100 years or something) period, which effectively corrected for earlier excessively high bond prices. Look at their current yield (i.e. the income they paid out in the last year), and at their yield to redemption (YTM); when the latter is lower than the current yield, there is a heightened risk of future capital losses — that was the position a few years ago, but generally not now.

Lots of common sense, but fyi SWR rates are lower if you have a lot of bonds in the portfolio versus equities.  And do bonds easily produce more income than say dividend paying equities?

Historically, the 'optimum' stock allocation depended on the country. For example, the graph (Figure 2) at https://www.financialplanningassociation.org/sites/default/files/2021-10/DEC10%20JFP%20Pfau%20PDF.pdf shows peaks at a variety of asset allocations (the assumption of perfect foresight makes this paper slightly odd, but the general principle should be the same).

In another example, the tabulated results in Estrada's paper (page 66-70 in https://blog.iese.edu/jestrada/files/2018/03/MaxWR.pdf - the P1 value is the relevant one) show a variety of outcomes (e.g., the peak for the UK is at 100% equities, but the peak for the US lies between 70% and 80% equities).

The duration of the fixed income also had an effect on the SWR outcomes (e.g., there is a difference where the peak lies  between using cash, short bonds, intermediate bonds, and long bonds).

dales1

The first year I plan to cash in an ISA. I may also get a tax refund large enough to enjoy the second year before having to sell off maybe another ISA. 

In general, people should cash in anything except their ISAs.

An ISA represents tax relief for life on that cash.