Any point in a Cash buffer in Pension Drawdown Account?

bearshare · 11 January 2019 at 10:25PM

Linton wrote: »

There are no assets at the moment that will safely produce a positive real return, something that will only make a limited real loss is the best you can do. Whilst you are building up a pension pot you have the fairly high security of a steady income and so can recover from major falls. This enables you to focus on the long term. Finances in retirement are very different, the short term is important if you want to enjoy the standard of living to which you have become accustomed. A loss cannot be recovered from new money and could impact your income for the rest of your life. Conversely maximising long term gain is of relatively low importance.

Using uncorrelated higher risk investments is fine, but being uncorrelated there is nothing to prevent them falling at the same time.

My point is, though, that cash NEVER gives a high return. Gold, bonds, property act all sometimes give a high real return. Cash struggles to beat inflation, even in good times.. as it should, being low risk.

tacpot12 · 11 January 2019 at 11:56PM

So for those running a buffer how and when is it used? What level of drop from a peak means you will take income from Cash? Of course this is going to introduce a whole level of complexity to your portfolio that wouldn't be there otherwise, when draw cash?, when topup cash? Clearly a level of "calling the market" is required here. For the novice investor two oft quoted rules seem to be: Don't try to guess the market; Maximise time in the market. Running a cash buffer pretty much runs against these doesn't it? Is a cash buffer for advanced investors only?

I completely agree that a degree of market calling is required when deciding to use the cash buffer, and thus having a cash buffer does indeed go against the two quoted rules. Perhaps a cash buffer might not work as well as I expect..

My rule for using my cash buffer is to only use it when the portfolio performance shows a market 'crash' has occured and a recovery is well underway. I would be the first to admit that this is a woolly definition, but in practice, I am looking for a deep decline in values (say greater than 15%) followed by recovery to at least 50% of the loss in the crash and some price stability over a period of a couple of months.

Does this mean that a cash buffer is for advanced investor only? I don't know, but I think a DIY investor should evaluate the evidence for the benefit of a cash buffer, and consider in practice whether they feel they could operate a cash buffer to produce any advantage. It does complicate things if one also has a bond buffer as well, although the rule of using cash, then bonds, then equities when equities have crashed is simple enough.

For me, managing my retirement portfolio is not only a necessity but also an opportunity to learn and to experiment. I think my pension planning has enough slack in it to allow me to experiment with the idea of a cash buffer, but I'm not currently set-up to monitor the difference this makes vs. having no buffer.

ams25 · 12 January 2019 at 12:35AM

OP - you might find it worthwhile investing in Michael McClung's "Living of your Money" (link) which backtests various withdrawal approaches (I believe including cash buffers) and proposes the most effective based on the past data covering the US (primarily), Uk and Japan.

I'm in the process of reading it now so can't comment on the full book yet but am impressed so far and have read enough glowing reviews and comments to know it is a worthwhile read that has led others to reappraise their withdrawal approach.

I think a few posters here have read it so they may have more to add.

kidmugsy · 12 January 2019 at 1:19AM

Linton wrote: »

What about inflation? There is both the steady decrease of the real value of cash of say 2% annually, if the BoE get things right, and the occasional major falls.

It's pretty variable. There were longish spells before the 2008/09 financial crisis where the personal investor's cash would beat inflation quite handily. Even since 2008 there have been a couple of years when one of my DB pensions put on no value because the relevant September inflation rate was zero.

Pointing at the 70s as a disaster zone for cash is fair enough as long as it's mentioned that much of it was a disaster zone for bonds and equities too. Equities had a bad time from (if memory serves) the late 60s until the early 80s.

Moreover the evidence suggests that equities often don't so much protect you from inflation as compensate you for the inflation once disinflation begins. This can be a big deal for a codger because the compensation might arrive after his death.

Consider for instance a man of 70. In 3 years time, we suppose, an inflation sets in at a rising rate for 7 years. Now he's 80. Then the inflation rate dwindles away for 10 years and his equities do very well. Now he's 90. He sells to enjoy the fruit of his success. He spends the profit over 5 years. Now he's 95. And if he doesn't reach 95 he might not have enjoyed much of the fruit at all.

I agree that inflation is a great risk for a codger. But I'm not convinced that there's a good, reliable way of getting much protection from it:
https://www.bondvigilantes.com/blog/2011/02/01/inflation-hedging-for-long-term-investors-the-most-important-academic-paper-you-will-read-this-year/

Unless you were to sink your money into a ladder of linkers: alas at the moment that would guarantee a loss versus RPI, though at least the loss would be capped at a modest annual value.

LHW99 · 12 January 2019 at 11:18AM

IMO the key point could be that the OP wants a withdrawal rate of 2.5%, which is likely to be sustainable from dividends / natural yield.
If your requirement is nearer 4% of your pot, then cash reserves may well be a useful tactic.

OldMusicGuy · 12 January 2019 at 11:32AM

green_man wrote: »

OldMusicGuy - accepts the analysis but believes it does not cover all possible scenarios (of course no analysis can). He believes a cash buffer de-risks his retirement by allowing for scenarios that have never occurred before. Its an interesting stance I'm just struggling to think what scenarios it actually helps in.

The scenario it actually helps in is allowing me a stress free retirement. I am incredibly risk averse, so I find volatility and market drops very stressful (I have learned this over several years). I probably have what is called obsessive-compulsive personality disorder, which means I need to feel that I am in control all the time.

I also have enough money accumulated to last us through a 30 year plus retirement provided what I have invested today matches inflation (I have done a detailed spreadsheet that forecasts all income and costs through a 32 year period).

So given all of that I have adopted a bucket strategy. I have enough cash to last at least 5 years both inside and outside my SIPP. Outside the SIPP I have a savings ladder, inside the SIPP it's just cash but that reduces the volatility of the portfolio (helps me sleep at night). I have 77% of my SIPP invested for the long term in three multi-asset funds that won't be touched at least until I am 70. I'm using UFPLS to take some cash tax free out of the SIPP and topping up with savings (I have 5 years until SP age).

So my strategy is all about protecting what I have from downside rather than trying to make more. I have plenty of money now, all I need to do is protect against downside, hence my very risk averse strategy. Also, unlike many on here, I have have no DB pensions so the impact of failure would be much higher for me.

Also, I don't believe in inflation. I can negate the effects of inflation when it at such low levels through controlling personal expenditure, so I don't buy the "your cash is going down in value" argument for the short term (within 5 years). I do accept it has an impact over the longer term, hence why I have long-term investments that I need to match inflation.

This is a strategy that I have worked out over the last 5 years. It works for me and my plans for retirement. But it certainly isn't for everyone.

peterg1965 · 12 January 2019 at 11:49AM

OldMusicGuy wrote: »

The scenario it actually helps in is allowing me a stress free retirement. I am incredibly risk averse, so I find volatility and market drops very stressful (I have learned this over several years). I probably have what is called obsessive-compulsive personality disorder, which means I need to feel that I am in control all the time.

I also have enough money accumulated to last us through a 30 year plus retirement provided what I have invested today matches inflation (I have done a detailed spreadsheet that forecasts all income and costs through a 32 year period).

So given all of that I have adopted a bucket strategy. I have enough cash to last at least 5 years both inside and outside my SIPP. Outside the SIPP I have a savings ladder, inside the SIPP it's just cash but that reduces the volatility of the portfolio (helps me sleep at night). I have 77% of my SIPP invested for the long term in three multi-asset funds that won't be touched at least until I am 70. I'm using UFPLS to take some cash tax free out of the SIPP and topping up with savings (I have 5 years until SP age).

So my strategy is all about protecting what I have from downside rather than trying to make more. I have plenty of money now, all I need to do is protect against downside, hence my very risk averse strategy. Also, unlike many on here, I have have no DB pensions so the impact of failure would be much higher for me.

Also, I don't believe in inflation. I can negate the effects of inflation when it at such low levels through controlling personal expenditure, so I don't buy the "your cash is going down in value" argument for the short term (within 5 years). I do accept it has an impact over the longer term, hence why I have long-term investments that I need to match inflation.

This is a strategy that I have worked out over the last 5 years. It works for me and my plans for retirement. But it certainly isn't for everyone.

Good post, if I may say so. This reflects my position as well, I want to be really risk averse when drawing down the DC part of my pensions. I have a different way of going about it but my philosophy is the same. If my Drawdown pot lasts 30 years until it is fully depleted, I will be very happy 😃

Audaxer · 12 January 2019 at 2:54PM

peterg1965 wrote: »

If my Drawdown pot lasts 30 years until it is fully depleted, I will be very happy 😃

If I was still alive after 30 years of retirement but had run down my pension pot completely and my only income was my State Pension, I wouldn't be very happy.

Robert_McGeddon · 12 January 2019 at 3:01PM

An absolutely brilliant thread with some fantastic contributions - thank you all. I've been on the thread for 4.5 hours, including visiting a lot of the links provided. I've learned a lot but there's a long way to go yet!

One to bookmark and revisit.

kidmugsy · 12 January 2019 at 3:23PM

It occurred to me the other day that a risk averse retirement investor might want to proceed as follows.

(i) Take his 25% TFLS. Use it to buy a level Purchased Life Annuity for self and one for wife. Since he's risk averse he'll buy the two from different companies to defend themselves from IT blunders and the like. Let each annuity be on one life to maximise its size. He should do the sums to check that the taxable part of the PLA falls entirely within each person's Savings Allowance. (The part of the PLA that is viewed as return of capital is anyway tax-free). This way they each get their annuity entirely tax-free. Its value will fall versus inflation, but if the rate of reduction is modest enough that might anyway reflect a natural reduction in spending with age.

(ii) Using some of the money in the 75% remaining, buy an RPI-linked annuity that will, added to the eventual State Pension, use the Personal Allowance against income tax. Perhaps this annuity might have up to 100% widow's benefit. This too will be tax-free.

(ii) Invest the remainder of the 75% as best suits the investor's stomach for market risk, interest rate risk, and inflation risk, perhaps drawing down to exploit the Personal Allowance before the State Pension begins.

(iii) Consider whether there's any useful advantage in deferring drawing the State Pension for a couple of years. You get an extra 5.8% for each year of deferral, CPI-linked. It might also be a wheeze to allow a couple more years of tax-efficient drawdown from a money-purchase pension.

The beauty of annuities is that (a) they pay better than bonds because of the mortality credit, (b) they offer longevity insurance; they don't peg out until you do, (c) they need no management after you buy them (and therefore don't attract management charges).

As long as our hypothetical investor has retained ample liquidity this might be the beginnings of a good sleep-at-night strategy.

Any point in a Cash buffer in Pension Drawdown Account?

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