# 4% safe withdrawal rate?



## gkp (30 Jan 2019)

Looking for some ARF investment thoughts.  Is it reasonable to assume I can withdraw 4% from an ARF (age 56 so need to last 30+ years, with approx €1m fund)?  
Would this require 5% fund growth to cover charges?
What equities/bonds ratio would be needed to get this return?


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## Zebedee (30 Jan 2019)

Isn’t there an imputed distribution of at least 4%pa?  Ie you pay tax on it regardless of whether you take the income on it or not. 

Beyond this I think it is best to talk to a financial adviser (I’m not one) to take a wholistic view of your circumstances, finances, risk appetite etc.


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## Conan (30 Jan 2019)

You must draw down a minimum of 4%pa from the ARF (5% pa after age 70). So in investing the ARF funds you do need to consider the issue of risk v return. However I don’t necessarily see that the objective should be to target a gross return of 5% (allowing for charges). This assumes you are trying to keep the €1m fund intact.
Had you bought an Annuity, you get a guaranteed income for life but the fund is given away. There is no fund available on death (other than perhaps a spouse’s Pension). So targeting a 5% return on the basis that you also want to keep the €1m fund intact on death is seeking to do more than an Annuity. That will involve taking a higher investment risk is order to possibly achieve such a return. That might work out OR it might not work out. Taking a lower risk investment strategy will probably result in a lower return but might also deliver less volatility. So if you take out 4% pa but only earn say 3% pa net of charges, then the fund will gradually reduce over time. But the fund will still see you out. Yes you might have a lower fund passing on to your estate, but so what.
In my opinion, I would focus more on managing the retirement income (and the investment risk) than focusing on leaving the €1m to my estate. You cannot take it with you on death (at least so I am reliably informed).
A good financial advisor should be able to give you a profile of the numbers under various assumptions . So look at 4% drawdown with 5% , 4%, 3% growth rates.


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## Cervelo (30 Jan 2019)

Couple of things to think about 
Can you live comfortably now on a 4% drawdown after tax 
Have you factored in years of no growth and what this will do to the longevity of your fund and lifestyle
Have you factored in inflation to your future drawdowns


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## RETIRED2017 (30 Jan 2019)

Lots have other savings /pension income along with ARF drawdown you have to take out 4% min you may not be spending all of it how you invest any spare cash along with pushing out date of starting ARF if it is possible,


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## Steven Barrett (30 Jan 2019)

gkp said:


> Looking for some ARF investment thoughts.  Is it reasonable to assume I can withdraw 4% from an ARF (age 56 so need to last 30+ years, with approx €1m fund)?
> Would this require 5% fund growth to cover charges?
> What equities/bonds ratio would be needed to get this return?



The million dollar question. If we knew how long we would live for, what inflation would be and what the markets would return, we would know the answer. 

Assuming a 60/40 mix, taking €40,000 out a year that is index linked for 40 years. Looking at the returns and inflation going back to 1900, the success rate over a 40 year period is 44%. Now, there's 2 World Wars and a Great Depression in there to skew the figures. For example, if you retired in 1914, you could safely withdraw €16,130 a year (inflation proofed) until 1953. Some period horrific investment markets in there. 

If you retired just 7 years later with the same pot of money, you could have taken out €71,625 a year for the same period of time!

Then you have to consider that if you retire at 56, you are going to spend more than the 86 year old you. For a good part of your retirement, your spending may increase over time and for the later part your spending will decrease over time.

So really, there's no magic blend or number. You need to look at what you want to do and what you need. Unfortunately, the unknowns of health, mortality, market performance and unplanned for expenditure gets in the way of providing that certainty that people look for.  

Steven
www.bluewaterfp.ie


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## Sarenco (30 Jan 2019)

Personally, I think it would be unwise to assume that an appropriately diversified, balanced portfolio of publicly traded stocks and bonds will do anything more than simply keep up with inflation over the course of your retirement, after all costs and taxes are taken into account.

Of course, returns on the portfolio might turn out to be better (or, less likely, worse) than that but I think that's a reasonable assumption for planning purposes.

So, if you are projecting a 35-year retirement (entirely reasonable for somebody planning to retire in their mid-50's), you would need a savings pot equivalent to 35 years' worth of your projected expenses.   A 60-year old planning on a 30-year retirement would need 30 years' worth of projected expenses, etc.

I certainly agree with Steven that annual expenses in retirement are unlikely to follow a uniform pattern (do they ever!).  However, I think it's unwise to assume that expenses will necessarily fall as we age and become less active - long-term/end of life care can be extremely expensive.  

Finally, I would personally ignore any State contributory pension or other benefits (including the Fair Deal scheme) for planning purposes.  Hopefully those benefits will still exist 30 years from now but really who knows?

I'm conscious that many will find the above to be an overly conservative approach.  But in an uncertain world, I think a reasonable degree of caution is entirely appropriate.


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## JoeRoberts (31 Jan 2019)

Conan said:


> ). This assumes you are trying to keep the €1m fund intact.
> .


v good point Conan.
I think a lot of advisors drive the idea of keeping as much of the fund as possible intact in order to ensure their maximum take from the fund in charges. If the retiree reduces the fund substantially then somewhere among the cloak and daggers of charges the "advisor" loses out. It is a very subtle idea planted and easily sold.

People need to be realistic about how much money they actually need and can spend once they reach 70/75 +, regardless of supposed increases in longevity which generally comes with limiting health factors. This assumes they own a house and don't need to pay rent or mortgage in retirement which is a point Brendan has correctly emphasised for many years that should be  a priority over a pension.


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## Colm Fagan (31 Jan 2019)

I've discussed this topic on a number of occasions with other contributors.  I disagree with the conventional wisdom. 
See, for instance, post #292 (19 August 2018) of my "Diary of a Private Investor".
I stand by what I wrote then.  For what it's worth, my ARF is now worth considerably more  than when I started it in December 2010, despite making net withdrawals of more than 4% a year on average since then.   I plan to increase the rate of withdrawal to more than 6% a year in future:  I prefer to spend the money than leave it to the next generation!


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## Sarenco (31 Jan 2019)

Colm Fagan said:


> For what it's worth, my ARF is now worth considerably more  than when I started it in December 2010


With respect Colm, that period happens to coincide with the longest uninterrupted bull market in global stock market history.  Your personal good fortune hardly represents a sound basis for any prudent retirement plan.

What would the value of your portfolio look like today if you had retired in 1928?  Or 1964?  Or 1999?


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## Marc (31 Jan 2019)

The following analysis relates to some of the issues when drawing income from an ARF.

The objectives at retirement can be boiled down to the following:


1. an overwhelming need for income and the sustainability of that income, and

2. a secondary (typically less important) need to leave assets for beneficiaries


The forces working against the achievement of these objectives can also be boiled down to the following:


1. financial market risk

a. this includes general market risk and sequencing risk

2. longevity risk

a. the time horizon in retirement is unknown

b. this speaks to the real risk of an investor outliving their capital base


We wanted to introduce real world constraints in a modelling framework to draw realistic conclusions and guidelines from our research.

The largest differentiator of our research is that we used a simulation process to produce portfolios that take any number of different paths possible given the risk and return characteristics of the portfolio.

Higher risk portfolios can withstand higher drawdown rates over long periods of time.

However, even with low drawdowns there is a small chance of failing over the period.

Low risk portfolios over long periods of time guarantee failure.

Risk assets are absolutely necessary to generate inflation beating returns and to
maintain living standards
Drawdowns above 6% become touch and go. 4% drawdown rates seem generally sustainable but not for conservative portfolios.

What about spending in retirement?


“Our findings suggest that typical consumption in retirement does not follow a U-shaped path –
consumption does not dramatically rise at the start of retirement or pick up towards the end of life to meet 
long-term care related expenditures.”

Dr Brancati, International Longevity Center


Consumption in retirement starts relatively high and ends low. This pattern is common to both high and low 
income groups, is robust to the inclusion of factors other than age and is not simply the result of the time period 
in which the data was collected.


Of course many people will need care in later life, but this is not typical.

 Consider the following:

• only 16% of people aged 85+ in the UK live in care homes
• the median period from admission to the care home to death is 462 days. (15 months)
• around 27% of people lived in care homes for more than three years, and
• people had a 55% chance of living for the first year after admission, which increased to nearly 70% for the second year before falling back over subsequent years.

Source AgeUK 2016

Some questions you need to ask yourself;


How much risk do you need to take in order to support a given income?

Is an ARF the right answer should you use an annuity?

What happens if the first few years of your retirement experience negative returns? What should you do?

How do you adapt to changing market conditions, changing interest rates changing inflation expectations?

Should you expect mean reversion in asset classes? If so how should you respond?


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## Steven Barrett (31 Jan 2019)

Sarenco said:


> Finally, I would personally ignore any State contributory pension or other benefits (*including the Fair Deal scheme*) for planning purposes.  Hopefully those benefits will still exist 30 years from now but really who knows?



Didn't you say on the mortgage lump sum or start a pension thread 





> Speculating about future taxes or levies is futile - we can only make reasonable decisions based on we know today.


 

Joking aside, from a planning point of view, potential home care screws everything up. You can be looking at about €60,000 a year for home care. And to be conservative, 5 years of care (people usually don't last longer than that in a home). Even without inflation, that's €300,000 net income. As the ARF is taxed, we'd be looking at about 50% of the ARF value to be kept just in case you find yourself in a care home. That's a lot of money not to spend when young an healthy for something that may or may not happen in 20/ 30 years time. 

The current situation is that the State will look after you if you need a care home. You pay for all of it as long as you can afford to, then the Fair Deal kicks in and you give up some of the value of your home. 



JoeRoberts said:


> v good point Conan.
> I think a lot of advisors drive the idea of keeping as much of the fund as possible intact in order to ensure their maximum take from the fund in charges. If the retiree reduces the fund substantially then somewhere among the cloak and daggers of charges the "advisor" loses out. It is a very subtle idea planted and easily sold.
> 
> People need to be realistic about how much money they actually need and can spend once they reach 70/75 +, regardless of supposed increases in longevity which generally comes with limiting health factors. This assumes they own a house and don't need to pay rent or mortgage in retirement which is a point Brendan has correctly emphasised for many years that should be  a priority over a pension.



If your advisor is taking that approach, you'd question the solvency of their business. You save for decades for retirement so you can spend the money and enjoy yourself. You are now entering the deccumulation stage of life when you start spending all that money you have saved for so long. People who have been prudent enough to save for their retirement are usually prudent enough in the spending of it too. They don't want to blow it all in the first few years, so you see a gradual reduction of the value of ARF funds over the years, not a sharp decline. 

Those with small ARF pots, should be taking out as much as possible each year within the tax limits. 


Steven
www.bluewaterfp.ie


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## Sarenco (31 Jan 2019)

Marc said:


> 4% drawdown rates seem generally sustainable


Over what timeframe?  25, 30, 40 years?  I assume you mean 4% adjusted for inflation.

And how would you define what is "generally sustainable"?  Would you consider a 10% chance of failure, based on your model, to be acceptable?  5%?


Marc said:


> only 16% of people aged 85+ in the UK live in care homes


I'm actually surprised it's as high as 16%.  An increasing number of seniors obviously choose to pay for long-term care to be provided within their own homes.


Marc said:


> Of course *many people *will need care in later life, but this is *not typical*.


Is that not a contradiction in terms?


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## Cervelo (31 Jan 2019)

Marc said:


> Drawdowns above 6% become touch and go. 4% drawdown rates seem generally sustainable but not for conservative portfolios.





Sarenco said:


> Over what timeframe?  25, 30, 40 years?  I assume you mean 4% adjusted for inflation.
> And how would you define what is "generally sustainable"?  Would you consider a 10% chance of failure, based on your model, to be acceptable?  5%?



Sorry for jumping in on your question Sarenco but I was wondering if Marc could clarify his interpretation of a "conservative portfolio" when responding


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## Marc (31 Jan 2019)

For example this portfolio is very conservative (expected volatility under 3%) and has a Gross expected return of CPI + 1.46%pa before costs. Take a 4% annual income and you are going to run out of money.


Higher risk portfolios can withstand higher drawdown rates over long periods of time. However, even with low drawdowns there is a small chance of failing over the period.

Low risk portfolios over long periods of time *guarantee failure*. Risk assets are absolutely necessary to generate inflation beating returns and to maintain living standards

Drawdowns above 6% become touch and go. 4% drawdown rates seem generally sustainable but not for conservative portfolios



IMPORTANT

Our analysis assumes that the income is 4% of the starting portfolio value.

Imputed distributions are 4% of the CURRENT value of the ARF

So, if the value of the ARF is €1 you are only required to impute an income of 4 cents so you will be left with 96cents.

An ARF cannot "bomb out" due to the imputed distributions since 96 cent is still a "positive value"

However, I'm more interested in declining living standards over retirement. If your income is down to 4 cent a year you have an issue


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## WhiteCoat (31 Jan 2019)

What guidance notes/best practice have the professional bodies issued around this question and how has the guidance changed over the years? Are the various representative bodies broadly in agreement? Are links available?


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## Colm Fagan (31 Jan 2019)

Sarenco said:


> With respect Colm, that period happens to coincide with the longest uninterrupted bull market in global stock market history. Your personal good fortune hardly represents a sound basis for any prudent retirement plan.



Sarenco, you're right:  I was lucky in my timing - but not that lucky.  As recorded in my diary update of 7 January, my portfolio fell by 28% in 2018.  The ARF fell 15%; other investments (including the AMRF) brought the average fall to 28%.  The long-term returns quoted in my last post allowed for the 2018 result.

My general point is that, as @Marc noted above, long-term income, not short-term security of capital, is the prime requirement for an ARF holder.  (And by "income" I don't mean dividends; I mean the income derived from capital gains and dividends).  Cash delivers a zero income, bonds aren't much better (possibly worse in the long-term).  Good quality equities and real estate are the best bet for achieving a reasonable long-term return, especially considering that the expected lifespan for a new retiree is probably more than two decades when future improvements in medical science are allowed for.

The "sequence of return risk" has often been cited as an argument against high equity levels in a retirement portfolio.  The risk is overblown.    Any theoretical studies I've seen on this topic start from the false assumptions that (i) the pensioner withdraws a constant amount each year, and (ii) they cash investments equal to the amount withdrawn.  Both assumptions are wrong.

If I do well in a year, I treat myself - bigger presents for the grandchildren, a nice holiday, whatever - but if I've done badly, I cut back on expenditure.  That doesn't fit with the model, but it is the reality.

Theoretical models also assume that the only way to derive an "income" from an ARF is by cashing investments.  Speaking once again from experience, that's just not true.  At the end of last year, when market values were on the floor, I had to raise some cash, but I managed to do it without selling investments (or by selling very little).  There is always a small cash balance in the portfolio.  At the end of 2018 I ran it down almost to zero.  That too is a significant departure from the theoretical model, which would have me cashing investments to meet income needs, even if I had cash in the portfolio.

If the model allows for withdrawals to be flexed (even slightly) in response to market returns, and also allows for "income" to be taken from the cash balance in the fund when markets are depressed (with the cash being replenished when market returns are good), I'm sure that the matrix @Marc kindly shared with us would look quite different.   As it stands, it should carry a health warning: "This matrix is based on artificial assumptions, which might bear no relationship to what happens in practice".


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## Gordon Gekko (31 Jan 2019)

I agree that the risks seem to be overblown.

For someone with €1.5m in his ARF, why not just keep, say, €300k in cash and €1.2m in equities?

And, to pick up on Colm’s point, isn’t a decent chunk of the 4% covered by the dividend yield on a typical portfolio?


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## elacsaplau (1 Feb 2019)

Sarenco said:


> Over what timeframe?  25, 30, 40 years?  I assume you mean 4% adjusted for inflation.



Excellent question. I, too, await clarity.



WhiteCoat said:


> What guidance notes/best practice have the professional bodies issued around this question and how has the guidance changed over the years? Are the various representative bodies broadly in agreement? Are links available?



I don't believe any professional body in Ireland has produced meaningful guidance in terms of asset allocation, safe withdrawal rates, etc.



Colm Fagan said:


> The "sequence of return risk" has often been cited as an argument against high equity levels in a retirement portfolio.  The risk is overblown.    Any theoretical studies I've seen on this topic start from the false assumptions that (i) the pensioner withdraws a constant amount each year, and (ii) they cash investments equal to the amount withdrawn.  Both assumptions are wrong.



These are not false assumptions. The purpose of many excellent studies is to determine the "safe" withdrawal rate. These studies are designed to give investors a guide so that they better understand the trade-off between maximising returns and maximising income security. They also, importantly, model the impact of various rebalancing strategies. These reports provide extremely useful information and show, for example, that a high equity content is the optimum strategy compared with the old adage of age in bonds. "High" in this context can differ between reports but typically is in the 60% to 80% range. I have seen no credible report that has advanced "age in bonds" as the optimum play to best match the competing needs of the retiree.

I can recall nothing in these reports which suggest that people must slavishly follow an X% rule. For example, if the experience of a given retiree has been positive by a given point in time in his retirement, there is nothing to prevent him from taking a one-off lump sum or increasing his withdrawal rate, etc.  Equally, these reports help to illustrate that the retiree could keep the withdrawals at a constant level to de-risk or have the comfort of knowing that they are likely to be leaving something behind. Favourable experience can also clearly serve as a protection against severe healthcare costs, etc.

In relation to the second point, the reports are designed with the typical individual investor in mind who invests his retirement account in unit linked funds. It is unfair the say that the approach adopted is false when the standard approach to withdraw funds in unit linked contracts is to encash units. What alternative assumption would you employ?


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## Cervelo (1 Feb 2019)

I gather from your post Marc that you would consider a 30/70 portfolio as conservative, presumably a 50/50 in neither here nor there and a minimum 70/30 would what be required to sustain a 4% withdrawal 
But what is the best way or current thinking about how to build the portfolio, my current portfolio is a 50/50 with 6 ETFs and I'm thinking that it needs to move to a more aggressive stance and that 6 ETFs is to many
My current thinking is I need to reduce these to 3 which I know will narrow the diversity, increase the risk but I feel its the better option for my goals. but I'm also questioning whether EFTs is the right option
I note Colm Fagan's route (if I have this right) is to build a portfolio of individual stock and shares rather then ETFs and am thinking this might be the better option but wondering about diversity
as in do I hold 10 stocks of 100k or 100 stocks of 10k, I have been dabbling in the stocks since the summer and am enjoying the ride but not sure I would be confident enough to build a good portfolio  
I know I'm asking a question that's the same as asking "how long is a piece of string" but I after the thinking behind each type of portfolio??


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## Marc (1 Feb 2019)

There are a couple of themes developing on this thread.

I will address a few here

1) "The best ARF strategy is to just invest in equities" (the Colm Fagan approach) whilst I can agree with some of Colm's arguments I think he has taken his own good fortune and extrapolated this to represent the "best course" for almost everyone with an ARF.

I have attached a white paper which sets out the arguments for the total return approach he is taking but also cautions against seeing a high yield strategy as a panacea for the ARF conundrum.

Colm has been extremely fortunate, but its hard to distinguish between luck and skill over short-time periods. I also take issue with the sequence of return risk being "overstated". It is one of the most significant risks facing those contemplating their ARF investment strategy and one of the most complex issues to attempt to resolve.










This illustrates the danger of a fixed withdrawal strategy which can result in capital and income depletion during retirement.

I agree with Colm that the answer is to dynamically vary the withdrawal strategy but, of course, this also needs to be managed within the context of the imputed distributions.







•      Certainty comes at a cost

•      Understanding your objectives (income and income growth vs succession) is pivotal in portfolio selection and management

•      This needs to be balanced off with your need, willingness and capacity for investment risk

•      A “default option” cannot replace the above trade-off process

2) What guidance notes/best practice have the professional bodies issued around this question and how has the guidance changed over the years? Are the various representative bodies broadly in agreement? Are links available?

I was talking to a leading consultant in Ireland on this very subject yesterday.

We agreed that the guidance for Irish financial advisers on this matter is virtually non existent compared to, say, the UK or USA.

One possible explanation that has been put to me on more than one occasion is that regulation in Ireland is principles-based whereas the UK has a rules-based regulatory system.

By way of an example, I recently consulted for someone who used to work in Ireland but has now moved back to the UK.

They have an Irish defined benefit pension and have been offered an enhanced transfer value.

The question: who regulates advice in respect of the numerous complex decisions they need to make?

It’s a lot of money. Nearly €500k
A substantial part of their retirement pot which will be required to provide for their needs for the rest of their lives.

It’s important right? So; there MUST be regulatory oversight. Surely.....

I consulted with both senior counsel and the UK FCA :

The Investment Intermediaries Act 1995 (IIA) in Ireland only applies to regulated activities related to investment services connected with investment instruments. The list of investment instruments includes Personal Retirement Savings Accounts (PRSAs) therefore if the Pension is not a PRSA, IIA does not
apply.

The Pensions Authority in Ireland governs the operations of Pensions in Ireland however they do not have any requirements placed on Financial Advisers with respect to providing advice on pensions.

We wrote to the UK Financial Conduct Authority (FCA) asking the question; would a UK resident who previously held an Irish Defined Benefit Pension scheme but had now moved back to the UK, need a UK Pension Transfer Specialist to provide advice? Their response; "'The mandatory advice requirement legal framework actually bites on trustees of pensions scheme in Great Britain and
Northern Ireland by requiring trustees to check that a member seeking to transfer has taken independent advice (see sections 48 and 51 of the Pension Schemes Act 2015). A member of an Irish scheme would not necessarily need to obtain advice from a UK authorised adviser.”

Consequently, there does not appear to be any regulatory oversight of this transaction by either the Central Bank of Ireland, The Pensions Authority of Ireland or the UK Financial Conduct Authority.
The Central Bank of Ireland does not regulate Taxation Advice

This is not to say that no part of the transaction falls under regulatory scrutiny but the horse will have already bolted by the time it comes onto the radar.


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## elacsaplau (1 Feb 2019)

Marc said:


> 1) The best ARF strategy is to just invest in equities (the Colm Fagan approach)



Can you explain the basis for this assertion please? You have provided absolutely no evidence to support it.


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## RedOnion (1 Feb 2019)

elacsaplau said:


> Can you explain the basis for this assertion please? You have provided absolutely no evidence to support it.


Marc didn't say that. He addressed that approach if you re-read.


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## elacsaplau (1 Feb 2019)

Point taken, RedOnion - apologies to all  

I'm actually pleased that Marc is cautioning against an all-equity approach. This makes total sense.

Still, it is fair to say, that the questions I posed this morning remain unanswered!


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## RedOnion (1 Feb 2019)

elacsaplau said:


> Still, it is fair to say, that the questions I posed this morning remain unanswered!


Patience is required. Some people have a living to make!


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## Colm Fagan (1 Feb 2019)

elacsaplau said:


> Still, it is fair to say, that the questions I posed this morning remain unanswered!



Are the questions meant for me?

I'm not sure what the questions are, but I wrote what I thought was common sense:
(1)  As a DC pensioner, I am likely to spend more if I have earned a good return in a year.  Conversely, if I've done badly, I am likely to spend less.
(2) One is better off in the long run selling stocks when they've risen in price than when they are depressed.
Fortuitously, therefore, reacting in the common-sense manner to good news/ bad news is good for your pocket.

My other observation was also common sense:  if I want to take an "income" from my pension fund, it's far more sensible to take it from cash that's already in the fund than to sell shares, particularly if they're depressed.

I note @elacsaplau's objection to this latter point:



elacsaplau said:


> In relation to the second point, the reports are designed with the typical individual investor in mind who invests his retirement account in unit linked funds. It is unfair the say that the approach adopted is false when the standard approach to withdraw funds in unit linked contracts is to encash units. What alternative assumption would you employ?



Unfortunately, I haven't seen any of the


elacsaplau said:


> many excellent studies is to determine the "safe" withdrawal rate.



so I didn't know they were "designed with the typical individual in mind who invests his retirement account in unit linked funds"  But doesn't the individual unit-linked investor put some money in an equity fund, some in a cash fund, etc.?  In that case, my argument still holds.

Don't get me wrong.  Marc is making an important general point that, while equities can be expected to generate significantly higher returns on average than bonds and cash (I reckon the gap is around 4% a year over bonds and 5% over cash), they have much higher volatility.   This means that, if you're unlucky and experience poor equity returns in the early years, it could prove difficult to claw back what you've lost and get back on the right road.

 I am saying, though, that the problem isn't as bad as it's often painted because of the two safety features mentioned above:  withdrawing less if markets are down and running down cash levels rather than redeeming investments to get an "income".  To the best of my knowledge, the studies mentioned don't allow for withdrawals to be flexed depending on market conditions nor for running down the cash portion of the fund when markets are depressed.  I honestly don't know, as I haven't read any of the reports in detail.

I also agree with @Gordon Gekko that dividends can be used to provide part of one's "income" in retirement.  That's very much the case for my ARF, but I recognise that this option isn't open to someone who invests through unit-linked funds.



Marc said:


> Colm has been extremely fortunate, but its hard to distinguish between luck and skill over short-time periods.



Marc, I agree.  I have been lucky in my timing.  I've also been lucky in that, while I have a concentrated portfolio (which increases the risk level), my biggest single investment for most of the last 20 years (it's just been overtaken by another one) performed remarkably well, as documented in my diary.  I recognise that discovering that share was pure luck.  Sticking with it, and increasing my holding in it over the years was less lucky.


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## elacsaplau (1 Feb 2019)

Colm Fagan said:


> To the best of my knowledge, the studies mentioned don't allow for withdrawals to be flexed depending on market conditions nor for running down the cash portion of the fund when markets are depressed.



In my earlier post, I explained that the general approach to "safe withdrawal rate" studies is that they should be treated as guidance figure and that the withdrawal basis can be adjusted in various ways depending on experience. They should be seen as highly useful guidelines.

Some, but fewer studies, examine dynamic withdrawal strategies. Pretty much all the studies divide assets between return seeking and defensive assets and examine in great detail the best withdrawal strategies under multiple market conditions and scenarios (and by extension the best rebalancing strategies). Anyone interested should just google this. One will find piles of credible reports from the U.S. and some from the U.K.


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## Sarenco (1 Feb 2019)

Gordon Gekko said:


> And, to pick up on Colm’s point, isn’t a decent chunk of the 4% covered by the dividend yield on a typical portfolio?


This way of thinking really puzzles me.

Obviously a cash dividend is a payment made by a company to investors out of its profits. This transfers economic value from the company to its shareholders, instead of the company retaining the cash for other purposes.  

The dividend payment causes a company's share price to drop by precisely the same amount as the dividend. So, for example, if a company makes a dividend payment equal to 5% of the stock price, shareholders will see a resulting fall of 5% in the price of their shares.  If the shareholder immediately reinvests the dividend payment back into company stock, the shareholder reverts to the position he was in immediately prior to the dividend payment (market movements and attritional costs aside).  A dividend isn't a bonus or free money – it's simply a transfer of value.

That being the case, what difference would drawing down funds from a dividend payment (as opposed to liquidating a stock position) make to the sequence of returns issue?


Colm Fagan said:


> I also agree with @Gordon Gekko that dividends can be used to provide part of one's "income" in retirement.  That's very much the case for my ARF, but I recognise that this option isn't open to someone who invests through unit-linked funds.


Shares held within a fund (unit-linked or otherwise) presumably also receive dividends.  The fact that they aren't ringfenced into a separate cash account seems irrelevant to me.  

Again, what's the difference between redeeming units in such a fund to generate liquidity and drawing down uninvested cash within your ARF?  Surely it amounts to the same thing.

It seems to me that eating into your liquid cash when risk assets are "on sale" is an odd approach.  Didn't Mr Buffett counsel that investors should be greedy when others are fearful?


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## Colm Fagan (1 Feb 2019)

Sarenco said:


> Again, what's the difference between redeeming units in such a fund to generate liquidity and drawing down uninvested cash within your ARF? Surely it amounts to the same thing.


There's a big difference.  Say a fund has 80% in equities and 20% in cash.  If you sell €100 of units, you sell €80 of equities and €20 of cash.  If you hold the equities (and cash) direct, you leave the equities intact and deplete your cash balance by €100.


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## Sarenco (1 Feb 2019)

Colm Fagan said:


> There's a big difference.  Say a fund has 80% in equities and 20% in cash.  If you sell €100 of units, you sell €80 of equities and €20 of cash.  If you hold the equities (and cash) direct, you leave the equities intact and deplete your cash balance by €100.


Maybe I'm missing something very obvious here Colm (it's been a long week) but I'm struggling to see any difference at all.

Maybe I'll try and put it another way...

Let's say you have €100 worth of stock in Acme & Co and I have €80 worth.  As it happens I also have €20 in cash but your wallet is empty.  

As soon as the markets open on Monday morning I buy €10 worth of additional stock and you sell €10 worth of stock.  We're now in precisely the same position - we both have €10 in cash and €90 worth of stock in the same company.

Now let's say we both had a lie in on Monday and missed the news that a serious fraud had been discovered in Acme & Co., causing its stock price to tumble by 50% while we were asleep.

You still need to eat so reluctantly sell €10 worth of stock.  Sensing a bargain, I pick up €10 worth of stock but this now buys me twice as many shares.

Are we in a different position on Monday evening?  

Would it matter if our respective positions were reflected in the asset allocation of two different funds?


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## Colm Fagan (1 Feb 2019)

Hi @Sarenco.  You've completely lost me with references to fraud at Acme, lying in on Monday, getting a bargain, etc.

Let's go back to your earlier posting:


Sarenco said:


> Again, what's the difference between redeeming units in such a fund to generate liquidity and drawing down uninvested cash within your ARF? Surely it amounts to the same thing.



Let's suppose that you hold €500 worth of units in a fund that is invested 80% in equities and 20% in cash.  In effect, therefore, you have €400 worth of equities and €100 cash.

You now want to get €100 cash, so you sell 1/5th of your units.  Therefore, you sell €80 worth of equities and €20 of cash.

I also have €500 of assets, split in exactly the same way:  €400 in equities and €100 in cash.
I want to get cash of €100.  I just take the €100 cash and leave the €400 in equities.

After the transactions (assuming no change in the value of the equities), you have €320 worth of equities and €80 cash.  I have €400 equities and no cash.

Straightforward, isn't it!?


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## WhiteCoat (2 Feb 2019)

I had a look at some of the US analysis on this. Much interesting material. I like the multi-faceted way that they approach this question together with the sheer range of strategies examined. Overall, I was impressed by the quality of the analysis. My impression is that they are a lot further down the road on this particular question. Given the difference between Euro & US bond yields, it seems strange that there does not seem to be equivalent research for the Euro/Irish investor? (Maybe it's there, I just couldn't find it). What strikes me, in particular, is where "defensive" assets are to be invested in the euro context? What's also is interesting is the trajectory of the 4% drawdown becoming 3.5% or lower in more recent studies. This ties in with what Sarenco said in an earlier post.


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## Sarenco (2 Feb 2019)

Colm Fagan said:


> Hi @Sarenco.
> After the transactions (assuming no change in the value of the equities), you have €320 worth of equities and €80 cash.  I have €400 equities and no cash.


Or to put it another way, we both end up with a portfolio that is worth €400!  

The only difference is that the risk profile of my portfolio hasn't changed whereas you would have to sell a further €80 of equities to get back to the original allocation.


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## Marc (2 Feb 2019)

I have updated my earlier thread to address @whitecoats question around guidance for advisers

However since the 6 nations has now started if you want to continue this discussion you’ll have to come to Landsdown Road!!

I’m easy to spot, I’ll be holding a pint of Guinness


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## elacsaplau (2 Feb 2019)

Marc said:


> I’m easy to spot, I’ll be holding a pint of Guinness



Yes - but who will you be shouting for?


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## Marc (2 Feb 2019)

Lol. To cover all the bases (and depending on who I’m with)

I’m typically wearing a Munster shirt and an Ireland shirt over an England shirt and an MBE. I think that’s called “hedging”


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## elacsaplau (2 Feb 2019)

Marc,

I think that this is far beyond hedging. This is the apparel equivalent of buying annuities with multiple suppliers and insuring the annuity providers against default, whilst simultaneously living in a self-sufficient compound. I'm just going to wear my lucky (read crusty) socks!

Like the SWR, you can have all the strategy in the world, but luck may well play its part also! C'mon the biys!


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## Colm Fagan (2 Feb 2019)

I'm "independent" of the financial institutions that dole out tickets for matches, so I'm stuck at home today



Sarenco said:


> Or to put it another way, we both end up with a portfolio that is worth €400!


I've been called many things in my lifetime, but never a magician.  If I have €500 worth of assets, and take away €100 worth, not even I can make that into anything other than €400. 

I think I've made my point that, if I need cash when market values are depressed, I can normally get the money without having to cash any of the under-priced assets (IMO, of course).  I'm not going to make the point again, but the next update of my "private investor" diary should make it clearer, by reference to a real life example.


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## WhiteCoat (2 Feb 2019)

Thanks Marc for taking the time to answer my question. It seems like an Irish study is very much warranted. Personally, I'm perplexed regarding where to invest "safe" assets. The U.S. studies I looked at last night invariably had an allocation to bonds which is probably reasonable enough given U.S. bond yields for the U.S. investor? Is the Irish investor supposed to invest in Euro sovereign bonds? Anyway, maybe if Colm's proposal gains traction, all this will be of less importance. Do Colm's proposals represent the proverbial ill wind for advisers? I'd be interested in your comments on these.

I'm not a big fan of the rugby. The musculoskeletal morbidity toll is too high. For me to watch it, I think that they would have to be playing to resolve, once and for all, the Backstop.


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## Sarenco (2 Feb 2019)

Colm Fagan said:


> I think I've made my point that, if I need cash when market values are depressed, I can normally get the money without having to cash any of the under-priced assets (IMO, of course).


I think you are fooling yourself.  

If you normally have cash in your portfolio then you are clearly not reinvesting all dividends as soon as they as they are received.  That is precisely the same thing, from a financial perspective, as selling a proportion of the stocks to which those dividends relate.

You may not be liquidating stocks, in the very literal sense of the word, to make the drawdown but that's the impact at a portfolio level.


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## Duke of Marmalade (2 Feb 2019)

Sarenco said:


> The dividend payment causes a company's share price to drop by precisely the same amount as the dividend. So, for example, if a company makes a dividend payment equal to 5% of the stock price, shareholders will see a resulting fall of 5% in the price of their shares.  If the shareholder immediately reinvests the dividend payment back into company stock, the shareholder reverts to the position he was in immediately prior to the dividend payment (market movements and attritional costs aside).


_Sarenco _I haven't fully plumbed the theological differences between yourself and Colm, but I guess it is simply that you are at cross purposes. However the above quote is not quite accurate.  On a *look through* basis, the day before the dividend payment the investor owns, say, 100 of productive assets and 5 of cash.  (I am presuming the company generates the dividend from its cashflow and not from disposing of productive capacity.)  The payment of a dividend crystalises the position to being the investor owning 100 of productive assets (on a look through to the company)  and separately 5 in cash.  If she uses the 5 to buy more of the same shares she finishes up, again on a look through basis, with 105 of productive assets.  This is not then a reversion to the previous position.


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## elacsaplau (3 Feb 2019)

Whitecoat,

Whatever about the musculoskeletal impact on the players, it's the brain cell destruction and the associated hangover of poor supporters like me that's the real concern.



Marc said:


> We agreed that the guidance for Irish financial advisers on this matter is virtually non existent compared to, say, the UK or USA.



On a serious note, as Marc has correctly confirmed, there has been such little published research in Ireland regarding this - this is very unsatisfactory.


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## Colm Fagan (3 Feb 2019)

elacsaplau said:


> as Marc has correctly confirmed, there has been such little published research in Ireland regarding this - this is very unsatisfactory.



I agree, and would go further.  There is a complete dearth of information on how the funds of individual DC/ ARF investors have performed.  We see lots of figures on the performance of unit-linked funds, but they're not what the end consumers see.  It's the end result that matters to them, after all charges by insurance companies, advisers, etc.

It's almost impossible to get even more basic information, such as where individual investors are putting their money.  One of the few statistics I've uncovered serves as a damning indictment of the financial advice industry:  a 2015 survey by a working party of the Society of Actuaries in Ireland found that 44% of insured ARF's/AMRF's were invested entirely in cash or cash-like funds (i.e. including capital protected), another 44% in managed funds (which include a cash element) and 12% in single asset funds.   Does anyone have any more up-to-date information?  Are any of the advisers who contribute to this forum prepared to tell how their clients' funds are invested, or how they've performed (net of all charges) over (say) the last 3 or 5 years?


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## Jimmy Dee (3 Feb 2019)

Colm Fagan said:


> Are any of the advisers who contribute to this forum prepared to tell how their clients' funds are invested, or how they've performed (net of all charges) over (say) the last 3 or 5 years?


Good luck with that one on here!


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## elacsaplau (3 Feb 2019)

Colm,

All fair comments (fair as in good - not fair as in fair!!)

One observation. An "unsophisticated" adviser could honestly claim that his clients achieved perfectly satisfactory returns over the last number of years given how markets have performed - i.e. pot luck. [I still believe in the role pot luck (randomness) can play in things in spite of my trusty crusty socks letting me down big time yesterday].

What concerns me most is the lack of developed debate on the subject. The OP's original question is just so sensible and obvious - we really should have been able to answer it with: _here is a link to a very useful template/guide on the subject produced by the XXX Professional Body. _

My belief is that the lack of data and debate and guidelines leads to poor quality advice to the public. I have seen new business ARF reports from reputed consultancy firms - frankly, the quality of commentary and analysis was very low grade. God alone knows what some of the other advisers out there are up to.


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## Marc (4 Feb 2019)




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## Marc (4 Feb 2019)

@WhiteCoat makes an interesting observation about the use of defensive assets in a European context.

My own analysis in this area has slightly improved (over the last 3 years or so) on a "traditional" Short-term, global Government and Investment Grade Euro Hedged Bond approach for the "defensive" part of the portfolio

But one has to recognise that you can't generate returns without exposure to risk and not all risks are worth taking and even those that are worth taking aren't guaranteed to pay off over your time frame (ask a value investor!!)




Source Morningstar to end of Jan 2019


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## Colm Fagan (4 Feb 2019)

@Marc

Fair dues, and thanks for sharing with us.  I’m glad I'm not the only one prepared to share my innermost secrets.

For what it's worth, here's my approach to estimating how much of an "income" I can draw from my portfolio, and how much I think could be drawn from the sample portfolio Marc shared with us.

I learned my trade in the old world, before the era of stochastic simulations.   Being stone age therefore, I look at financial questions firstly in deterministic terms, and then try to allow - more intuitively than scientifically -  for the possibility (certainty!) that things won't work out as planned.

I have a spreadsheet, which projects expected investment return and pension outgo each month, starting from the current smoothed value of the fund (using smoothed values rather than market values is another story, too complicated to go into here; basically, I don’t think the market is always right).  I also include a modest provision for contingencies.

The aim is that, if expected returns are achieved, there will be enough in the fund to last us until we're well into our 90’s.  If either or both of us kick the bucket sooner, there'll be something left in the kitty.  I haven't factored our house into the equation.  That’s a form of "insurance policy", in case the fund fails to deliver the required return or we live even longer than expected.   The default assumption is that our home will form part of our estate.

My fund is invested exclusively in equities, with a tiny amount in cash.  I expect an average return of slightly over 6% a year before charges by external providers, 5.75% after charges.  (I manage my own investments to keep charges to a minimum).   Plugging the 5.75% assumed return into the spreadsheet, the affordable pension is more than is needed for “survival”.   However, I plan to withdraw an average of the affordable amount from the fund each month anyway.   If times get tough, we can cut back, but I don't plan on cutting back otherwise:  I much prefer to spend the money now than leave it for someone else to spend when we’re dead.

Looking at the portfolio Marc put up, I calculate an expected blended return of around 4.4% a year before charges.  The calculation assumes a zero return on cash, around 1% a year on government bonds, etc.   I won't go into detail on the assumptions for each asset category; that would distract from the core issues, but the message is clear:  I expect a low return from low risk assets and a high return from high risk assets.  I haven't allowed at this stage for the greater volatility of the high-risk assets.  The difference between the 4.4% for Marc's sample portfolio and my 6% plus (both before charges) is the higher average risk profile of my portfolio, particularly that I don't have any cash or low-risk bonds.

From my (limited) experience of the retail financial services market, I estimate an average charge of 2% per annum on a portfolio of the type Marc outlined.  That includes asset management fees, additional charges by the unit trust/ unit-linked fund provider, and finally the financial adviser’s fee/ commission.  The 2% pa estimate for charges could be wrong  - how far out I don't know.  Thus, the expected net return on what I'll call Marc's portfolio is 2.4%.

If I plug a projected 2.4% return into my spreadsheet and assume the same level of regular outgo, I run out of money eight-and-a-half years sooner than I've assumed for my portfolio.    Alternatively, the affordable "income" is much lower.  The risk that things will not work out as planned is not as great for Marc’s portfolio as for my pure equity portfolio, but it's still a risk, which will have to be allowed for.

I suppose the main message I want to convey is that volatility of future returns is an important consideration, but the expected return, before volatility but after charges, is far more important in determining what level of “income” can be taken from a pension fund.


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## Marc (4 Feb 2019)

Colm,

The expected return of the portfolio is included in the first graph and is the benchmark CPI + 2.32%pa (we assume 2% ECB inflation target) so the nominal expected return is 4.32%pa. So, 4.4% isn't a bad guess.

The total cost of the portfolio is 1.82%pa so again, not a million miles away.

The stochastic calculation looks like this



The identical analysis of a proxy for "your" portfolio looks like this


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## Colm Fagan (4 Feb 2019)

That looks like nifty software.

Is the x-axis projecting into the future?  The shape of the graphs look like what I learned in my studies donkeys' years ago as an "expanding funnel of doubt".  If it is projecting possible fund values into the future, I presume it's not allowing for future drawings from the fund?  There's no way I'd allow my (completely theoretical) €1.5 million fund to grow to €6 million, if things went well.  My ideal is not to leave anything - possibly other than the house - when my wife and I fall off our perches.  The plan is to have spent/ dispensed any funds surplus to our requirements while we're alive.

For what it's worth, taking your hypothetical €1.5 million fund, I would allow for withdrawals of €92,000 a year (increasing with inflation), or 6.1% of its starting value, on my portfolio (after setting aside a small lump sum for contingencies), based on my investment return and expense assumptions.  The corresponding figure for your asset configuration (and return and expense assumptions) is €63,000 a year, or 4.2% of the fund's starting value.   The €63k income is less risky than my €92k income - although I couldn't see the increased risk on my portfolio coming through clearly in your graph.


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## Marc (4 Feb 2019)

Yes, the x axis is age.

So, let's zoom in, and look at the downside risk, since the key to managing other people's money (as distinct from one's own) is the need to manage against the rare (but perfectly possible) risks of catastrophe rather than assuming a benign investing environment. It's why for investment advisers, diversification is always the answer.

So, let's model your assumed investment return against historic equity volatility and start with an income of 5% of the €1.5M keeping this expenditure constant so that you don't have to suffer declining income in retirement.



Each bar represents a 5 year period





So, yes, there is a possibility of a good inheritance, or rising income in retirement. But, we could be 5% confident you would be broke 10 years in and on average, you should expect to run out of money at age 84!


Keeping everything else constant but changing the income to 5% gives the following results.






If anything, I am understating the actual risk in this analysis as I am using "market" volatility whereas the risk of a small undiversified stock portfolio is considerably higher than that of the market due to the risk of any one company going bust has significantly more impact.

I'll now model the €92,000 income from your post above





I other words there is only a 25% probability you’d make it past 90.

Given the combined life expectancies of you and your other half, you can’t afford to take that risk.


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## Colm Fagan (4 Feb 2019)

Hi Marc
Before discussing your latest posting, could I go back to your previous one (#49)?  That shows the value of the portfolio falling in the middle outcome (the black line) of "your" portfolio, and rising only very slightly over the period for "my" portfolio.  I had been under the impression that these graphs assumed no withdrawals, but that can't be true if the middle outcome shows market values falling over time.  I've obviously missed something.  Can you explain?

Now moving to your last posting, you'll have me on the breadline unless I change my ways!  The projections are missing the key point that I have no intention of maintaining withdrawals at the current level (adjusting for inflation) if returns don't meet my expectations.  As Charlie McCreevy said years ago:  "If I have it, I spend it; if I don't, I don't"  I'm in the lucky position that I won't be on the breadline if I have to cut back.  I'm aware of that possibility; I'm not sure the same is true of my other half!  (Thankfully, she doesn't read AAM!).


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## Marc (4 Feb 2019)

Colm,

They are both taking 5% of the value of the account.

I’ve also reflected your charge differential.

My post 21 includes the work we are doing on variable spending strategies but remember in Ireland you get nailed for the tax on at least 4 or 5% whatever you choose to do in terms of actual withdrawals.

I’d argue in an environment where you are effectively forced to take a minimum withdrawal then a 100% equity strategy is simply reckless.

I’d also suggest and indeed judicial opinion supports the view, that private investors can not afford the downside risk of holding a concentrated stock portfolio when a globally diversified portfolio can be attained at extremely low cost.


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## elacsaplau (4 Feb 2019)

Or maybe even a higher % for our Sunday Times journalist?!

I'd suggest editing your post.....maybe put "at least" before 4 or 5%!!


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## Colm Fagan (15 Jun 2019)

I’m revisiting this thread because I’ve extracted some statistics on past returns on my own retirement savings (ARF, AMRF and some non-exempt investments), which may shed light on a question that has generated much discussion on this forum.

The question is whether someone in drawdown (my status for the last few years) is best advised to invest in bonds or equities, or a combination of the two.

The conventional wisdom is that it’s wrong to invest close to 100% in equities because, while they produce a higher return than bonds on average, the occasional nasty market fall can cause havoc.  Someone drawing a regular income must cash equities when they’re on the floor.  If this happens shortly after retirement, the portfolio might never recover.

I believe that conventional wisdom and associated academic research are wrong.  They start from the false premise that the amount withdrawn each month/year remains the same, irrespective of how markets perform.   In practice, retirees withdraw more when markets are up and less when they’re down.  This changes the conclusion.

My own experience over the last five years bears this out.  My savings are entirely in equities.  I’m lucky that the amount required to keep a roof over our heads and food on the table is less than each month’s planned withdrawal, where the “planned withdrawal” is calculated as the regular withdrawal that will exhaust our funds by the time we die (assuming we live to a ripe old age).  It helps that I’m still working part-time, so I’m not completely dependent on my retirement savings, but I’m not unique in this.  Very few go from working full-time to doing nothing.

After making sure we’ve enough to cover the necessities, I work on the principle of “If I have it I spend it; if I don’t, I don’t.”, i.e. when times are good, I splurge on a nice holiday, change the car sooner than I might otherwise, redecorate a room, give better presents to the grandchildren, whatever.  When times are bad, I cut back.

I discovered that the money-weighted return on my retirement savings over the last five years (i.e. the “real” return, based on actual amounts withdrawn each month) is a full 1% a year more than the time-weighted return, i.e. the return assuming that there were no withdrawals and no deposits in the period.  I believe that this 1% difference between the real return and the notional return is due in large part to my practice of withdrawing more in good times and less in bad times.

I believe that incorporating a simple rule on these lines into academic research, in place of the artificial assumption of a constant withdrawal amount irrespective of market conditions, would change the conclusion in favour of increasing the equity content of a retiree’s portfolio.


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## Marc (16 Jun 2019)

Colm,

We are currently developing an adaptive drawdown strategy



However, you also need to factor in the imputed distribution requirement in Ireland which is an external constraint on the model forcing a higher liquidity requirement on the portfolio.

This means that the only strategy that "works" is a combination of an equity bias as you set out combined with a liquidity pool capable of smoothing the imputed distributions in down markets thereby avoiding the sequence of return risk making one a forced seller of equities in a depressed market.

However, since the impact of sequence of return risk is more dramatic in the early years of retirement, one could make a theoretical argument for ramping up equity exposure as an investor ages which is of course contrary to the natural inherent conservatism that goes with older investors and whilst theoretically sound I doubt the courts would agree with the argument of increasing the equity exposure for an 80 year old in order to maximize the inheritance for the next generation.


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## Colm Fagan (16 Jun 2019)

Hi Marc
I assure you that the requirement to take at least 4% or 6% a year from an ARF is not a constraint for me.  I've no intention of leaving a big inheritance to the next generation(s).  I would much prefer to give it to them now.   The average return on the portfolio is well north of 6%, so cashing at least 6% a year isn't a problem.  In any event, I also have (some of) the proceeds from selling my shares in the business that I once owned/ part-owned.  Those funds don't have the constraint of a minimum withdrawal amount.
Liquidity is rarely an issue for someone managing their own portfolio.  There's always a cash balance, either from dividend receipts (my largest shareholding has a dividend yield of close to 7%) or from natural turnover: selling down one holding and ramping up another.
Your model only allows for yearly transactions.  That's completely unrealistic.  You need monthly modelling to get anywhere close to the real market. Looking at my own portfolio (which I recognise is more volatile than most), the monthly market movements over the last 12 months alone have varied from highs of +12.0% and +11.6% to lows of  -15.8% and -12.1%.  I assure you that I withdrew a lot more in months with positive returns than in months with negative returns.  Your model doesn't capture those intra-year changes in withdrawal amounts.
I cannot (yet) speak for 80-year olds.  From this remove, I feel much the same as you.  I'll probably be OK when/if I get to that age, especially if I'd had another decade of the equity risk premium under my belt by then, but I recognise that others won't have the same insouciance to market fluctuations.  You've probably seen my smoothing proposals for Group  ARF's and auto-enrolment.  One of the aims of smoothing is to ease the concerns of such people while still enabling them to capture the Equity Risk Premium.  I hope that someone will have implemented the proposals before the bulk of DC pensioners with substantial funds get to 80.


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## McGaggs (16 Jun 2019)

Marc said:


> I’d argue in an environment where you are effectively forced to take a minimum withdrawal then a 100% equity strategy is simply reckless.


What would your thoughts be on taking a 5% withdrawal, living  on say 3%, and investing the balance of the withdrawal in the same strategy as the ARF (but outside that structure)? Would that reduce the recklessness of a 100% equity strategy?


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## Marc (17 Jun 2019)

McGaggs

If you take the 5% from the ARF it is taxed.

So you have the net proceeds to invest.

Those proceeds are also subject to tax (income tax and CGT or exit tax) so you would be potentially subject to double tax

Therefore keeping money in the ARF is the “best strategy” which is why revenue force an imputed distribution in the first place.

A better approach is to delay retiring some benefits and leaving these to grow in a pre-retirement structure free from imputed distributions and only ARF such benefits as are necessary to meet required expenditure.

However this strategy has also come under attack by Revenue who will now force income in the form of imputed distributions from age 75 even if you don’t retire benefits.


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## Steven Barrett (17 Jun 2019)

Interesting post Colm. 

Is this where capacity for loss comes into play? While retirees do indeed take out less when the value decreases, there is a minimum income required too. When you have an ARF of €2m+, personal investments and are still generating a regular income, you can afford to take the risk of an equity portfolio and so enjoy greater returns over the long term. 

For a lot of people, loss aversion is a bigger driver and minimising their losses is more important than maximising the gains.

Academic research tends to look at the numbers only but not the impact of human nature. This is something that we have to work with everyday when advising people on their money. 


Steven
www.bluewaterfp.ie


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## Colm Fagan (17 Jun 2019)

SBarrett said:


> For a lot of people, loss aversion is a bigger driver and minimising their losses is more important than maximising the gains


Steven.  I agree that loss aversion is a major reason why savers of all ages put less in equities than they should and that it is more acute in older people for the reasons you mentioned.

It is a major hurdle to be overcome by anyone advising people where to put their money.  It is especially intractable because loss aversion is hard-wired into us by evolution. (He who fights and runs away will live to fight another day - and to procreate).  Unfortunately, some advisers are even more risk-averse than their clients and exacerbate the problem.  From what I hear, you're not one of them.  Fear of loss on the part of the adviser is perfectly understandable.  If I were an adviser, I would be terrified that the client could lose money in the first month.  There is close to a 50:50 chance that they will, irrespective of where markets are at the time I'm advising them.  That could make me look stupid.  Daniel Kahneman, who won a Nobel Prize for his work in behavioural economics, recognised this when he wrote that ".. decision makers who expect to have their decisions scrutinised with hindsight are driven .. to extreme reluctance to take risks.”

My proposals for smoothing returns over many years for Group ARF's and auto-enrolment were partly designed to address the problem of loss aversion.


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## Colm Fagan (17 Jun 2019)

SBarrett said:


> While retirees do indeed take out less when the value decreases, there is a minimum income required too


The minimum income requirement isn't as much of a constraint on investment freedom as it is sometimes made out to be.  The minimum income requirement in any month is (say) 1/12th of 4% of the value of the fund.  That's only 0.3% of the fund value.  If the pension account is on the ropes at that time, it's not the end of the world.  Okay, it's a bigger problem if the downturn lasts for (say) two years, but even then the likelihood is that less than 10% of the fund has been permanently impaired, to borrow a phrase from the accountants.


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## Sarenco (17 Jun 2019)

Colm Fagan said:


> Okay, it's a bigger problem if the downturn lasts for (say) two years...


What happens if stocks take 5 years to recover their value?  Or 10 years?  Or 25 years?

What would an all equity portfolio look like if you had retired in 1928 and drew down @4%pa?  Or 1964?  Or 1999?

I know I’ll need to eat - and sleep - in retirement whatever happens so my modest portfolio won’t be anything remotely like 100% in equities.


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## Marc (17 Jun 2019)

It would look like this ( in each of these graphs I am taking an income of 4% of the initial value of the pension) not adapting to market conditions


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## Marc (17 Jun 2019)

I think on reflection you meant to say 1974


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## Marc (17 Jun 2019)




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## Marc (17 Jun 2019)

I changed the last graph to Euro base currency, MSCI World Index and starting in December 2000.


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## Marc (17 Jun 2019)

Last one, this looks at 20:20 hindsight of getting an all equity portfolio spectacularly wrong compared to short term T bills and short-dated US Bonds. Funny how the really daft portfolio (bonds) does really well when the equity markets are going to hell in a hand-basket. Maybe there is something in this diversification lark after all


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## Marc (17 Jun 2019)

For the sake of completeness, if you had waited until May 1955 you would have got back to where you stated. So if you had been 65 in 1929 you would have been 94 when you returned to par but obviously still way behind a less risky portfolio.


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## Duke of Marmalade (18 Jun 2019)

Good stuff Marc!



SBarrett said:


> For a lot of people, loss aversion is a bigger driver and minimising their losses is more important than maximising the gains.


Absolutely, but I want to challenge any suggestion (I am not saying you are making it, Steve)  that this is irrational and that there is a role for "behavioural" advisors to protect folk from themselves.
Let's move along the wealth spectrum.
Say one's only income is State Basic Pension and Eddie Hobbs as Renua MoF decides to buy them all out at commercial annuity terms.  It would be a brave advisor who would recommend 100% equities as you are risking dire poverty versus modest improvements in lifestyle.
Next think of an individual who can say just about afford a car and an annual holiday.  They are risking no car or no holiday versus a better car or more exotic holiday.
Next an individual who is quite comfortable and has an expectation that they will leave some inheritance.  They are risking having to downsize the car or the holiday versus more inheritance for the kids.
Next, someone who anticipates that their estate will be paying significant CAT.  They will feel they can weather any reasonably foreseeable downturn in equities without affecting their lifestyle but on the other hand the upside is going not only to their estate but also to the taxman.
It is really only when you get to the Donald Trump end of the spectrum that you are indifferent as to the relative value of gains and losses, so for The Donald the ERP is truly a free lunch.


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## elacsaplau (18 Jun 2019)

Excellent post Duke. I, very literally, could not have said better myself.

This thread was revised by Colm a few days ago. One of the problems that I have with Colm's post(s) generally is that he tends to segue from the specific (his own experience) to the general (the right general approach) without adequate consideration and/or caveating of the implications for different groups. My concern, in this instance, is that the cohorts that the Duke so eloquently described could get mushed in the all in equity crossfire!

By the way, Elacsaplau's first lau (law)....
As an on-line discussion thread lengthens, the probability of The Donald being mentioned approaches 1.


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## Steven Barrett (18 Jun 2019)

Colm Fagan said:


> The minimum income requirement isn't as much of a constraint on investment freedom as it is sometimes made out to be.  The minimum income requirement in any month is (say) 1/12th of 4% of the value of the fund.  That's only 0.3% of the fund value.  If the pension account is on the ropes at that time, it's not the end of the world.  Okay, it's a bigger problem if the downturn lasts for (say) two years, but even then the likelihood is that less than 10% of the fund has been permanently impaired, to borrow a phrase from the accountants.



Or as I put it to clients, say you have €500,000 in an ARF and you get 4% a year, €20,000. If the ARF falls by 20% to €400,000 (always have to tell them the actual value, not the percentage  ),your income will fall to €16,000. Can you still fund your lifestyle or do you have other savings to supplement your ARF income?

But yes, the length of the downturn will always be an issue, especially as none of us know what the next downturn will be or how bad it will be. But investing in quality companies should minimise the risk of permanent impairment. If Microsoft, Johnson & Johnson etc all go bust, we have a lot more problems on our hands than pension income!

Am currently reading Thinking Fast & Slow. A book that should be read like you'd eat an elephant...one bite at a time 


Steven
www.bluewaterfp.ie


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## Steven Barrett (18 Jun 2019)

Duke of Marmalade said:


> Good stuff Marc!
> 
> 
> Absolutely, but I want to challenge any suggestion (I am not saying you are making it, Steve)  that this is irrational and that there is a role for "behavioural" advisors to protect folk from themselves.
> ...



It's not irrational at all!! That is why capacity for loss should be the biggest factor in advising on any investment strategy for a client, which is exactly what you have outlined in your post. 

I see a lot of cases where a client is told to complete a risk profiling questionnaire and it spits out a fund strategy at the end. It's impossible to advise properly on just a risk profiling questionnaire. While I do use one, it has less and less importance with the advice I give as talking to clients about the circumstances and needs take more importance. 


Steven
www.bluewaterfp.ie


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## Colm Fagan (18 Jun 2019)

Duke of Marmalade said:


> It is really only when you get to the Donald Trump end of the spectrum that you are indifferent as to the relative value of gains and losses, so for The Donald the ERP is truly a free lunch.


Duke,  the smoothing approach, by spreading losses and gains across generations, means everyone can avail of the free lunch.



Sarenco said:


> What would an all equity portfolio look like if you had retired in 1928 and drew down @4%pa? Or 1964? Or 1999?


I don't have monthly figures for 1928 and 1964, but I do have them for 1999.  The results are interesting.

First of all, 31 December 1999 marked the last day (literally) of the dot-com boom.  Markets had more than doubled over the previous four years: +17% in 1996, +24% in 1997, +14% in 1998 and +24% in 1999.  Investors paid the price over the following few years:  -6% in 2000, -13% in 2001 and -23% in 2002.  Then, just when people thought they were out of the woods after a few good years, the market fell 30% in 2008.

It really is a challenge to see how an ARF investor who was stupid enough to put all their money into the market at the very peak of the boom on 31 December 1999 and withdrew 4% each year (of their original investment, not of the value from time to time) would have done.

Remarkably, the answer (to end 2017 - I didn't input 2018 figures) isn't nearly as bad as one might think.  In the 18 years to end 2017, someone who invested €100,000 on 31 December 1999 would have withdrawn €72,000 in "income" (18 years at 4% a year) and their account would be worth €85,000 at the end of 2017.  This equates to a compound annual return of 3.4% a year, despite all the adversity this poor sod would have had to endure.  Allowing for charges of 0.75% a year, the balance at end 2017 would have been €67,000, equivalent to 2.5% a year.

If they had put their money in a year earlier, at 31 December 1999, they would still be going in on a high - markets having gone up 14% that year, 24% the previous year and 17% the year before that again.  Despite that, at end 2017 their original €100,000 would be worth €133,000 (no charges) or €106,000 (charging 0.75% a year) despite having withdrawn €76,000 in the 19 intervening years.


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## Colm Fagan (18 Jun 2019)

When I revisited this thread last evening (Note to @elacsaplau :  Not "revised" .  Me revise something?  Never!) I wrote the following:



Colm Fagan said:


> I discovered that the money-weighted return on my retirement savings over the last five years (i.e. the “real” return, based on actual amounts withdrawn each month) is a full 1% a year more than the time-weighted return, i.e. the return assuming that there were no withdrawals and no deposits in the period. I believe that this 1% difference between the real return and the notional return is due in large part to my practice of withdrawing more in good times and less in bad times.



My own personal financial adviser (who gets rewarded with an odd coffee) came back to me privately with the following:
"I did a few doodles on Excel. I am not sure that the discrepancy is in the main down to your withdrawal strategy. The period is characterised by a long bull run followed by a correction. Even with a regular withdrawal rate that would mean the money weighted return would be higher than the time weighted return, as you have less exposure to the correction having made withdrawals."

I confirmed (going from the specific to the general, @elacsaplau :  I was always better at arithmetic than algebra) that he's right.  I looked at the figures for a 4% withdrawal strategy from end 1998 (results quoted in the previous post) and varied the strategy slightly by hypothesising that the ARF pensioner would only make withdrawals on months when the price had increased, none when the price fell the previous month.  Every time he/she made a withdrawal, they would take whatever was due since the previous withdrawal.  The results were almost identical to those derived on the assumption of a constant withdrawal each month.

My argument isn't completely dead, though.  I really believe that the market is manifestly undervalued or overvalued on the odd occasion.  Needless to say, it's hard to incorporate a "manifestly overvalued/undervalued" rule into an algorithm.  It played some role in the excess of the money-weighted return over the time-weighted return over the last five years, maybe not the full 1% but possibly 0.5%.


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## Duke of Marmalade (18 Jun 2019)

Colm Fagan said:


> My own personal financial adviser (who gets rewarded with an odd coffee)...


Don't you think he is worth a proper coffee?


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## Sarenco (18 Jun 2019)

Colm Fagan said:


> Remarkably, the answer (to end 2017 - I didn't input 2018 figures) isn't nearly as bad as one might think. In the 18 years to end 2017, someone who invested €100,000 on 31 December 1999 would have withdrawn €72,000 in "income" (18 years at 4% a year) and their account would be worth €85,000 at the end of 2017. This equates to a compound annual return of 3.4% a year, despite all the adversity this poor sod would have had to endure. Allowing for charges of 0.75% a year, the balance at end 2017 would have been €67,000, equivalent to 2.5% a year.


Interesting.

Mind you, if our 2000 retiree had increased his 4% drawdown each year to account for inflation, he would be pretty much broke at this stage.  

Adding a reasonable allocation to Government bonds would have improved the picture considerably.


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## Steven Barrett (18 Jun 2019)

Sarenco said:


> Interesting.
> 
> Mind you, if our 2000 retiree had increased his 4% drawdown each year to account for inflation, he would be pretty much broke at this stage.



But in reality that's not what we see. Retirees tend to be very cautious with their ARF, taking out the required amount and not much more. Usually, if they are prudent enough to save for their retirement, they have other savings, which is used to supplement the ARF income (use up the taxed income first before drawing down an income that is liable to income tax). And after the retiree has got past the loads of holidays, giving money away part of retirement, they tend to spend less so there is less need to inflation proof their retirement income. 


Steven
www.bluewaterfp.ie


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## Sarenco (18 Jun 2019)

Fair enough but the CPI is up nearly 50% since 2000 - that's pretty significant.

Also, imputted distributions rise to 5% at 71....

My main point really is that adding a reasonable allocation to Government bonds can increase the risk-adjusted return of an equity heavy portfolio.


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## elacsaplau (18 Jun 2019)

Colm Fagan said:


> Duke,  the smoothing approach, by spreading losses and gains across generations, means everyone can avail of the free lunch.



Colm - are we now not segueing from the specific to the general to the theoretical - the thread is about real-world safe withdrawals at an individual level?!


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## Steven Barrett (18 Jun 2019)

Sarenco said:


> Fair enough but the CPI is up nearly 50% since 2000 - that's pretty significant.
> 
> Also, imputted distributions rise to 5% at 71....
> 
> My main point really is that adding a reasonable allocation to Government bonds can increase the risk-adjusted return of an equity heavy portfolio.



My anecdotal evidence doesn't go back that far!! I have worked with 4 different companies since 2000, so have not been able to track the expenditure of the retiree's I looked after back then!  

And yes, I agree with you on bonds. It's as much about protecting your fund on the downside so it doesn't have to grow by as much to recover. And helps the retirees sleep at night too.


Steven
www.bluewaterfp.ie


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## Colm Fagan (18 Jun 2019)

I deleted a post.  It says the same as the one below


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## Colm Fagan (19 Jun 2019)

elacsaplau said:


> the thread is about real-world safe withdrawals at an individual level?!


Smoothing of investment returns allows the individual to benefit from the pooling of investment risk, so it is very much about real-world safe withdrawals at the individual level.


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## Gordon Gekko (19 Jun 2019)

I agree with Colm’s broad approach; I just don’t agree with his concentrated approach.

My own approach would be to retain 4% in cash to cover the mandatory drawdown and the rest in global equities.

If the portfolio falls in value, the 4% is a smaller number so I can use the excess cash to buy equities at cheaper levels. If the portfolio rises in value, I can sell to cover the larger drawdown.

Say I pay my QFM 0.75%; over time, I should be fine.


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## WhiteCoat (19 Jun 2019)

Duke of Marmalade said:


> …...and Eddie Hobbs as Renua MoF decides to buy them all out at commercial annuity terms.



I'm afraid that I can't add anything meaningful to the substantive debate so just a quick aside. Duke of Marmalade's mention of Mr. Hobbs reminded me of an article of his that I happened upon a few weeks ago.





						Money matters with — Eddie Hobbs
					

In a new column for Irish Medical Times, financial guru Eddie Hobbs says that many pension funds — including the GMS pension fund — haven't allowed for




					www.imt.ie
				




The article is from 2009 in which he makes predictions with an authority that was not justified even back then. His style is akin to a gombeen who figures that speaking in an inappropriately loud manner somehow improves the quality of what's been said. Anyway, at this remove, many of the predictions look very silly indeed - a case of Comical Eddie.

What's more disturbing is that he criticises the management/operation of the GMS scheme when it is patently obvious to me that he literally hadn't a clue about the nature of this scheme.


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## Colm Fagan (23 Jul 2019)

WhiteCoat said:


> I'm afraid that I can't add anything meaningful to the substantive debate so just a quick aside. Duke of Marmalade's mention of Mr. Hobbs reminded me of an article of his that I happened upon a few weeks ago.
> 
> 
> 
> ...


WhiteCoat's decision to revisit Eddie Hobbs' predictions from years back came to mind when I decided recently to publish all my old "Diary of a private investor" articles, going back to September 2015.  They can be found at http://www.colmfagan.ie/investments.php 
I leave it to readers to decide how they stand the test of time. 
PS:   I had reason to look at the GMS scheme recently, mainly because it has similarities to my proposals to  Government for a smoothed approach to auto-enrolment and the related suggestion for the introduction of smoothed ARF's.  Unfortunately, there hasn't been much take-up of either idea.   My smoothed pension ideas can be accessed on the same website, at http://www.colmfagan.ie/pensions.php


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## fistophobia (23 Jul 2019)

I have experience of the medical sector, consultants in particular, and they are surprisingly clued-in about pensions, and ways around the 2M limitation.


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## Sarenco (24 Jul 2019)

fistophobia said:


> I have experience of the medical sector, consultants in particular, and they are surprisingly clued-in about pensions, and ways around the 2M limitation.


This sounds interesting.

Would you be willing to tell us a little more?


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