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  • FIRST POST
    • green_man
    • By green_man 10th Jan 19, 4:59 PM
    • 240Posts
    • 111Thanks
    green_man
    Any point in a Cash buffer in Pension Drawdown Account?
    • #1
    • 10th Jan 19, 4:59 PM
    Any point in a Cash buffer in Pension Drawdown Account? 10th Jan 19 at 4:59 PM
    So the old school wisdom seems to be that itís sensible to carry a cash sum within your investments so that in the event of a crash you can draw on this sum and allow for the market to recover before you sell anymore investments. Seems sensible but these sums seem to be specified as 2-3 years of typical drawdown withdrawal, so you have this portion of your pot permanently out of the market. Does this stand up to financial scrutiny?

    Iíve got to say I currently do follow the this and although Iím not in drawdown yet I will be in two years. But would you just not be better off in the long run by running 100% equities and just selling what you need each month. Iím talking about selling 0.2% of equities a month here to fulfill living expenses, so even in a crash this will only go up to 0.3-0.4% per month. Doesnít the benefit of extra investment in the market outweigh the savings made in event of crash?
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    • OldMusicGuy
    • By OldMusicGuy 12th Jan 19, 5:30 PM
    • 849 Posts
    • 1,836 Thanks
    OldMusicGuy
    I understand your concerns and everyone should pursue a strategy they they are comfortable with, however the research I posted before does indicate that holding cash actually increases risk in all their modelled scenarios!
    .
    Originally posted by green_man
    What you're missing is my "bucket" strategy. I am not following the example set out in the article. I have a significant amount of money currently invested 50/50, which I think is safe for a long-term retirement. My cash buffer does not require me to reduce that to 10/40/50. I have always separated the cash out in my mind and will use that to fund early years of retirement at no risk. FWIW I actually moved 100K from cash into funds in Feb last year (two days before the correction!). Even I felt I was holding too much cash.

    Now I could put all my money into more equity and bonds but as I explained, my personality type really would not like that. The downside is just too much for me to contemplate. And if it was wildly successful, I would end up with too much money anyway.
    • green_man
    • By green_man 12th Jan 19, 5:31 PM
    • 240 Posts
    • 111 Thanks
    green_man
    I think the real question isn't 'Should I have a cash buffer?' it's 'What is my tactic going to be if markets go down?' A cash buffer may be a useful way to mitigate stress, but only if you have a plan on how to use it that you are comfortable with.
    In my view there are 3 basic responses to a market fall:
    1. Carry on regardless and trust that all will be well / accept that there is now a higher risk of things not going well.
    2. Reduce your spending.
    3. Take part of your income from different sources eg cash buffers or part time work.
    You need to have a plan that works with both your financial position and your personal psychology. Personally I plan to use a combination of the last two using a 1 year cash buffer to cover half of any shortfall and spending reduction the other half. That would cope with a 40% fall sustained for 5 years which is sufficient to let me sleep at night.
    Originally posted by Triumph13
    But have you convinced yourself that in this scenario (40% fall, 5 years) that the cash buffer approach gives an advantageous outcome once you take the whole economic cycle into account?.. Iím beginning to think the personal psychology element is in fact the overriding factor for most people.
    • green_man
    • By green_man 12th Jan 19, 5:38 PM
    • 240 Posts
    • 111 Thanks
    green_man
    What you're missing is my "bucket" strategy. I am not following the example set out in the article. I have a significant amount of money currently invested 50/50, which I think is safe for a long-term retirement. My cash buffer does not require me to reduce that to 10/40/50. I have always separated the cash out in my mind and will use that to fund early years of retirement at no risk. FWIW I actually moved 100K from cash into funds in Feb last year (two days before the correction!). Even I felt I was holding too much cash.

    Now I could put all my money into more equity and bonds but as I explained, my personality type really would not like that. The downside is just too much for me to contemplate. And if it was wildly successful, I would end up with too much money anyway.
    Originally posted by OldMusicGuy
    Not missing, just ignoring. In your situation it sounds like you are comfortable enough not to be too concerned whatever approach you took. You could go 100% equities and be quite comfortable enough to ride out a 5 year 40% drop. You current approach clearly fulfils your requirements. Iím not trying to change your mind, I just find the different approaches to similar scenarios interesting.
    • Linton
    • By Linton 12th Jan 19, 5:55 PM
    • 10,418 Posts
    • 10,816 Thanks
    Linton
    Looking at the article two things strike me...


    1) the figures are based on a 50-50 equity/bond allocation. Then a 10% cash allocation is taken from the equity tranche reducing the overall equity % to 40%.

    2) The success figures (ie not running out of money before death) seem remarkably low to me. In past discussions something approaching 95% is deemed reasonable. Would you really accept a strategy with a 1 in 5 chance of you ending your life in poverty? To be able to safely withdraw a relatively high % of your initial pot increasing with inflation you do need a substantial % in equities.



    With such a high % in bonds the effects of crashes are substantially diminished. One could well believe that the further reduction in average returns by removing 20% of your equity into cash would outweigh any benefit of the relatively small amount of cash during crashes. In any case you can use bonds as your buffer with much the same effect as using cash. There seems little point in having the extra 10% cash buffer.



    It seems to me that the scenario being modelled is pretty unrealistic im UK circumstances, at least with current bond returns. It would be more interesting to compare the risks of say a 80%equity/20% cash buffer portfolio vs a 100% equity one.
    • Audaxer
    • By Audaxer 12th Jan 19, 5:55 PM
    • 1,594 Posts
    • 984 Thanks
    Audaxer
    I understand your concerns and everyone should pursue a strategy they they are comfortable with, however the research I posted before does indicate that holding cash actually increases risk in all their modelled scenarios!
    Originally posted by green_man
    OldMusicGuy is pursuing a strategy he is comfortable with. The modelled scenarios I have looked at show that holding cash may produce a drag on returns and not maximise them. However I don't think that means you are increasing risk by not holding cash. If you don't need to maximise returns, there is a benefit of holding cash as well as other defensive assets like bonds in a portfolio. If there is a poor sequence of returns in the first decade of retirement I think there would definitely be a risk of running out of money if you go 100% equities with no cash.
    • kidmugsy
    • By kidmugsy 12th Jan 19, 6:17 PM
    • 12,480 Posts
    • 8,846 Thanks
    kidmugsy
    The issue with (i) is that a Purchased Life Annuity is unlikely to be good value.
    Originally posted by coyrls
    Compared to what? Equities that might lose two thirds of their value over the next two or three years?

    As I understand it, the purchased annuity market is very small and people who buy purchased annuities tend to live longer than average.
    Originally posted by coyrls
    I don't think our hypothetical investor would buy the PLAs unless he had objective reason to hope that he and his widow might live a long time. Though if he was in poor health he would presumably get a higher annuity rate anyway.

    The point is to diversify your risks. Retirement investing isn't just about returns: risk matters hugely because your human capital - i.e. your ability to earn a living - is so depleted.
    Free the dunston one next time too.
    • kidmugsy
    • By kidmugsy 12th Jan 19, 6:19 PM
    • 12,480 Posts
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    kidmugsy
    As the percentage is now only 5.8% just wondering how many years it would take to break even after deferring for a year?
    Originally posted by Audaxer
    You tell me the CPI inflation rate, and the return you might have got on the pension money if you hadn't deferred, and I'll tell you the break even time.
    Free the dunston one next time too.
    • Audaxer
    • By Audaxer 12th Jan 19, 8:57 PM
    • 1,594 Posts
    • 984 Thanks
    Audaxer
    You tell me the CPI inflation rate, and the return you might have got on the pension money if you hadn't deferred, and I'll tell you the break even time.
    Originally posted by kidmugsy
    I am planning to get the maximum SP of £8,546 per year at age 66, which will be subject to 20% tax. If I deferred it for one year, and estimate it increases by 2.5% each year with inflation, if my calculations are correct it would take me 15 years to break even. So maybe a bit less time than I thought to break even, but I don't think I'll be deferring it.
    • kidmugsy
    • By kidmugsy 13th Jan 19, 1:19 AM
    • 12,480 Posts
    • 8,846 Thanks
    kidmugsy
    If I deferred it for one year, and estimate it increases by 2.5% each year with inflation, if my calculations are correct it would take me 15 years to break even. So maybe a bit less time than I thought to break even, but I don't think I'll be deferring it.
    Originally posted by Audaxer
    The point of buying extra state pension would be that you were frightened by the prospect of substantial inflation and therefore wanted more inflation-linked income. In that circumstance it's rather potty to model with 2.5% inflation. Surely the pensioner would be worried by a 1970s scale of inflation?
    Free the dunston one next time too.
    • Triumph13
    • By Triumph13 13th Jan 19, 7:20 AM
    • 1,434 Posts
    • 1,933 Thanks
    Triumph13
    But have you convinced yourself that in this scenario (40% fall, 5 years) that the cash buffer approach gives an advantageous outcome once you take the whole economic cycle into account?.. Iím beginning to think the personal psychology element is in fact the overriding factor for most people.
    Originally posted by green_man
    That depends entirely on how you define advantageous. Too many models concentrate solely on enabling the most spending possible over the course of retirement. The real aim should always be to maximise happiness. To do that you need to understand, for the individual concerned, the marginal utility of both more and less money in a given year, the anxiety levels caused by fluctuating markets and whether they think leaving money on the table at the end means they lost or they won.
    • Robert McGeddon
    • By Robert McGeddon 13th Jan 19, 9:47 AM
    • 24 Posts
    • 10 Thanks
    Robert McGeddon
    Indeed, if within 100% equities it should be comfortably such. Yet others say if you donít need the growth why risk 100% equities! Itís an interesting dilemma
    Originally posted by green_man
    Equities have the potential for both income and capital growth (or loss!).There is not necessarily a direct connection - if the stock market rises or falls by, say, a third for a year or two the dividends will probably be much less volatile.. So if you're investing in shares for growth then yes, be wary of stock market crashes, If you're just in for the natural yield then I think you should be less concerned about market volatility - you're more interested in the best revenue stream you can achieve on your investments. There is still a risk on the revenue side of things of course, but that's true of all investment types. .
    • Fermion
    • By Fermion 13th Jan 19, 11:18 AM
    • 103 Posts
    • 41 Thanks
    Fermion
    I keep a small cash buffer of about 6 months of monthly income drawdown payments, but the key thing about my portfolio is that all of my funds are held in Income units which I find is easier to track the ongoing income/Dividend Yield and so far has avoided me having to sell any funds, particularly when the market is depressed as it is currently

    The ongoing cash income statements that I get from HL makes it very easy to check if my pension withdrawals are on track. (For info I'm only trying to take the natural yield and keep my income drawdown pot generally intact)
    • bearshare
    • By bearshare 13th Jan 19, 12:27 PM
    • 38 Posts
    • 23 Thanks
    bearshare
    I keep a small cash buffer of about 6 months of monthly income drawdown payments, but the key thing about my portfolio is that all of my funds are held in Income units which I find is easier to track the ongoing income/Dividend Yield and so far has avoided me having to sell any funds, particularly when the market is depressed as it is currently

    The ongoing cash income statements that I get from HL makes it very easy to check if my pension withdrawals are on track. (For info I'm only trying to take the natural yield and keep my income drawdown pot generally intact)
    Originally posted by Fermion
    The 'problem' with that approach is that the natural income from a balance equity portfolio is fairly low: about 1.8% from memory, which is lower than the safe withdrawal rate. If the fund focuses on high income equities, you can get up to about 3.5%, BUT the total return of the fund tends to be much lower.

    You may be OK with this, but it is an issue for me.

    TL;DR: you are giving up higher returns for the sake of easier administration.
    • kidmugsy
    • By kidmugsy 13th Jan 19, 3:09 PM
    • 12,480 Posts
    • 8,846 Thanks
    kidmugsy
    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.
    Originally posted by Robert McGeddon
    Right then, young man, another one for your reading list: be sure to be suspicious of strategies that rely on so-called safe withdrawal rates from equity portfolios. They are probably a rather extravagant way to fund a retirement. To see why, google "The 4% RuleóAt What Price?"
    by Jason S. Scott , William F. Sharpe , and John G. Watson
    Free the dunston one next time too.
    • Linton
    • By Linton 13th Jan 19, 4:38 PM
    • 10,418 Posts
    • 10,816 Thanks
    Linton
    Right then, young man, another one for your reading list: be sure to be suspicious of strategies that rely on so-called safe withdrawal rates from equity portfolios. They are probably a rather extravagant way to fund a retirement. To see why, google "The 4% RuleóAt What Price?"
    by Jason S. Scott , William F. Sharpe , and John G. Watson
    Originally posted by kidmugsy

    Having read that paper I am a little unclear as to exactly what their proposed alternative is. Perhaps you could explain.


    However two aspects did concern me. In their calculations they made the assumption that one could get safe bonds with a real return of 2%. At the moment that is impossible, at least in the UK. Secondly, they appear to advocate the use of call options to reduce risk. Whether these are readily available in the US I dont know. However as an experienced but amateur UK investor I would not know how to do this. It would be far beyond the capabilities of most retirees. And then it raises questions like are they eligible for SIPPs and ISAs?


    I would agree with them that blind and rigid use of something like a 4% rule based on a relatively high % equity portfolio is less than optimal. However at the moment I do not see any alternative simple strategy that can be used at least as a starting point for managing ones finances in retirement.
    • Spreadsheetman
    • By Spreadsheetman 13th Jan 19, 4:40 PM
    • 216 Posts
    • 241 Thanks
    Spreadsheetman
    Right then, young man, another one for your reading list: be sure to be suspicious of strategies that rely on so-called safe withdrawal rates from equity portfolios. They are probably a rather extravagant way to fund a retirement. To see why, google "The 4% RuleóAt What Price?"
    by Jason S. Scott , William F. Sharpe , and John G. Watson
    Originally posted by kidmugsy
    Interesting. The bond-based strategy appears to ignore real-world inflation though unless I've missed something?
    • zagfles
    • By zagfles 13th Jan 19, 5:14 PM
    • 13,907 Posts
    • 11,985 Thanks
    zagfles
    However two aspects did concern me. In their calculations they made the assumption that one could get safe bonds with a real return of 2%. At the moment that is impossible, at least in the UK.
    Originally posted by Linton
    Exactly - index linked gilts have yields of -1.5% or worse, not surprising when inflation is higher than interest rates. At that yield the guaranteed option would only get you 2.6% rather than the 4.46% they use in their example.
    • goRt
    • By goRt 13th Jan 19, 6:15 PM
    • 273 Posts
    • 159 Thanks
    goRt
    I'm fairly certain that the £85K limit doesn't apply to anything held in a SIPP, be it in cash or not.
    Originally posted by Paul_Herring
    The FSCS thinks differently to you, maybe you should tell it?

    https://www.fscs.org.uk/what-we-cover/
    • kidmugsy
    • By kidmugsy 13th Jan 19, 6:22 PM
    • 12,480 Posts
    • 8,846 Thanks
    kidmugsy
    In their calculations they made the assumption that one could get safe bonds with a real return of 2%..
    Originally posted by Linton
    Yes, back then they probably could have got 2% on TIPS. But then, back then, 4% might have been a "safe withdrawal rate". Nowadays an American might easily be persuaded to subtract 1% from each number. I dare say a Briton should subtract even more.

    But that's detail - the point is that there were (and doubtless still are) reasonable assumptions that lead to the conclusion that drawing a fixed income from a highly erratic portfolio is asking for trouble, and that the trouble shows up as the whole enterprise being needlessly expensive. If I remember rightly, they also point out that another trouble would be that the profits are likely to turn up at the wrong age - late in retirement rather than early in retirement.
    Free the dunston one next time too.
    • kidmugsy
    • By kidmugsy 13th Jan 19, 6:32 PM
    • 12,480 Posts
    • 8,846 Thanks
    kidmugsy
    Exactly - index linked gilts have yields of -1.5% or worse
    Originally posted by zagfles
    No; versus CPI it's about -0.5%.

    Nor does it much matter because in the UK (unlike the US back then) it's easy to buy an index-linked annuity which would probably do a better job than a ladder of I-L gilts.


    Anyway, that's two commenters I've seen who've missed the point. Any more?
    Free the dunston one next time too.
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