# Should I switch some of my pension fund to cash as I approach retirement?



## Spud50 (19 Jul 2021)

Hi , my intention is to finish work next year (at 55) but not draw down my pension (currently >900k) till i am 60. My DC pension is currently invested at Risk level 6 global equites and i was wondering :

should i keep my pension at level 6 to age 60 and then derisk as part of the ARF with a mixture of equities and Bonds?

Should i keep it at level 6 indefinietly

Should i derisk it in the next 2 or 3 years

I dont really mind the ups and down of the stockmarket but there is a lot of wisdom and experience in this forum so id be interested to know if there is a standard Methodology that people adhere to.


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## Sarenco (19 Jul 2021)

Do you have assets outside your pension fund?  

It's important to look at your overall financial position and not to focus on one account in isolation.


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## Marc (19 Jul 2021)

To keep the maths simple I’m going to assume a 100% equity allocation and a €1m pension fund.

back in 2008 global equities dropped 40% and in March last year almost the same

so that’s a €400k downside from a higher risk strategy

what’s the upside

lets assume a 10% pa return

so you are adding at a rate of €100kpa but losing at a rate of potentially 4 times that.

if the market drops like it did in 2008 you could easily be down to €600k. Now your 10%pa return is only worth €60k pa to you and it will take a long time to recover back to your €1m and that’s especially true if you NEED to keep your income the same as before (See later post on volatility drag)

In principle you could have achieved a €60kpa return from a less risky portfolio say a 60%equity 40%bond mix. That would have also served you better in a bad year. A well-constructed balanced portfolio was down around 20% in 2008 whereas the market was down 40%.

as you get closer to retirement the drops hurt more than the gains so de risking makes sense *to a point. Note I’m not suggesting selling everything and going to cash here. *

This is absolutely critical once you start to draw on the fund a big drop hurts even more known as “sequence of return risk” so the strategy we advise is to reduce risk either side of the planned retirement date







 as set out in our guide to planning for retirement below

[broken link removed]

You should definitely seek independent advice and not the advice of the company administering the scheme.

a good adviser will pursue an asset location strategy which seeks to maximise the after tax returns from different asset classes.

you need to make sure you have sources of taxable income to make full use of your allowances between now and age 60.

if you don’t then drawing on the pension earlier might make more sense, if you do then deferring might make more sense.

a lot of this turns on your overall financial position which you haven’t disclosed.

because tax is so ridiculous in Ireland this means turning the approach on its head compared to other jurisdictions which is why you can’t  use a US or U.K. website to inform your decisions

I set out below a working example of a prudently diversified ARF account going through the fall of March last year with no interruptions in income payments and just as importantly, no break down in investor composure.






And the asset allocation that generated these returns





Remember that the objective for an ARF should be to maintain the income payments to the investor for the whole of the rest of their life however long they might live, preferably in real terms allowing for inflation and generate an income which overall is at least as good as the annuity that they could have purchased at outset.






						Key Post - People should consider buying an annuity on retirement
					

Why an Annuity matters to an ARF investor   How should one approach investing an ARF?  As we set out in our [broken link removed] for retirement planning in Ireland, an investor’s risk tolerance is only one of several factors that go into the decision to go into an ARF.  A far more appropriate...



					www.askaboutmoney.com
				




For most people, the goal is* NOT* to maximise the potential inheritance for the next generation at the expense of one's own financial security.









						Do You Need to Review Your ARF Strategy? - Everlake
					

More people invest in an Approved Retirement Fund (ARF), over the certainty of an annuity. But do you need to review your ARF strategy?




					globalwealth.ie
				




As you can see from that post *we are not against investing in equities* in an ARF far from it, many of the accounts we review are excessively conservative and our recommendation is generally to have more than 50% Equities in an ARF.

We are able to limit total equity exposure by over weighting stocks with higher expected returns such as high beta stocks, generally smaller companies, and stocks with high book to market or "value" stocks.









						When the Cheapest Option Isn't Always the Best - Everlake
					

We're advocates of low-cost investing. However, an obsession with the lowest cost option isn't always in investors' best interests.




					globalwealth.ie
				




However, later in this thread is an assertion that a 100% equity strategy might be suitable and/or appropriate and to make matters worse the investments are in fact just 12 companies rather than an index fund which is frankly completely insane and significantly increases the risk far beyond the risk capacity of the vast majority of private investors.

*We would consider such an approach to be reckless and therefore all subsequent debate on the matter irrelevant to the average investor in Ireland.*

By way of an example using the US Market for the period January 1929 to December 1938

The annualised return of the US Market over this period was -0.89%pa a total return of -8.52%

However, the cumulative return to the end of 1932 was -64.22% that's losing 22.66%pa for 4 years.

That means a million invested at the start of 1929 was worth around 360,000 by the end of 1932!!

You would need a return of 278% just to get back to where you started just 4 years earlier.

To avoid a drop in income you would need to continue to take €40,000pa from the depleted pension fund making the annualised withdrawal now an unsustainable 11%pa.

I set out below several arguments why including an allocation to fixed interest or bonds makes sense for most if not all retirees with an ARF. In some posts this has been corrupted into a position of why would you hold 100% in cash? You wouldn’t of course; and that’s not what I’m arguing at all.

However, as is all too common on here the debate quickly descends into mud slinging.

I am blocking a large number of posters so don’t be surprised if many subsequent posts go unanswered, I’m ignoring them and so should you.

“Ignorance more frequently begets confidence than does knowledge: it is those who know little, and not those who know much, who so positively assert that this or that problem will never be solved by science.” Charles Darwin










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## AJAM (19 Jul 2021)

Hi Spud50,
You should arrange to talk to someone from your pension advisor to discuss what your retirement options are.
At your stage in life you need specific advice for your circumstance as opposed to general advice. For example, if you intend to buy an annuity vs continue to invest in an ARF, then your best course of action is very different. Depending on how much of your pot you intend to take as a cash free lump sum will also make a big difference. Do you intend to have spent all of pot by the time you kick the bucket, or do you want to leave a substantial amount of your pot behind for your heirs? How long are you likely to live (based on current health and family history)? Are you willing to reduce your annual drawdown amount for years when the market is not performing well? There's too many variables. Your pension advisor will be in a much better position to guide you. You've been paying them fees for decades, its time they earned their money!

That said, let me lay some general advice. Assuming you are not buying an annuity and that you are taking a 25% tax free cash lump sum. With 5 years to retirement, you should get that 25% into a very stable bond fund as quickly as possible. then look at the remaining 75%. Is it already big enough for what you need or not? If it is big enough, then why take excessive risk? Derisk it down to 60/40 or even 50/50 equities. 

I can't post links here, but if you search for "allocation advice for betterment portfolios" they have a really good article there.
If you intend to continue to self manage your portfolio in retirement, I would recommend you check out the Vanguard target date funds, and see what % of those are invested in equities. That's a great starting point.


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## Sarenco (19 Jul 2021)

AJAM said:


> With 5 years to retirement, you should get that 25% into a very stable bond fund as quickly as possible. then look at the remaining 75%. Is it already big enough for what you need or not? If it is big enough, then why take excessive risk? Derisk it down to 60/40 or even 50/50 equities.


Would that still be your advice if the OP has, say, €900k in cash savings outside his pension?


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## Steven Barrett (20 Jul 2021)

AJAM said:


> That said, let me lay some general advice. Assuming you are not buying an annuity and that you are taking a 25% tax free cash lump sum. With 5 years to retirement, yo*u should get that 25% into a very stable bond fund as quickly as possible. then look at the remaining 75%.* Is it already big enough for what you need or not? If it is big enough, then why take excessive risk? Derisk it down to 60/40 or even 50/50 equities.
> 
> I can't post links here, but if you search for "allocation advice for betterment portfolios" they have a really good article there.
> If you intend to continue to self manage your portfolio in retirement, I would recommend you check out the Vanguard target date funds, and see what % of those are invested in equities. That's a great starting point.



That's nothing but marketing guff that was produced by some of the life companies. Secure the 25% lump sum. If the other 75% falls in value, the money in cash/ bonds will make up a higher percentage of the overall fund and the lump sum received will be lower. Say his 75% falls by 20%, he will have a fund of €765,000 instead of €900,000. His lump sum will then be €191,250 instead of €225,000, a loss of €28,750 (after taxes on excess). 



AJAM said:


> I can't post links here, but if you search for "allocation advice for* betterment *portfolios" they have a really good article there.
> If you intend to continue to self manage your portfolio in retirement, I would recommend you check out the *Vanguard target date funds*, and see what % of those are invested in equities. That's a great starting point.


They are US investments that aren't available here. 



The OP needs to look at all his assets together and not in isolation. He obviously has other assets if he is retiring at 55 but doesn't need to draw down on his pension until age 60. With the ARF, the investment journey will continue on for decades to come so the real reason for derisking is to protect the tax free lump sum. There is no other reason except for people thinking that's what you are supposed to do because they still have a purchase annuity mindset where you need the biggest pot of money to purchase your pension for life. 


Steven
www.bluewaterfp.ie


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## Sarenco (20 Jul 2021)

Steven Barrett said:


> With the ARF, the investment journey will continue on for decades to come so the real reason for derisking is to protect the tax free lump sum. There is no other reason except for people thinking that's what you are supposed to do because they still have a purchase annuity mindset where you need the biggest pot of money to purchase your pension for life.


Hi Steven

I disagree that the only reason to de-risk a portfolio in the run up to retirement is to protect the tax-free lump sum.  In fact, I think the tax-free lump sum is a complete red herring in these discussions.

It seems to me that the primary reason to de-risk a portfolio is to reduce the variability of returns on that portfolio.  That becomes particularly important when you start spending down your portfolio in order to help preserve the longevity of the portfolio.

If you get a particularly bad run of returns in the early years of retirement, you could well find yourself running out of money later in life.  The extent to which you can benefit from any subsequent market recovery will be limited by the fact that you have already spent a significant portion of your portfolio.

There is no way of avoiding sequence risk.  However, you can mitigate the impact of a bad sequence of returns by diversifying into bonds in the run up to retirement.


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## AJAM (20 Jul 2021)

Hi Steven, 

I'm a fan of your posts, so please don't take the following attempt to deconstruct your argument as disrespect 



Steven Barrett said:


> They are US investments that aren't available here.


I didn't say buy it. I said read it. It's an article detailing exactly what the OP is asking about, namely the effect of asset allocation and time horizon on risk. The math works the same in the US as it does here.



Steven Barrett said:


> If the other 75% falls in value, the money in cash/ bonds will make up a higher percentage of the overall fund and the lump sum received will be lower. Say his 75% falls by 20%, he will have a fund of €765,000 instead of €900,000. His lump sum will then be €191,250 instead of €225,000, a loss of €28,750 (after taxes on excess).


Using your own example: 900K with 25% (225K) in bonds. Market falls 20% so pot now worth 765K, and you can take 191,250 tax free.
Versus, If you leave it as 100% equity and the Market falls 20%, the pot is now worth 720K, and you can take 180k tax free. The fact that you put 225K in bonds with the idea of taking it as a cash lump sum, does not force you to do so. Obviously you adjust based on market outcomes.



Steven Barrett said:


> The OP needs to look at all his assets together and not in isolation.


That's exactly what I said! General advice here is not advisable for this OP. The only general advice I'm really trying to say is that at 55, with a 5 year time horizon till retirement, it's probably not ideal to be in 100% equities.


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## Sarenco (20 Jul 2021)

AJAM said:


> The only general advice I'm really trying to say is that at 55, with a 5 year time horizon till retirement, it's probably not ideal to be in 100% equities.


How do you know the OP is 100% in equities?  He has only told us the allocation within his pension fund.


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## moneymakeover (20 Jul 2021)

Spud50 said:


> my intention is to finish work next year (at 55) but not draw down my pension (currently >900k) till i am 60


Therefore you must have other means

If you can live comfortably without your pension I'd say leave it at equities

If you need it in 5 years time (which you do), I'd say move a portion each year into low risk. 

Decide what fraction you want in level 6 equities in retirement say 30%

Each year between now and age 60 move 10% to low risk

Draw down 25% in 5 years.

Remainder is split 70% low risk: 30% equities

The general approach I think is to move entirely out of equities before drawing down the lump sum which seems overly conservative to me.


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## Spud50 (20 Jul 2021)

Thanks for all the informative comments , there is a lot to think about ,
 just to clarify my pension 100% of it is in Global equities , my intention is to set up an ARF  and take the 200k Lumpsum only because my understanding is, it is tax free ,
 i hope to have roughly 200K from savings and sale of shares by end of next year which im hoping will last me 4 or  5 yrs as i have no mortgage ,car loans , kids are nearly tru college etc., it will run out and i will have no other source of income other than the pension so i dont need to mess it up


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## Marc (20 Jul 2021)

Spud50 said:


> Thanks for all the informative comments , there is a lot to think about ,
> just to clarify my pension 100% of it is in Global equities , my intention is to set up an ARF  and take the 200k Lumpsum only because my understanding is, it is tax free ,
> i hope to have roughly 200K from savings and sale of shares by end of next year which im hoping will last me 4 or  5 yrs as i have no mortgage ,car loans , kids are nearly tru college etc., it will run out and i will have no other source of income other than the pension so i dont need to mess it up



if your pension is currently 900k then your lump sum is €225k

€200k of this Is tax free, the next €25k is only taxed at 20%

However, if you took an income from the pension of say 13,000pa then (assuming no other sources of income) you would pay no tax on this at all.

So you might be better off taking an ARF now and taking your €200k tax free lump sum plus an annual payment of €13k pa as, in principle, you would pay no tax at all on the payments

€13k pa from a remaining fund of around €700k is only 1.8%pa

that could allow you to get around €65k out tax free over 5 years just making use of your exemptions


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## kinnjohn (20 Jul 2021)

Marc said:


> if your pension is currently 900k then your lump sum is €225k
> 
> €200k of this Is tax free, the next €25k is only taxed at 20%
> 
> ...


Do you have to take 4% of the 700K


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## Marc (20 Jul 2021)

kinnjohn said:


> Do you have to take 4% of the 700K


No not until you are aged 61


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## kinnjohn (20 Jul 2021)

Thanks, Marc,


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## Colm Fagan (22 Jul 2021)

Apologies for coming late to this discussion, but my experience may be of interest to @Spud50.   I emphasise that this is purely a personal story; I am not suggesting that anyone should do as I did.
I am now 'retired' over 10 years, i.e. I started taking an 'income' from my ARF just over 10 years ago (at the end of 2010).  As I recall, there were some tax advantages to starting drawdown (and taking the tax-free lump sum) at that particular date, but that's irrelevant now.
For me, 'retirement date' was just a staging post on the retirement journey, not an end-point.   I made no significant changes to my portfolio in the lead-up to 'retirement' nor afterwards.  I was close to 100% in growth assets (essentially, equities) beforehand and remained close to 100% in them afterwards.  Now, ten years later, I'm still close to 100% in equities; nothing in bonds.
The question of whether the market was elevated or depressed at my retirement date didn't really bother me, as it meant transferring equities from a tax-exempt account to a taxable one.  It didn't matter much what their market value was at the time, as it was essentially an in specie transfer from one account to another.
The concept of 'sequence of return risk', which some commentators see as all-important, has no meaning for me.   That is because I cash only a small proportion of my fund each month (I take the 'income' monthly).  Thus, for example, @Marc gave the scare story of equities falling massively in March last.  That's true, but I cashed only 1/12th of 6% of my ARF in March 2020 - and the market more than recovered the losses later in the year.  Also, the 'income' comes almost entirely from dividends , so I didn't have to cash any investments at the prices prevailing in March.  (It is worth clarifying that I invest in "real" companies, most of which pay dividends, rather than through funds, as I don't believe in paying so-called "experts" to manage my money, when those same "experts" have been shown to do worse than the market on average).
My decision to remain invested close to 100% in equites post-retirement has worked out OK.  For every €1,000 in the ARF/AMRF at 'retirement date', I withdrew €700 over the following10 years* (see note at end, clarifying what this means), and the value of the remaining fund at end 2020 was €1,750.  (It has since increased to close to €1,850, after withdrawing approximately one-twelfth of 6% each month in 2021).    There were some bumpy periods during the ten years.  In the very first year, for example (2011), I suffered a loss of close to 3%, but the risk of short-term loss is part of the reason the longer-term return has been good.  I still see myself as a long-term investor, despite my advancing years.
*Note on the €700 'withdrawn' calculation above. *
The €700 is a combination of a number of different elements.  At the core is the requirement to withdraw 6% of the prevailing market value of the ARF each year.  I think the requirement was less than 6% for some of the early years.  I also had an AMRF, which didn't have to be cashed until the SW pension amount exceeded a certain level.  After that, I had to treat the AMRF as an ARF.  Another complication is that I consolidated an insurance company pension account with my self-managed ARF part-way through.  The "withdrawal" calculation is net of the amount transferred from the insurance company pension plan.


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## Marc (23 Jul 2021)

WARNING

To anyone reading the post above

sequence of return risk is a proven mathematical phenomenon which has been shown to cause the most damage in the early years of one’s retirement and in particular to those with high risk portfolios.

it makes absolutely no difference what the sequence of returns are while you are saving. It makes a huge difference when you are drawing. Colm, a retired Actuary should be aware of this mathematical fact.









						Developing a Measure of Sequence Risk
					

We discuss the nature and importance of the concept of Sequence Risk, the risk that a bad return occurs at a particularly unfortunate time, such as around the p



					papers.ssrn.com
				




just because the Stockmarket recovered quickly last year doesn’t mean that it always will.

For example, equities essentially went sideways for 14 years in the 1970s and early 80s. Colm, a retired Actuary should be aware of this historical fact.

Just because he has been lucky following  what my learned friends in the Judiciary would consider to be an objectively imprudent strategy doesn’t mean that it can be applied universally - it’s a sample size of one for Pete’s sake hardly statistically significant.

Colm is hardly typical of a retiree since the average pension fund in Ireland is hardly €1.8m is it? Constantly pedalling the same story of one fortunate individual at the very least implies that he believed that this is the “best” approach for the population in general when it isn’t at all appropriate for many people.

It’s like Brian Waldon saying “this is not necessarily my opinion” and then being as rude as he wanted to Margaret Thatcher.

one might be willing to assume a high degree of investment risk (risk tolerance) but objectively what matters most and certainly from a regulatory perspective is an objective assessment of one’s ability to bear losses (risk capacity) many people will find with the benefit of hindsight that buying an annuity at outset may well have been a better decision.

In court  any financial professional who was found to have “advised” their clients to pursue such a, from a fiduciary perspective, reckless approach, would be  Judged by international standards of jurisprudence which ordinarily demand of professional advisers a more diversified investment strategy.  Colm, a retired Actuary should be aware of this legal fact.

pursuing a high dividend investment approach has been shown in numerous studies to be sub-optimal to a total return approach.

if we just take miller and modigliani in classic finance theory it makes absolutely no difference to the expected return of a company if a dividend is paid or not.









						Episode #28: Larry Swedroe, Buckingham Strategic Wealth, “There is Literally No Logical Reason for Anyone to Have a Preference for Dividends” - Meb Faber Research - Stock Market and Investing Blog
					

Episode #28: Larry Swedroe, Buckingham Strategic Wealth, “There is Literally No Logical Reason for Anyone to Have a Preference for Dividends”    Guest: Larry Swedroe is a principal and director of research for Buckingham, an independent member of the BAM Alliance. Previously, he was vice...




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just sometimes acknowledging that “so called experts” are in fact just plainly “experts” in their subject matter rather than pouring scorn might just lead to better decision making overall and avoid the consequences of such matters recently like,oh I don’t know, Brexit, the Global Pandemic - you know, avoidable catastrophic events, that sort of thing.....









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## Colm Fagan (23 Jul 2021)

I always smell a rat when someone produces a string of letters as long as your arm when arguing against me!
As I said at the start, I am not a financial adviser, so I'm not advising anyone to follow my lead.  In fact, I don't know how anyone ever subjects themselves to the stresses of being a financial adviser.   We all worry about our money, and get upset if we make a loss on an investment.  For a financial adviser, there is the additional trauma that the client could blame you for the loss even though your advice to invest in something could be absolutely kosher in probability terms.  The problem for the financial adviser is that they are on a hiding to nothing.  The client is likely to apportion at least part of the blame to the adviser if things go wrong, but to take the credit themselves if things go right.  This makes the adviser even more loss-averse than the client, because of the asymmetrical payoffs.   Rather than it being the reverse (as it should be in a rational world), the client has often to overcome the adviser's loss aversion.  There are some notable exceptions.
Anyway, I have read some of the stuff written about sequence of return risk ("studied" would be too grand a word for papers that have no real substance).  "Pound cost ravaging" is a fancy way of saying the same thing.  Everything I've read is completely artificial.  For example, it assumes that everyone cashes their investments (to obtain an income) once a year rather than once a month as I do (or even once a quarter).  Secondly, it completely ignores dividends and assumes investments are cashed every time.  Thirdly, it assumes that retirees withdraw a specified amount each year rather than doing what is natural to all of us, of pulling in our horns a bit (giving a bit less to the grandchildren, etc.) if times are tough and splurging a bit if times are good.  As soon as @Marc or anyone else produces a "pound cost ravaging" argument that looks at what happens in the real world as described above rather than in an academic's ivory tower, I'll start to take it seriously.  Until then, I'll stick to the one that my academic and practical research has told me works well in all conditions.


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## NoRegretsCoyote (23 Jul 2021)

Marc said:


> The average pension fund in Ireland is hardly €1.8m is it?


@Colm Fagan didn't say that. He was just giving indicative figures.

Otherwise I tend to agree that he has been extremely lucky to ride near-uninterrupted equity bull run since retirement. He doesn't give us a broader picture of his lifestyle and assets (nor does he have to) but it may suit him personally.

I think his investment and withdrawal strategy would be far too risky for the average retiree with a pension fund in the low hundreds of thousands.


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## Colm Fagan (23 Jul 2021)

NoRegretsCoyote said:


> Otherwise I tend to agree that he has been extremely lucky to ride near-uninterrupted equity bull run since retirement. He doesn't give us a broader picture of his lifestyle and assets (nor does he have to) but it may suit him personally.
> 
> I think his investment and withdrawal strategy would be far too risky for the average retiree with a pension fund in the low hundreds of thousands.


Hi @NoRegretsCoyote   You've hit on an important issue.  During the discussion of my paper to the Society of Actuaries in January, one contributor said (and I'm paraphrasing - I hope I've got him right) that it was fine for affluent people like Seamus Creedon (who opened the discussion) and myself to leave our money in equities post-retirement, but ordinary savers couldn't take those risks; they had to put a high proportion of their savings in low-return, and supposedly low-risk assets like government bonds, eschewing the opportunity to earn a good return on their savings.  The purpose of my paper was to make those high long-term returns available to all through an auto-enrolment scheme invested entirely in equities from cradle to grave, with returns smoothed to protect members from the risks of short-term (or not-so-short-term) equity underperformance.  
I also agree that I have been relatively lucky.  My _a priori_ expectation (based on historic equity returns) was that the fund would now be worth around €1,000 or slightly less for every €1,000 invested at the start, after taking 6% a year.   Instead, it's worth almost 85% more than that, and I've taken an income of more than 6% of my starting capital a year, on average.   
Keeping costs as low as possible has also been an important element in the mix.


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## NoRegretsCoyote (23 Jul 2021)

Colm Fagan said:


> The purpose of my paper was to make those high long-term returns available to all through an auto-enrolment scheme invested entirely in equities from cradle to grave, with returns smoothed to protect members from the risks of short-term (or not-so-short-term) equity underperformance.


Most pension funds are in the low hundreds of thousands at retirement. It's probably *personally *optimal to shift toward bonds at this stage, but not *socially *optimal. I agree that government should have a greater role in co-ordination here to keep pension holders more invested in equities. I am not sure that any government is big enough to absorb equity underperformance though over a sustained period though.

Much depends on your overall position of course. Suppose at retirement you have a mortgage-free house, kids through college, a full state pension, a partial DB pension, and opportunities to work part time. Then you can afford to take risks with your financial wealth.



Colm Fagan said:


> Keeping costs as low as possible has also been an important element in the mix.


This is helpful of course, but self management isn't an option for most people, and will never be.


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## Colm Fagan (23 Jul 2021)

NoRegretsCoyote said:


> I am not sure that any government is big enough to absorb equity underperformance though over a sustained period though.


The paper mentioned above studied 120,000 simulated years of future experience (plus many years of actual past experience, including the horrific Japanese experience since 1990) and proved resilient in all circumstances.  The government would never be on the hook.  It would play the same role as the UK government does for its NEST auto-enrolment scheme, which was was set up by government but is run completely independently of government, by a Board of trustees.  Some of those 120,000 years of future experience included some pretty frightening bad patches, including at least one where the return on cash flows over an entire 60-year period was negative, and the smoothing formula worked throughout, without any risk of the scheme becoming insolvent.  Of course, results for contributors in that simulation weren't pretty.  As I wrote, the smoothing formula cannot prevent a train crash; however, it can ease the pain.
Therefore, in summary, under the proposed smoothed equity approach to auto-enrolment, any government is big enough to absorb equity underperformance over a sustained period.  Neither the Society of Actuaries in Ireland nor the Institute and Faculty of Actuaries, with whom the paper has also been discussed, disagree with that conclusion.


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## Sarenco (23 Jul 2021)

Colm Fagan said:


> Everything I've read is completely artificial. For example, it assumes that everyone cashes their investments (to obtain an income) once a year rather than once a month as I do (or even once a quarter). Secondly, it completely ignores dividends and assumes investments are cashed every time. Thirdly, it assumes that retirees withdraw a specified amount each year rather than doing what is natural to all of us, of pulling in our horns a bit (giving a bit less to the grandchildren, etc.) if times are tough and splurging a bit if times are good.


There is nothing remotely artificial about sequence risk.

If you are drawing from a portfolio that suffers negative returns in the early years of your retirement, then the extent to which you can benefit from any subsequent market recovery will be limited by the fact that you have already spent a portion of the portfolio.  That should be obvious.

Dividends are an important source of return but they are not magical.  Failing to reinvest dividends is precisely the same thing economically as selling shares that produced those dividends.  

You can't avoid sequence risk by simply increasing the frequency of drawdowns from a portfolio.  Drawing less from a portfolio during down years (or months) is certainly one way of mitigating sequence risk.  Another is to hold uncorrelated assets (bonds) to reduce the variability of returns on the overall portfolio.

You were extremely lucky to retire near the start of (what turned out to be) the longest bull market in history.   Others may not be so fortunate.


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## Brendan Burgess (23 Jul 2021)

Marc said:


> To keep the maths simple I’m going to assume a 100% equity allocation and a €1m pension fund.
> 
> back in 2008 global equities dropped 40% and in March last year almost the same
> 
> ...



Marc

That really is a terrible example and would mislead a lot of people.

It sounds as if there is a choice between  + 100 or -400. 

And is just wrong.   The -400 occurred twice over a short period. The +100 in your example, is an annual figure. 

Brendan


----------



## Brendan Burgess (23 Jul 2021)

I think most of us would agree that a person investing for the long term should have most of their assets in equities or property? 

So if someone reaches retirement but will not be drawing down from their pension fund, then they should be almost fully invested in equities.


----------



## Brendan Burgess (23 Jul 2021)

So the question is whether someone who is drawing down their pension and spending it should have some of their funds in cash? 

If they are just moving 4% a year from their ARF into their own direct investments, then it should make no difference to their investment strategy. It should remain in equities.


----------



## Brendan Burgess (23 Jul 2021)

But, most people will be actually running down their pension fund and spending it. 

In other words, their annual expenditure will exceed their income. 

They face two uncertainties - remaining years to live and investment returns. 

I don't think that there is a correct answer to the question:  Should they switch to cash? 

I think that a mathematical model which purports to answer the question is likely to give a false sense of confidence in the answer. 

Switching to cash is certainly not de-risking.  Cash is at much greater risk from inflation than equities. 

Brendan


----------



## Brendan Burgess (23 Jul 2021)

Sarenco said:


> It seems to me that the primary reason to de-risk a portfolio is to reduce the variability of returns on that portfolio. That becomes particularly important when you start spending down your portfolio in order to help preserve the longevity of the portfolio.
> 
> If you get a particularly bad run of returns in the early years of retirement, you could well find yourself running out of money later in life. The extent to which you can benefit from any subsequent market recovery will be limited by the fact that you have already spent a significant portion of your portfolio.



This describes the dilemma very well. 

But I am not sure that bonds will extend the real value of my portfolio. It may extend the nominal value, but that should not be a concern for me. 

The only way to really extend the longevity of my portfolio is to cut my expenditure. 

Brendan


----------



## Brendan Burgess (23 Jul 2021)

moneymakeover said:


> If you need it in 5 years time (which you do), I'd say move a portion each year into low risk.
> 
> Decide what fraction you want in level 6 equities in retirement say 30%
> 
> Each year between now and age 60 move 10% to low risk



But unless he is buying a holiday home , he won't need it in 5 years. 

Taking out the tax-free lump sum in 5 years does not constitute "needing" it in 5 years. 

The tax-free lump sum is not relevant. If the market is down 40% when he takes out the tax-free lump sum, well he will be investing the lump-sum in directly own equities at a lower price.   He is just changing the label on the investments from "pension fund" to "owned by Spud".

Brendan


----------



## Brendan Burgess (23 Jul 2021)

Colm Fagan said:


> The question of whether the market was elevated or depressed at my retirement date didn't really bother me, as it meant transferring equities from a tax-exempt account to a taxable one. It didn't matter much what their market value was at the time, as it was essentially an in specie transfer from one account to another.



That is what I am trying to say.


----------



## Brendan Burgess (23 Jul 2021)

Marc said:


> one might be willing to assume a high degree of investment risk (risk tolerance) but objectively what matters most and certainly from a regulatory perspective is an objective assessment of one’s ability to bear losses (risk capacity) many people will find with the benefit of hindsight that buying an annuity at outset may well have been a better decision.



Yes, with the benefit of hindsight. 

But with annuity rates so low at the moment it just seems very wrong to buy an annuity. 

You may well have an income 30 years, but it might be worthless due to inflation. 

Marc - this is the second time you have recommended annuities recently.  I am surprised. Would you do a separate post on this issue?  I would like to see your reasoning. 

Brendan


----------



## Brendan Burgess (23 Jul 2021)

Sarenco said:


> Drawing less from a portfolio during down years (or months) is certainly one way of mitigating sequence risk. Another is to hold uncorrelated assets (bonds) to reduce the variability of returns on the overall portfolio.



Agreed that drawing less from a portfolio extends the life of the fund.

Reducing the variability of the returns should not be an objective.   Because people can't really measure risk, they use variability as a measure of risk and it is not a measure of  long-term risk.

So holding bonds, might reduce variability. It reduces the risk that my fund will be worth less in a year's time. But it increases the long-term risk as the bonds are at greater long-term risk than equities due to inflation.

Brendan


----------



## Sarenco (23 Jul 2021)

Brendan Burgess said:


> So holding bonds, might reduce variability. It reduces the risk that my fund will be worth less in a year's time. But it increases the long-term risk as the bonds are at greater long-term risk than equities due to inflation.


Hi Brendan

Maybe a stylised example would help to demonstrate the impact of sequencing and how adding a slug of bonds to a portfolio can help.

Take a retirement portfolio of €1m that was withdrawn and spent over a 30 year retirement, at a fixed rate of €40k per annum.

Imagine over that 30-year period the portfolio had 29 years where the portfolio had a positive return of 5% and one terrible year where the portfolio dropped in value by 30%.

If the bad year happened at the start of the withdrawal period (so, 1 year down, then 29 years up), the remaining portfolio at the end of year 30 would be €223,741.

However, if the bad year happened at the end of the withdrawal period (29 years up, then 1 year down), the remaining portfolio at the end of year 30 would be €1,026,529.

Big difference!

Note that if there were no withdrawals, both sequences would produce identical returns over the 30-year period - sequence risk only arises where withdrawals are being made from a portfolio with variable returns.

Now, we obviously cannot control the sequence of returns on a portfolio – that is simply a question of luck.

However, we can add uncorrelated assets (bonds) to a portfolio of equities to reduce the severity of any draw-down in the early years of the withdrawal period.

Adding bonds to an equity portfolio will always reduce the expected (but in no way guaranteed) return on the portfolio.  However, that might be a cost that an investor is willing to bear in order to mitigate (but not entirely remove) the sequence risk described above.


----------



## Spud50 (23 Jul 2021)

thanks for the informative discussion ,one of the concerns i have is with drawing down 4% from the ARF , paying tax/stamp , AMC , brokers  trailing fee etc., if i dont invest my pension Longterm in Global equities (s&p500) to counter the above secondary drawdowns  then the sum will prob run out anyway , so to me there are risks on both sides ,


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## Brendan Burgess (23 Jul 2021)

Sarenco said:


> If the bad year happened at the start of the withdrawal period (so, 1 year down, then 29 years up), the remaining portfolio at the end of year 30 would be €223,741.



OK, so I put 30% of the portfolio in bonds each year yielding 2%. 

There was a 30% fall in the first year in the stockmarket as before.

The portfolio at the end of year 30 is €271k  ( You might check my numbers.) 

So sure it cushions the blow where you are unlucky enough to get the fall immediately you stop adding to your pension fund. 

But if you had not invested in funds and the fall was at the end, you would have  €1m 

I think that this stylised example doesn't support the case for bonds.


----------



## Brendan Burgess (23 Jul 2021)

The case for bonds would be something like the following : 

A sustained fall in the stockmarket over the first ten years of retirement. 

Brendan


----------



## Marc (24 Jul 2021)

COMPOUND VS AVERAGE RETURNS

Imagine an investor that earns 10% on her portfolio in one year, and then loses 10% the next. The common mistake is to think that the investor would now be back to where she started. After all, the average of the two annual returns of +10% and-10% is simply 0%.

In actual fact, our investor would have lost 1% over the two years!

That’s an annual loss of about 0.5%

And the effect would have been even worse for more extreme movements. If the investor had instead gained 15% and then lost 15%, the net loss over the two years would have been 2.25%. 20% up and 20% down and the loss would have ballooned to 4% over two years.


VOLATILITY DRAG

This unfortunate effect is due to the fact that compound annual returns are always below average annual returns.

Mathematicians, using a branch of mathematics called stochastic calculus, have come up with an approximation for this effect:
g=µ-σ2/2


where g is the compound (or geometric) return of the investment, µ is its (arithmetic) average return, σ its volatility and thus σ2 its variance.

The difference between compound return and average return,approximated by half the variance (σ2/2), is known as volatility drag.


There is another generally more accurate but slightly more complicated approximation which we use in practice: g = (1+µ)(1+σ2(1+µ)-2)-1/2–1.

This particular approximation generally results in a higher (and more accurate) estimate of g than the arithmetic average minus half the variance and is exact _if returns are distributed lognormally_.

As required, it will also ensure the estimate of g is below µ. See: On the Relationship between Arithmetic
and Geometric Returns; Dimitry Mindlin, MAAA, PhD; CDI Advisors LLC; 14.08.2011

_"We agree that Mandelbrot is right. As we can see when looking at the daily market returns, the distribution is fat-tailed relative to the normal distribution. In other words, extreme returns occur much more often than would be expected if returns were normal.

However most of what we do in terms of portfolio theory and models of risk and expected return works for Mandelbrot's stable distribution class, as well as for the normal distribution.

Our conclusion is that for long-term passive investors, the short term distribution doesn’t matter beyond being aware that outlier returns are more common than would be expected if return distributions were normal.”_

Eugene F Fama


----------



## Marc (24 Jul 2021)

Rebalancing

The benefits of portfolio re-balancing derive from controlling risk exposure which ultimately benefits investors composure (less likely to sell during a crash) and not from an increase in the expected returns.

The proposition that rebalancing can increase the expected return of a portfolio is dubious. One thing is certain: rebalancing entails costs and costs reduce expected rates of return.

For rebalancing to increase expected returns over time, asset prices would have to be  consistently mean reverting and clients would need to be able to accurately time their rebalancing decisions.

A portfolio’s asset allocation determines the portfolio’s risk and return characteristics.

Over time, as different asset classes produce different returns, the portfolio’s asset allocation changes. To recapture the portfolio’s original risk and return characteristics, the portfolio must be rebalanced to its original asset allocation.


----------



## Marc (24 Jul 2021)

Modern Portfolio Theory has four basic premises:

1) *Investors are inherently loss averse*. Investors are generally more concerned with loss than they are with reward.

2) Securities markets are competitive and drawn to a long run state of equilibrium.

This means that investors should assume that the price of any publicly traded security reflects the views and opinions of all market participants and is therefore probably a “fair price”.

3) The focus of attention should be shifted away from individual securities analysis to consideration of a portfolio as a whole, predicated on the explicit risk/reward parameters and on the total portfolio objectives. The efficient allocation of capital in a portfolio to specific asset classes is far more important than selecting the individual investments.

4) For every risk level, there is an optimal combination of asset classes that will maximise returns. Portfolio diversification is not so much a function of how many individual stocks or bonds are involved, as it is of the relationship of each asset to each other asset.


----------



## Marc (24 Jul 2021)

Why own Bonds?


Fixed-Income Investments

As the long-term returns figures show, an all-equity portfolio has attractive growth potential, but significant uncertainty about the exact outcome. For this reason, we describe an all-equity portfolio as being aggressive. It is most suitable for investors who are willing and need to take substantial risk in the pursuit of reward.

Investors with shorter investment horizons, a high level of risk aversion or less need to take risk should maintain portfolios that are significantly less aggressive than the all-equity strategy.

For these investors, some portion of the portfolio should remain in fixed-income instruments. Bonds provide income and help reduce the overall risk in a portfolio.

However, because of the fixed nature of the income stream from a bond, there is
comparatively little upside potential in a bond portfolio. Investors are sometimes
surprised to learn that bond prices can rise and fall with changes in interest rates, but the main source of investment returns from bonds are the interest payments they make.

A portion of an ARF portfolio’s assets should be invested in fixed-income investments.

Fixed-income investments will help reduce the overall level of risk in your portfolio, because fixed-income investments tend to be less risky than equities, and because the fixed-
income investments represent an additional diversification of your assets.

Fixed-income instruments should be used to reduce the overall level of risk to your comfort level. It is important to note that over the long term, fixed-income investments will typically have returns approximate to inflation.

in fact short-term fixed interest has been described as an inflation-hedge strategy and can work better than equites as an inflation hedge under certain economic conditions.

equally investors can purchase inflation-protected bonds which provide another source of inflation protection albeit at a price.





__





						What Drives Bond Yields?
					

In this overview of the various factors that influence government bond yields, we show that both in theory and in the data, non-monetary policy factors drive significant variation in yields, particularly at longer maturities. Despite the exceptionally low yield environments we have witnessed...




					www.aqr.com
				




Some takeaways
- bond risk remains two-sided
- bonds still provide diversification
- a fundamental approach to investing in bonds still makes sense


The bottom line: Building a prudent portfolio requires careful consideration of the unique characteristics of both equities and fixed income and what each can add to the portfolio


----------



## Duke of Marmalade (24 Jul 2021)

Sarenco said:


> Dividends are an important source of return but they are not magical.  Failing to reinvest dividends is precisely the same thing economically as selling shares that produced those dividends.


I am not sure I follow this point. 
Let us assume the pension fund is invested in a widget maker.  The current share price is 1000 and over the next 6 months it accumulates 10 in cash from the profits on widgets to pay out a dividend.  This 10 is just sufficient to meet the pensioners consumption needs.  The share price doesn't matter unless you have to sell.  So it doesn't matter if the share price jumps 20% today and falls back 20% in 15 years time or vice versa.  So I think Colm is right that dividends are a means to dampen the sequence risk of share price movements.  
Now if the dividends get reinvested automatically as they would in a fund then any withdrawal at all involves substantial share sales and is, I agree, exposed to sequence risk.

@Marc Interesting paper by Dimitri Mindlin but what are the learning points for the current debate?

_Boss _I agree with Marc that Cash has an inflation protection dimension - inflation is quickly followed by an increase in the interest rate on cash - and has beaten inflation over the longer term (for pension funds not subject to tax on interest).  But I certainly can't understand why anybody invests in long term bonds at these yields, unless you are a financial institution seeking to match liabilities.


----------



## Sarenco (24 Jul 2021)

Duke of Marmalade said:


> I am not sure I follow this point.


All else being equal, when a stock goes ex-dividend its price will fall by an amount equal to the declared dividend, because new shareholders will not be entitled to the dividend payment.  

So, failing to reinvest the dividend is basically the economic equivalent of selling shares to the value of the dividend.


----------



## Brendan Burgess (24 Jul 2021)

Duke of Marmalade said:


> _Boss _I agree with Marc that Cash has an inflation protection dimension - inflation is quickly followed by an increase in the interest rate on cash - and has beaten inflation over the longer term (for pension funds not subject to tax on interest). But I certainly can't understand why anybody invests in long term bonds at these yields, unless you are a financial institution seeking to match liabilities.



Hi Duke 

That surprises me.  But I stand corrected. 

Just to be absolutely sure I understand you.  Someone who has put their money in a deposit account over the last 30 years and reinvested the interest received would have retained the real value of their money?   Or would  have done so, if the returns were not subjected to DIRT? 

So if I am retired today aged 65 and have €1m in my ARF after I have taken out the tax-free lump sum. I can leave that money safely in a deposit account and expect that it will keep pace with inflation? 

Brendan


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## Marc (24 Jul 2021)

Brendan Burgess said:


> Hi Duke
> 
> That surprises me.  But I stand corrected.
> 
> ...



No, the economic conditions that have been historically poor for equities have been fine for short term cash, or more specifically short term fixed interest and therefore provides a valuable diversification benefit for periods when equities perform poorly.

As I have already said, it’s perfectly possibly that the next 20 years will be a terrible time to be an equity investor and cash/bonds could provide the highest returns.

if you were retiring at the start of any of the following graphs with a 100% equity portfolio you would have had a better investment experience with all your money in the bond market.

for the avoidance of doubt I’m not suggesting putting all of an ARF portfolio into bonds. I am saying it’s reckless to put ALL of an ARF into equities







And in the US 5 Year treasury notes provide an even better result







Another period in history when you would have been better off in bonds






Also putting the 70s and early 80s into perspective






Including inflation data over the same period


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## Duke of Marmalade (24 Jul 2021)

Boss said:
			
		

> So if I am retired today aged 65 and have €1m in my ARF after I have taken out the tax-free lump sum. I can leave that money safely in a deposit account and expect that it will keep pace with inflation?


Now, now _Boss _don't be naughty.  Nothing is that certain an inflation hedge, not even equities.
This Cash Returns Calculator is for the US market and for 30 years there has been a .24% real return on 3 month T-bills.  This is 1.04% since 1980 and 0.35% since 1928.
The same link does say that equities have been the best long term hedge, 10 year bonds second and cash third.  Now obviously 10 year bonds provide no hedge over 10 years but over the long term, if the government wants to borrow it will have to compensate for expected inflation.
So let's say someone is looking ahead to a 20 year retirement, 20 year bonds would seem to be useless in the face of possible inflation.  Yes there are economic arguments that equities will be a good hedge though in the short term they tend to react negatively against inflation upticks.
Cash on notice deposit will be unlikely to match inflation but term deposits do have some historic inflation protection.


----------



## Brendan Burgess (24 Jul 2021)

Marc said:


> No, the economic conditions that have been historically poor for equities have been fine for short term cash, and therefore provides a valuable diversification benefit for periods when equities perform poorly.



Hi Marc and Duke

I am trying to translate this into what the OP or anyone else should do today in today's conditions.

He has €1m in an ARF. 

He can buy 30% bonds, but that looks crazy today.  

(But maybe it won't look crazy in two years, when we look back at a 50% fall in the stock market.)

Or would you say put the 30% in a deposit account/current account earning nothing? 

It just seems wrong. 

Brendan


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## Sarenco (24 Jul 2021)

Currently banks are charging institutional depositors (including pension funds) around 60bps on their cash deposits.

The yield to maturity of Eurozone government bonds (EGBI) is currently around 5bps.

And obviously management fees also apply to cash held within a pension.

So, where possible, it probably makes sense for a retail investor to hold cash deposits outside their pension vehicle and maintain a higher allocation to equities within their pension/ARF.


----------



## Duke of Marmalade (24 Jul 2021)

Brendan Burgess said:


> Hi Marc and Duke
> 
> I am trying to translate this into what the OP or anyone else should do today in today's conditions.
> 
> ...


Difficult one to answer.  Though I was discussing the inflation hedge aspect and with negative inflation cash under the mattress is such a hedge.
@Sarenco has made the important point that pension funds are earning negative interest rates.
Who would be a financial advisor in these conditions?


----------



## Marc (25 Jul 2021)

Earlier post updated to include some graphs of periods in history where bonds won hands down for over a decade

it doesn’t matter what starting interest rates are for the bond market when you are rolling over short-term fixed interest positions.

lets say you are running a short bond fund with terms up to 5 years.

right now you hold a portfolio of bonds with zero or negative yields so the logical assessment is that you can’t possibly make any money so why bother.

wind the clock on a year and lets say that inflation assumptions have changed and interest rates have gone up.

some of your bonds with terms of a year or less have now matured and you have a pile of cash to reinvest.

you get to roll over that cash back into the bond market which now has higher yields due to the rise in interest rates

as you keep repeating this process you get to constantly reassess inflation and interest rate conditions in the market.

think of it like a conveyor belt in a supermarket.

your purchases keep getting put back at the top and run through the til at constantly rising prices fall off the front and get put back at the top again.

Traditional retail bank deposits with DIRT paid are completely irrelevant in this analysis since in a pension fund you would use a global euro hedged short bond fund and there is no tax on the interest.

We can see that over the very long term short-term bonds have been a consistently good hedge against inflation. This is data for the USA from 1926






One of the benefits of this approach is that it doesn’t rely on having to forecast the future rate of inflation or interest rates. The market is doing this for you.

You simply need to be confident that the relationship between inflation and short term fixed interest is reasonably stable over time.

And you can ignore every post that had phrases like “I think” in them





__





						What Drives Bond Yields?
					

In this overview of the various factors that influence government bond yields, we show that both in theory and in the data, non-monetary policy factors drive significant variation in yields, particularly at longer maturities. Despite the exceptionally low yield environments we have witnessed...




					www.aqr.com
				




Some takeaways
- bond risk remains two-sided
- bonds still provide diversification
- a fundamental approach to investing in bonds still makes sense


The bottom line: Building a prudent portfolio requires careful consideration of the unique characteristics of both equities and fixed income and what each can add to the portfolio


----------



## NoRegretsCoyote (25 Jul 2021)

Duke of Marmalade said:


> I agree with Marc that Cash has an inflation protection dimension - inflation is quickly followed by an increase in the interest rate on cash - and has beaten inflation over the longer term (for pension funds not subject to tax on interest)


Show me a time series where after-DIRT retail rates have beaten inflation over a sustained period over the last 40 years. You'll find it about 2009-2013 where banks were fighting for deposits and inflation was very low (negative in one year) but I can't think of any other.


Marc said:


> As I have already said, it’s perfectly possibly that the next 20 years will be a terrible time to be an equity investor and cash/bonds will provide the highest returns.


But the risk is just not symmetric for bonds and equities right now. There is a lower limit to interest rates which we are at or very close to. Interest rates could fall from 5% to 1% but they can't fall from 1% to -3%. There is very little upside for bonds.

Equities can and do fall in value but there is effectively unlimited upside to equities the way there just is not for bonds.



Brendan Burgess said:


> But with annuity rates so low at the moment it just seems very wrong to buy an annuity.
> 
> You may well have an income 30 years, but it might be worthless due to inflation.


Inflation can erode equity values too though. A small annuity (say 10% of fund on retirement) makes sense as it provides insurance against heavy equity losses. Central banks have struggled to generate much inflation and may continue to to do and inflation may not be a big risk.


----------



## Brendan Burgess (25 Jul 2021)

Duke of Marmalade said:


> Who would be a financial advisor in these conditions?



This is their problem.

But the OP's problem which a lot of us face, is how we should invest on retirement for the rest of our lives. 

Every option is risky.  Which results in some people with all their money in cash and others with all their money in equities. 

Brendan


----------



## Duke of Marmalade (25 Jul 2021)

Sarenco said:


> All else being equal, when a stock goes ex-dividend its price will fall by an amount equal to the declared dividend, because new shareholders will not be entitled to the dividend payment.
> 
> So, failing to reinvest the dividend is basically the economic equivalent of selling shares to the value of the dividend.


Taking a dividend does not impact future dividend pay-outs.  Selling shares does reduce future dividend pay-outs.  So there is an economic difference.
The counter example to sequence risk is someone who lives off the dividends alone and never has to sell shares - the ups and downs of market movements and their timing are of no consequence.  It is an extreme example of course but suggests that Colm has a point that using dividends to fund withdrawals mitigates against sequence risk.
This assumes that market prices move simply because of market sentiment and are not tied to the real dividend prospects of the shares.  Your example of a 30% fall in share values at the beginning followed by regular encashments assumes in effect that the market was right and subsequent dividends are 30% lower.  Clearly if dividends are to be 30% lower it is better that happens later than earlier but this is not so much sequence risk as economic risk.
I was wrong though in saying that Colm's approach cannot be applied to a fund.  If one encashes fund units at the average internal dividend rate it is true that at the point of encashment one is selling shares but internally at the point of dividend receipt the fund reinvests thus cancelling out that selling.


----------



## Duke of Marmalade (25 Jul 2021)

Brendan Burgess said:


> This is their problem.
> 
> But the OP's problem which a lot of us face, is how we should invest on retirement for the rest of our lives.
> 
> ...


Yes and I wouldn't dare to advise.  However, reading these pages OP can get a flavour of all the "on the one hand, on the other hand"s but ultimately it is their call.


----------



## Gordon Gekko (25 Jul 2021)

In my view, cash would be a ‘riskier’ asset than equities taking a 30 year view from here.

After WWII, when there was a large amount of public debt in the world, the powers that be kept interest rates behind inflation with a view to inflating away the debt. My understanding is that the average ‘real’ (i.e. after inflation) interest rate was around -1.5% per annum for the period 1945 to 1980. So wealthy people who thought that they were being sensible bought things like ‘War Bonds’ and saw their wealth destroyed by inflation.

The playbook this time seems exactly the same, and there’s even more debt out there, both public and private.

I would really worry for anyone who plans to sit in cash for a prolonged period of time.

Bank of Ireland now was -0.6% for some cash deposits; imagine the effect of that over 30 years with inflation at 1.5-2.5%?

That could be going from being rich to struggling to afford to heat your home.

The financial industry and the regulators define ‘risk’ as volatility, i.e. the amount that something goes up and down in value. But that’s horse manure. Risk is actually permanent loss of capital and permanent loss of purchasing power.

Taking a 20-30 year view, I would classify €1m in cash as far riskier than a €1m diversified portfolio of global equities.


----------



## Brendan Burgess (25 Jul 2021)

Gordon Gekko said:


> Bank of Ireland now was -0.6% for some cash deposits; imagine the effect of that over 30 years with inflation at 1.5-2.5%?



Hi Gordon,

I agree with your conclusion, but I don't think that this point is valid.

Charging 0.6% for deposits is unlikely to continue for very long and certainly won't continue if inflation returns.

Brendan


----------



## Sarenco (25 Jul 2021)

Duke of Marmalade said:


> Taking a dividend does not impact future dividend pay-outs.  Selling shares does reduce future dividend pay-outs.  So there is an economic difference.


Failing to reinvest dividends will reduce the number of shares that would otherwise be held by an investor. 

Holding less shares obviously reduces the quantum of any future dividend payments and potential capital gains. 

Exactly the same thing that happens when you sell shares.


----------



## Duke of Marmalade (25 Jul 2021)

Gordon Gekko said:


> That could be going from being rich to struggling to afford to heat your home.


We're told that won't be an issue


----------



## Duke of Marmalade (25 Jul 2021)

Sarenco said:


> Failing to reinvest dividends will reduce the number of shares that would otherwise be held by an investor.
> 
> Holding less shares obviously reduces the quantum of any future dividend payments and potential capital gains.
> 
> Exactly the same thing that happens when you sell shares.


My main point is that if the 30% fall is just due to an increase in dividend yields with no change in dividends then to the extent that withdrawals are covered by dividends the fall is of no relevance.  So Colm's dividend point against sequence risk has some validity.


----------



## Gordon Gekko (25 Jul 2021)

Brendan Burgess said:


> Hi Gordon,
> 
> I agree with your conclusion, but I don't think that this point is valid.
> 
> ...


Hi Brendan,

The nominal rate isn’t really relevant though.

If Bank of Ireland stop charging -0.6% for deposits, inflation will probably still be 1.5-2.5% higher and purchasing power will be steadily eroded over time.

Real after-inflation rates are probably -2.5% right now. Imagine the negative compounding effect of that over time, especially in a pension or ARF with fees as well.

People talk about equities being risky but cash strategies seem like a sure fire route to the poorhouse.


----------



## NoRegretsCoyote (25 Jul 2021)

Gordon Gekko said:


> Taking a 20-30 year view, I would classify €1m in cash as far riskier than a €1m diversified portfolio of global equities.


That's a bit of a straw man.

Keeping a million in a retail bank account for decades would not be wise advice in any time or place.


----------



## Gordon Gekko (25 Jul 2021)

NoRegretsCoyote said:


> That's a bit of a straw man.
> 
> Keeping a million in a retail bank account for decades would not be wise advice in any time or place.


How is it a ‘straw man’?

The industry classifies cash as ‘safe’ and equities as ‘risky’, when the reality is very different.

Lots of people do it in different ways, whether it’s too little risk in their pension fund or too much cash in the bank.

I spoke with my friend’s wife recently and her pension was far too ‘safe’. She’s in her mid 30s. Some fella from Mercer sat down with her for 10 mins and asked her whether she fancied high risk or low risk. She had no idea what those concepts meant, and like many people would answered “low risk”. She now has a significant six figure sum which is closer to cash than equities. That’s a far riskier approach in my view.


----------



## Brendan Burgess (25 Jul 2021)

Gordon Gekko said:


> The industry classifies cash as ‘safe’ and equities as ‘risky’, when the reality is very different.



Agree fully. 

Brendan


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## Sarenco (25 Jul 2021)

Duke of Marmalade said:


> …to the extent that withdrawals are covered by dividends the fall is of no relevance.


The stylised example referred to the total return on the portfolio from all sources  - there is no additional source of return coming to the rescue in Year 1.


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## Sarenco (25 Jul 2021)

Gordon Gekko said:


> How is it a ‘straw man’?


It’s a straw man in the context of this thread because you are not simply concerned about the long term return on a portfolio once you are about to make withdrawals from that portfolio.

If the portfolio suffers a major drawdown in the early years of spending down the portfolio, your ability to benefit from any subsequent market recovery will be limited by the fact that you have already spent a portion of the portfolio.  The sequence of returns matters.


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## Marc (25 Jul 2021)

Brendan Burgess said:


> Agree fully.
> 
> Brendan



except that these are two entirely different scenarios which are being mixed up to make a point.

someone in their mid 30s adding to a pension SHOULD have an equity bias. They have risk capacity and sequence of returns makes no difference.

Someone 5 years out from drawing their pension has an entirely different set of risks.


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## NoRegretsCoyote (25 Jul 2021)

Gordon Gekko said:


> How is it a ‘straw man’?



Because with a thirty-year investment horizon you would buy a thirty-year government bond. You would not leave it in retail deposits which almost always pay a lower interest rate. Your comparison was between equities and cash in the bank over 20-30 years.


Gordon Gekko said:


> The industry classifies cash as ‘safe’ and equities as ‘risky’, when the reality is very different.


These industry definitions are unfortunate simplifications but I expect a more financially literate discourse on AAM.


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## Duke of Marmalade (25 Jul 2021)

Sarenco said:


> The stylised example referred to the total return on the portfolio from all sources  - there is no additional source of return coming to the rescue in Year 1.


I'm obviously not explaining myself very well. 
I am not questioning the math of your stylised example.  I am not denying the existence of sequence risk.
I am challenging your apparent rejection of Colm Fagan's claim that using dividends to meet withdrawals mitigates sequence risks.
Let my try again.
If the 30% fall in equity values is due to the dividend yield going from 2.5% to 3.6% but with no change to prospective dividends then provided one is not selling the shares but simply pocketing the unchanged dividends the 30% fall is irrelevant.


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## Gordon Gekko (25 Jul 2021)

NoRegretsCoyote said:


> Because with a thirty-year investment horizon you would buy a thirty-year government bond. You would not leave it in retail deposits which almost always pay a lower interest rate. Your comparison was between equities and cash in the bank over 20-30 years.
> 
> These industry definitions are unfortunate simplifications but I expect a more financially literate discourse on AAM.


That’s the whole point. The person who buys the 30 year bond may get wiped out by inflation. What do you think happened to the patriotic rich Briton who bought a War Bond in 1945? Wiped out. What do you think will happen to the conservative pension investor who buys Eurozone goverment debt now yielding zero or negative? I think there’s more of a chance of being cleaned out by inflation than by investing in equities.


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## Sarenco (25 Jul 2021)

Duke of Marmalade said:


> I am not questioning the math of your stylised example. I am not denying the existence of sequence risk.


Let me try again.

A dividend isn't "free money" - it comes off the share price.  Say you bought a share in ACME plc on 1 January and it pays a dividend of €5 every quarter.  If the share price is entirely unaffected by any factor other than the dividend payments for the entire year, the share price of ACME plc would be exactly €80 at year end.

Dividends are not interest payments.  Interest is a return ON your principal; dividends are a return OF your principal.  Interest compounds; dividends do not - unless you reinvest them.

Pocketing a dividend, rather than re-investing it, is exactly the same thing as selling a share of equal value to the dividend to achieve a return OF your principal.

In either case, you end up with a portfolio with a lower value than would otherwise be the case and you thereby limit the extent to which you would otherwise have benefitted from any subsequent returns on the portfolio if there had been no such withdrawals of principal. 

That's what gives rise to sequence risk.


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## Duke of Marmalade (25 Jul 2021)

Sorry @Sarenco but that is so not right.  Dividends are a pay-out from profits nothing to do with principal/interest etc.  All things equal ACME’s price would be 100 at end year provided it earned those divies.  Think property earning you rents.  Rents are not a return of a piece of the property.
The first chapter on investments tells us that a share price is the market value of its future dividends from said profits (ignoring noise such as potential takeover).
So seeing that the price of a share is the value the market puts on its future dividends it can fall by 30% for the following reasons:
1.  Future dividend prospects have fallen
2.  The risks attaching to future dividends emerging have increased
3.  The discount rate used to value the dividends has risen
4.  Purely sentimental factors with no rational basis
For someone depending on dividends only (1) is of relevance.  The other 3 are irrelevant (2 makes our investor a bit nervous).  All 4 are of course relevant to someone who actually needs to sell the shares.  A dividend is NOT the same as selling a share or getting a return of your principal.
Your example posits that the fund falls by 30% and then increases by 5% p.a. thereafter the same as it would have before the fall.  This assumes that the reason for the fall is purely (1).
Here is the diagram:
Current price 100, dividends 5 so a 5% return
Price falls to 70, dividend stays at 5 and so return increases to 7.1%.
Your example has the return stay at 5% and so you have assumed that dividends have fallen by 30%


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## Gordon Gekko (25 Jul 2021)

Sarenco said:


> It’s a straw man in the context of this thread because you are not simply concerned about the long term return on a portfolio once you are about to make withdrawals from that portfolio.
> 
> If the portfolio suffers a major drawdown in the early years of spending down the portfolio, your ability to benefit from any subsequent market recovery will be limited by the fact that you have already spent a portion of the portfolio.  The sequence of returns matters.


I don’t disagree.

It’s why people who are reliant on a sum of money to last them the rest of their life should look at ideas such as:

- Keeping 3-5 years cash aside and living on that for 3-5 years without drawing on the invested portfolio
- Considering not taking the full ARF distribution in “down years” so only the deemed tax gets withdrawn
- Just keeping 4-6% of the value of the ARF in cash at all times so units/shares never need to be sold


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## NoRegretsCoyote (26 Jul 2021)

@Gordon Gekko

You are arguing against points I haven't made and are forgetting your original comparison which was a basket of equities compared to retail deposits. The latter would never make any sense for anyone with a decades-long investment horizon.

Otherwise you claimed:


Gordon Gekko said:


> What do you think happened to the patriotic rich Briton who bought a War Bond in 1945? Wiped out.





Gordon Gekko said:


> My understanding is that the average ‘real’ (i.e. after inflation) interest rate was around -1.5% per annum for the period 1945 to 1980. So wealthy people who thought that they were being sensible bought things like ‘War Bonds’ and saw their wealth destroyed by inflation.


You can look this up and find that real yields on 10-year UK bonds were about 0.2%  1945-1980.

It is (as you would expect) a miserable return compared to equities, but it is not a wipe out.


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## Gordon Gekko (26 Jul 2021)

It’s a wipeout


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## NoRegretsCoyote (26 Jul 2021)

Gordon Gekko said:


> It’s a wipeout


Sure, if you define a wipeout as a very slightly positive real yield over the period which would maintain the purchasing power of your investment.

Your previous threshold was a real yield of -1.5% pa which over 35 years is a loss of about 40%......

Edit: here is UK equities which in real terms lost a lot of value 1945-1980, much of this due to the high inflation of the 1970s.


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## Sarenco (26 Jul 2021)

Duke of Marmalade said:


> Sorry @Sarenco but that is so not right.


So how do you explain the fact that the price of a dividend stock falls as soon as it goes ex-dividend?


Duke of Marmalade said:


> The first chapter on investments tells us that a share price is the market value of its future dividends from said profits (ignoring noise such as potential takeover).


There is no expectation that Berkshire Hathaway will ever pay a dividend so how come its share price isn’t zero?


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## Colm Fagan (26 Jul 2021)

The discussion has moved on since my last contribution.  However, I would like to pick up the thread on a few points.


Sarenco said:


> There is nothing remotely artificial about sequence risk.


I agree that losses early during drawdown have more impact than if they happen later.  My "artificial" point referred to the artificiality of the scenarios put forward by advocates of "sequence of return" or "pound-cost ravaging" risk, with specific reference to so-called 'studies' which assumed yearly withdrawals and no flexing of withdrawals, i.e. the ability to take less when times are tough, more in good times.
An equity portfolio can experience a severe loss at any time.  It could be next month; it could be next year; we could get a few bad years together.  I lost almost 3% in my first year of drawdown.  My point is that, if I had decided to (say) invest 50% in bonds at the start, to address this risk, I would have been resigning myself to an extra 2% annual drag on the expected return on the portfolio (assuming a 4% equity risk premium:  50% of 4% = 2%).  We would all jump up and down if we were told there was an extra 2% a year management charge on our portfolios.  This is exactly the same; it's just expressed differently.  For a 61-year old (which I was at the time I started the ARF), the possibility of suffering a 2% drag on performance for up to 30 years was far too high a price to pay to avoid the risk of a severe fall in the value of the investments every now and again. 
In relation to dividends, once again, I don't disagree with the argument that a return is a return, whether it comes by way of dividend or capital gain.  My point, as a practical investor, is that, to the best of my recollection, I have never had to redeem investments at the 'wrong' time in order to draw the obligatory 'income' from my ARF.   The money for the 'income' has always been there when I needed it, either from dividends on stocks in my portfolio or from natural stock turnover, i.e. a particular stock falling out of favour.   Of course, there is also the option of deferring taking an 'income' for a month or two, if needs be.
Finally, I don't deny that I have been lucky since I started the ARF at end 2010.  When I started, I expected to be able to take a 6% income each year and to keep the original capital intact (on average).   Things worked out worse than expected in the first year (when I lost close to 3%), but I more than made up for that loss in subsequent years, so that every €1,000 at the start is now worth close to €1,850, after taking an 'income' each year.  If my _a priori _expectation had been realised, I would now be worth around €1,000, which is still far more than I could have expected if I had invested a substantial portion of my ARF in bonds at the start, withdrawing 6% a year. 
I still hope to have a good number of years ahead of me, so I continue to invest close to 100% (bar a small liquidity float) in equities.


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## NoRegretsCoyote (26 Jul 2021)

Colm Fagan said:


> Finally, I don't deny that I have been lucky since I started the ARF at end 2010. When I started, I expected to be able to take a 6% income each year and to keep the original capital intact (on average). Things worked out worse than expected in the first year, but I more than made up for that loss in subsequent years, so that every €1,000 at the start is now worth close to €1,850. If my _a priori _expectation had been realised, I would now be worth around €1,000,


I'm deliberately picking the worst 11-year period I can find, but between 1971 and 1982 and the S&P 500 lost about half of its value in inflation-adjusted terms.

If this had been your immediate experience after retirement, would you have persisted for the full 11 years with your original strategy of a 6% annual drawdown and full exposure to equities?


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## Duke of Marmalade (26 Jul 2021)

Sarenco said:


> So how do you explain the fact that the price of a dividend stock falls as soon as it goes ex-dividend?


Because it has less cash.  That was easy.
Let me recall from that text book the standard model of how our joint stock capitalist economy works.
A company is an organisation of capital and labour to sell goods or services to the community for which it receives turnover in the form of cash.  So it builds up a pile of cash to handle.  In the first place it will have to replace depreciating stock.  Then it might want to expand the enterprise by further investment.  Finally it has cash which it has no immediate use of and which would be better off in the hands of its investors.  It pays this residual cash out in dividends.  That is not in any way economically equivalent to a part sale of the enterprise.
Now the recipient may indeed wish to use the dividends to buy more stock in the second hand market, that is increasing her stake in the company.  In your example a reinvesting holder of ACME stock would finish the year with 20% more share of ACME than she began.
I think you would understand it better in a property context.  So take a rental property and just for more accurate analogy let it be held by a property company which manages the rents.  Periodically the rents are distributed to the owners.  This process naturally sees the worth of the holding company fall by the amount of the rents it distributes.  But this is not equivalent to selling the properties by any stretch.


Sarenco said:


> There is no expectation that Berkshire Hathaway will ever pay a dividend so how come its share price isn’t zero?


This is getting silly.  I am not an expert on BH but the first few lines of Wiki tell me it is a holding company.  So I am assuming it is somewhat like a fund.  Funds don't pay dividends either.  But on a look through we see that they are made up of the elementary text book examples of enterprises paying dividends.  It's just that they have undertaken to reinvest these dividends for their owners rather than distribute them.
Please don't ask me to explain the Tesla share price or the dotcom share prices of old.


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## Colm Fagan (26 Jul 2021)

NoRegretsCoyote said:


> I'm deliberately picking the worst 11-year period I can find,


HI @Sarenco.  I obviously can't put myself in the hypothetical situation you envisage, but I hope that I would always be guided by logic. And logic tells me that, by investing (say) 50% of my portfolio in bonds, I am sacrificing 2% a year in expected return.  Do you not agree with that simple argument?


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## NoRegretsCoyote (26 Jul 2021)

Colm Fagan said:


> And logic tells me that, by investing (say) 50% of my portfolio in bonds, I am sacrificing 2% a year in expected return


Of course. Over something like a 30-year horizon almost certainly equities will outperform bonds.

But for you: life expectancy of a 61-year-old male is about 22, and you have a desired withdrawal rate of 6% per annum. Therefore your investment horizon is a lot shorter than 30 years and a full equity allocation exposes you to sequence risk.

You've done great, and well done. But it's coincided with the best period for equities in a century. If you'd hit the worst period your strategy would have been a disaster.


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## Sarenco (26 Jul 2021)

Duke of Marmalade said:


> Because it has less cash


Exactly.  And that comes off the share price.


Duke of Marmalade said:


> Funds don't pay dividends either


There are accumulating funds and distributing funds (US mutual funds, for example, are required to distribute all income and realised capital gains).

Guess what?  The NAV per share of a distributing fund falls by the amount of the declared dividend as soon as the fund goes ex-dividend. 

Again, there is nothing magical about dividends.  Pocketing a dividend from a distributing fund is the same thing as redeeming shares to the value of the dividend in an accumulating version of the same fund.  The investor ends up in precisely the same financial position in either case.

Surely you can see that?


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## Duke of Marmalade (26 Jul 2021)

Sarenco said:


> Exactly.  And that comes off the share price.
> 
> There are accumulating funds and distributing funds (US mutual funds, for example, are required to distribute all income and realised capital gains).
> 
> ...


You are really making me tear my hair out at this stage, and it is thin enough.  I make straightforward examples and you cite exceptions to the rule such as dividend paying mutuals, or shares which are in effect funds, which are totally irrelevant to the point I am trying to make.  I will shout it one more time.

*TAKING A DIVIDEND IS NOT THE SAME ECONOMICALLY AS SELLING SHARES*

In more subdued tones "receiving a rent is not economically the same as selling a piece of the property".


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## Colm Fagan (26 Jul 2021)

NoRegretsCoyote said:


> But for you: life expectancy of a 61-year-old male is about 22,


Sadly, those of us in drawdown cannot plan on the basis of life expectancy.  We must plan on the assumption that we'll stay around for quite a while longer than the life expectancy for our age.  That's a common mistake by financial advisers. 
As a long-standing investor in real businesses, I view equity risk in a different light to theoretical investors.   I gave one example on pages 8 to 10 of my January paper, of one of my core investments, whose price fell by half despite the fundamentals of the business remaining broadly unchanged.  Another example is a company whose share I've held for at least seven years.  The dividend hasn't fallen once in the last eight years at least, and management has indicated that the dividend is safe for the next 20 years.  The dividend now is almost 50% more than it was 10 years ago.  Yet I can buy that share now for a dividend yield of 7%.   Its price now is over 50% higher than in March 2020.  Was I worried then? Am I worried now?  Do you think I should transfer some of the money earning a dividend yield of 7% to an asset that will yield me zero - or probably less?


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## Sarenco (26 Jul 2021)

Duke of Marmalade said:


> In more subdued tones "receiving a rent is not economically the same as selling a piece of the property".


Nobody said it was.  But receiving rent on a property is not analogous to receiving a dividend on a share.

Take your property holding company example.  The company receives rent on its property.  It now has a choice, it can retain the cash or it can distribute the cash to its shareholders.  

If it distributes the cash to its shareholders, the value of their shares will fall by an amount corresponding to the dividend payment. Alternatively, if it retains the cash on its balance sheet, this cash amount will continue to be reflected in the value of its shares.

So far, so good?

A shareholder wants the cash to pay his bills.  

If the company distributes the cash, then the shareholder will receive the cash and his shares will have a correspondingly lower value.  However, if the company retains the cash, the shareholder will have to sell shares (the value of which still reflects the retained cash) to generate the cash.

Either way, the shareholder ends up in exactly the same financial position - he either has the same number of shares with a lower value (because the cash has been distributed by the company) or less shares with a higher value (because the cash has been retained by the company).

Dividends are not an independent source of income that is disconnected from the share price or capital value of the shares to which they relate.  To think otherwise is sometimes called the "free dividend fallacy".


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## Colm Fagan (26 Jul 2021)

Sarenco said:


> Take your property holding company example. The company receives rent on its property. It now has a choice, it can retain the cash or it can distribute the cash to its shareholders.
> 
> If it distributes the cash to its shareholders, the value of their shares will fall by an amount corresponding to the dividend payment. Alternatively, if it retains the cash on its balance sheet, this cash amount will continue to be reflected in the value of its shares.


@Sarenco.  I think you're getting confused by cum-div and ex-div status for shares.  Of course the share price falls when the dividend is paid.  Get back to @Duke of Marmalade 's example of someone with a rental property, or my example cited above of a company paying a dividend of 7% a year like clockwork.  Yes, of course the share price falls by half of 7% every time the share goes xd.  So what?  I just hang around for the next half-year's dividend.


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## Sarenco (26 Jul 2021)

Colm Fagan said:


> Yes, of course the share price falls by half of 7% every time the share goes xd.


But that's the whole point!

You could equally sell shares to the value of 3.5% of your shareholding to generate the cash with the same net result.

Again, unlike rent on a property, dividends are not an independent source of income that is disconnected from the capital value of the shares to which they relate.


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## Colm Fagan (26 Jul 2021)

A financial adviser whom I hold in high regard once told me that one of his biggest challenges was persuading clients to overcome their fear of losing money and to realise that, as long-term investors, they would be far better advised to invest in equities than bonds.  This is despite what I could describe as the adviser's curse, quoted earlier:


Colm Fagan said:


> We all worry about our money, and get upset if we make a loss on an investment. For a financial adviser, there is the additional trauma that the client could blame you for the loss even though your advice to invest in something could be absolutely kosher in probability terms. The problem for the financial adviser is that they are on a hiding to nothing. The client is likely to apportion at least part of the blame to the adviser if things go wrong, but to take the credit themselves if things go right. This makes the adviser even more loss-averse than the client, because of the asymmetrical payoffs. Rather than it being the reverse (as it should be in a rational world), the client has often to overcome the adviser's loss aversion. There are some notable exceptions.


Against that background, it is depressing to find advisers on this forum doing everything they can to frighten people off investing in equities.
One of the most ridiculous is this:


Marc said:


> Imagine an investor that earns 10% on her portfolio in one year, and then loses 10% the next. The common mistake is to think that the investor would now be back to where she started. After all, the average of the two annual returns of +10% and-10% is simply 0%.
> 
> In actual fact, our investor would have lost 1% over the two years!
> 
> ...


Later, the same poster refers to prices being distributed lognormally, meaning that their logarithms are distributed normally.  Translated into English, this means that the probability of a gain of 10% (over a very short period) is exactly the same as a loss of 9.09%.  So why did @Marc choose to assume a loss of 10%?  Was the purpose to frighten clients off investing in a volatile asset?  That is exactly the opposite of what my financial adviser friend says is the challenge with his clients. 
The same objective of frightening people off investing in equities is evident in the rubbish about arithmetic and geometric means, and in the reference to the so-called "volatility drag"
A simple example will show why arithmetic means are meaningless in this type of situation.  Suppose I am considering an investment returning 0% in the first year and 12% in the second year.  No one would be stupid enough to say that the average return over the two years is 6% a year (12% divided by 2).  Anyone with a brain in their head will at least start by calculating what return they would need each year, reinvesting the proceeds, to have 112 after two years, which is 5.83%.  If they're in the honours class, they may go on to calculate what they would need to earn if the return was paid half-yearly (5.75%).  The 6% is a meaningless calculation, so I don't know why anyone bothers with it. 
Then we get the reference to "Volatility drag". 



Marc said:


> VOLATILITY DRAG
> 
> This unfortunate effect is due to the fact that compound annual returns are always below average annual returns.


If anything, one could interpret the latter part of this post as saying that it should be called a volatility bonus rather than a volatility drag, because the expected return under @Marc's favoured lognormal distribution is e^(µ +0.5*σ^2).    Thus, for any given µ, the higher the volatility (σ), the higher the expected return.  @Marc should therefore be looking for investments with high σ for his clients!
In saying all that, I confess that I'm not an expert on stochastic calculus.  I'm sure there are some such experts who will set us both right.


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## Colm Fagan (26 Jul 2021)

@Sarenco.  I can see why the Duke got frustrated.  All other things being equal, the share price falls by half of the dividend payment at a moment in time every half year, then recovers all that loss evenly over the following six months so that the price is exactly the same every six months.  The only difference being that the investor has received a half-year's dividend in the meantime.  (I am assuming, of course, no change in the capital value of the share).


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## NoRegretsCoyote (26 Jul 2021)

Colm Fagan said:


> Sadly, those of us in drawdown cannot plan on the basis of life expectancy. We must plan on the assumption that we'll stay around for quite a while longer than the life expectancy for our age.


Okay so add 50% to your life expectancy at 61.

Your investment horizon is still not long enough to recover from a bad sequence of returns.

I'm still curious as to why you won't answer if your ex ante strategy could have dealt with the opposite set of equity performance than has occured since 2010.


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## Duke of Marmalade (26 Jul 2021)

Sarenco said:


> If the company distributes the cash, then the shareholder will receive the cash and his shares will have a correspondingly lower value.  However, if the company retains the cash, the shareholder will have to sell shares (the value of which still reflects the retained cash) to generate the cash.
> 
> Either way, the shareholder ends up in exactly the same financial position - he either has the same number of shares with a lower value (because the cash has been distributed by the company) or less shares with a higher value (because the cash has been retained by the company).


I think this gives me something on which  to hang my refutation of your argument.  Take a simplified example with distorted relativities.  Let the company be either a property company or a widget making company.
The company is valued at time 0 at 1,100.  This consists of 1,000 worth or property or a widget making machine plus 100 in the bank which has accrued from rents or sales of widgets.  So the balance sheet of the investor at time 0 looks as follows:
Shares in company  1,100
Now she needs 100 cash.  Either:
(A) She sells 1/11th of her shares in the company in which case her balance sheet looks as follows:
Shares in company  1,000
Cash 100
Or:
She waits till afternoon when the company pays a dividend of 100.  Her balance sheet now looks like:
Shares in company 1,000
Cash 100
I think we actually agree so far.  And indeed the ex post balance sheet looks identical between A and B which I think is your argument.  It looks very much like both scenarios have reflected a reduction in the investor's interest in either property or widget making to fund 100 cash.
But on a look through the two situations are quite different.  The look through balance sheets are as follows:
A)
Value of property/widget machine 909
Cash in company 91
Cash in bank 100
B)
Value of property/widget machine 1,000
Cash in bank 100
It is clear that in (A) there has been a genuine reduction in "real" assets whilst in (B) this is not the case.
You will tell me that in (A) when the company pays the 91 in dividends the investor will buy shares in the company to put her in the same position as (B).
Your assertion then becomes that if there is full reinvestment of dividends then, subject to minor timing differences, withdrawing dividends is the same as selling shares.  Actually what you are saying is that withdrawing  dividends is the negation of reinvesting  and I will agree that the negation of reinvesting is economically the same as selling.
But leaving aside the angels dancing on pins debate I stand by the assertion that to the extent that withdrawals are funded from dividends one is not exposed to the whims of how the market is valuing the widget maker or property and is not exposed to sequence risk.


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## Colm Fagan (26 Jul 2021)

NoRegretsCoyote said:


> Your investment horizon is still not long enough to recover from a bad sequence of returns.
> 
> I'm still curious as to why you won't answer if your ex ante strategy could have dealt with the opposite set of equity performance than has occured since 2010.


I'll be more than happy to prove that it is.   I presume you'll accept my a priori assumption of a 4% ERP?  

Also, tell me which historic 30 years you'd like me to simulate as the worst possible experience.  

I don't presume, by the way, that you're expecting me to run time backwards since 2010?!


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## Colm Fagan (26 Jul 2021)

@NoRegretsCoyote 
I've tried to put some numbers on our discussion.  The example chosen is simple, but hopefully sufficient for illustration purposes.
The investor has €1,000,000 and has decided to withdraw €45,000 level each year.
They have a choice of two investments:
(a) 100% in equities, which return -30% in the first year, then 6% a year from there on.
(b) 50% in equities, with the same returns as (a), the other 50% in bonds, which return a level 2% a year (i.e. an ERP of 4% after year 1). 
Each year, the withdrawal of 45k is taken from equities or bonds in proportion to their value at the time.

After 30 years, the residual fund value under (a) is 235k; under (b), the residual fund value is 150k.


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## Sarenco (26 Jul 2021)

Sarenco said:


> Failing to reinvest dividends is precisely the same thing economically as selling shares that produced those dividends.





Duke of Marmalade said:


> I will agree that the negation of reinvesting is economically the same as selling.


Thank you, that was always my point.


Duke of Marmalade said:


> I stand by the assertion that to the extent that withdrawals are funded from dividends one is not exposed to the whims of how the market is valuing the widget maker or property and is not exposed to sequence risk.


I thought we just agreed that failing to reinvest dividends (at whatever share price the market determines) is economically the same as selling those shares?  It's just another way of spending down a portfolio, which is where sequence risk arises.


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## Colm Fagan (26 Jul 2021)

Sarenco said:


> It's just another way of spending down a portfolio, which is where sequence risk arises.


I trust that my reply to @NoRegretsCoyote (#92 above) has addressed the sequence risk to your satisfaction?


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## Brendan Burgess (26 Jul 2021)

Colm Fagan said:


> They have a choice of two investments:
> (a) 100% in equities, which return -30% in the first year, then 6% a year from there on.
> (b) 50% in equities, with the same returns as (a), the other 50% in bonds, which return a level 2% a year (i.e. an ERP of 4% after year 1).



They are very interesting figures. 

If the fall is 30% and the return is 6% after that, then the 100% equity allocation is better.

The problem would be if there was a sustained fall of 30% over 10 years. Then I presume that investing in bonds would have been better. 

It seems clear to me that under most circumstances, 100% equity allocation will be better. 

But there must be circumstances where the person would have been better investing in bonds rather than equities. 

But the conditions in the world are mad today.  We could have a huge crash in equities or bonds or both. I am sure that equities will recover in time. But will the drawdown deplete the fund so much that it won't have a chance of recovering? 

Brendan


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## Sarenco (26 Jul 2021)

Colm Fagan said:


> Each year, the withdrawal of 45k is taken from equities or bonds in proportion to their value at the time.


Why wouldn't you withdraw €45kpa from the bond portfolio until your equity portfolio had recovered to its original value?  Or rebalanced back to the original 50/50 allocation at the end of the first year?


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## Duke of Marmalade (26 Jul 2021)

Sarenco said:


> I thought we just agreed that failing to reinvest dividends (at whatever share price the market determines) is economically the same as selling those shares?  It's just another way of spending down a portfolio, which is where sequence risk arises.


That negation to reinvest is equivalent reinvesting followed by selling is a logical truism. This does not mean at all that selling is the economic equivalent of receiving dividends.  So let me go back to an earlier tack which has a relevance beyond our theological debate.  I want to start by stating what I think is a logical truism - a Premise followed by a Conclusion based on that premise.  The Premise itself is open to debate as to the extent of its applicability but before we go there I want to establish the tautology.
*Premise*
The actual dividend pay-outs of the company are independent of changes in the market value of its share price.
*Conclusion*
To the extent that a withdrawal strategy is based on dividends, changes in market value are irrelevant and there is therefore no sequence risk.

Do you accept the tautology?

I hope so.  We can then move on to discuss the appropriateness of the premise.  Colm has cited a share with a healthy dividend which seems pretty nailed on for the foreseeable future.  I don't think he has any intention of selling those shares in the near future so he would appear not to be concerned by market values or to be facing any sequence risk at least in respect of this share.


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## Sarenco (26 Jul 2021)

Duke of Marmalade said:


> The actual dividend pay-outs of the company are independent of changes in the market value of its share price.


But dividend pay-outs are not disconnected from a company's share price!  

We're just going around in circles at this stage...


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## Duke of Marmalade (26 Jul 2021)

Sarenco said:


> But dividend pay-outs are not disconnected from a company's share price!


Agreed, but to the extent that they are disconnected (as in Colm's high dividend example) and are more tied to economic fundamentals, they are not subject to sequence risk.  
Share sales are completely related to market values and so are totally exposed to sequence risk.  It is wrong to regard dividends as identical to share sales in respect of sequence risk.


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## Colm Fagan (26 Jul 2021)

Brendan Burgess said:


> The problem would be if there was a sustained fall of 30% over 10 years. Then I presume that investing in bonds would have been better.


@Brendan Burgess   I would think so as, on the assumption of an equal drop every year, it would imply equity underperformance relative to expectations of 9% every single year for the first ten years. In similar vein, I'm also sure that, if I assumed that equities dropped 100% in year 5, the client would be better advised to put their money in bonds 

What surprises me about this thread is how many posters, some of whom are probably financial advisers, go out of their way to try to convince people NOT to invest in equities when, as my friend the good financial adviser says, the financial adviser's primary challenge is to convince clients to be LESS loss averse than is in their nature.   

Presumably with the same intent of frightening investors off equities, someone (not sure who) wrote on this thread that there were ten-year stretches in the past when bonds outperformed equities.  I would guess that, on all or nearly all such occasions, bond yields fell by 3% to 5% over the ten-year period.  If bond yields were to fall from their current levels by 3% to 5% over the next ten years, God help us all!



Sarenco said:


> Why wouldn't you withdraw €45kpa from the bond portfolio until your equity portfolio had recovered to its original value? Or rebalanced back to the original 50/50 allocation at the end of the first year?


I could have made lots of assumptions.  I'm not sure why I chose the approach assumed in the spreadsheet.  In some ways, a more natural approach would have been to assume a 50:50 split of withdrawals each year between bonds and equities.    I tried that first, but found that the bond portfolio had gone negative by the end.  It is doubtful if a real life investor would follow the withdrawal pattern you suggest.  Do you really think they would want to run down their bond portfolio in favour of boosting their equity portfolio as they got older?  Not even an ageing Colm Fagan would try that!


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## Sarenco (26 Jul 2021)

Colm Fagan said:


> It is doubtful if a real life investor would follow the withdrawal pattern you suggest


Well, a balanced fund (which I imagine most real life investors hold in their ARFs) would rebalance periodically to maintain a consistent asset allocation.  

If you rebalanced the portfolio following a drawdown in the equity portfolio, you would obviously increase the impact of the subsequent equity returns, while maintaining the original allocation.


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## Sarenco (26 Jul 2021)

Duke of Marmalade said:


> ...but to the extent that they are disconnected...


But they cannot be disconnected to any extent - dividend payments simply come off of the share price (as determined by the market).

We are obviously talking at cross purposes so I will leave it there.


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## SPC100 (26 Jul 2021)

NoRegretsCoyote said:


> @Gordon Gekko
> 
> You are arguing against points I haven't made and are forgetting your original comparison which was a basket of equities compared to retail deposits. The latter would never make any sense for anyone with a decades-long investment horizon.
> 
> ...



Aside: what was the return for an Irish investor! Irish retirees care less about the local gbp experience and more about the Irish/euro experience.


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## Marc (26 Jul 2021)

Spud50 said:


> thanks for the informative discussion ,one of the concerns i have is with drawing down 4% from the ARF , paying tax/stamp , AMC , brokers  trailing fee etc., if i dont invest my pension Longterm in Global equities (s&p500) to counter the above secondary drawdowns  then the sum will prob run out anyway , so to me there are risks on both sides ,



this is the crux of the issue.

this is first and foremost a financial planning question as I set out in this post 





__





						Buy out Bond - what are my options
					

I have a few questions on Buy out bonds and whether I should take one out or not.   I am currently in a Company DC pension , im in my mid 50’s and my intention is to leave the company next year and life off investments for approx 5 years before setting up an ARF   If I take out a BOB, can I...



					www.askaboutmoney.com
				




The endless debating of an objectively imprudent investment strategy is simply a side show


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## Colm Fagan (26 Jul 2021)

Sarenco said:


> Well, a balanced fund (which I imagine most real life investors hold in their ARFs) would rebalance periodically to maintain a consistent asset allocation.
> 
> If you rebalanced the portfolio following a drawdown in the equity portfolio, you would obviously increase the impact of the subsequent equity returns, while maintaining the original allocation.


Your wish is my command!
I re-did the sums, assuming the portfolio was rebalanced each year-end, aiming always for a 50:50 distribution between bonds and equities (but purely by splitting the total withdrawal between bonds and equities, not by selling bonds).  This resulted in the entire withdrawal being taken completely from the bond portion of the portfolio for the first three years, and being taken more from equities than bonds in subsequent years (because of the differential performance of the equities).  The final fund value on this assumption was 152, compared with 150 on the alternative assumption, and 235 assuming 100% in equities throughout.  I think I've proved my point, no matter how you look at it.


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## Gordon Gekko (26 Jul 2021)

Hi Colm,

Would you consider just paying the tax in a ‘down year’ and not taking the full distribution?

i.e. you’re not compelled to take 6% and could choose to just lose less than 3% in a down year


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## NoRegretsCoyote (26 Jul 2021)

SPC100 said:


> Aside: what was the return for an Irish investor! Irish retirees care less about the local gbp experience and more about the Irish/euro experience.


There aren't reliable statistics but probably something pretty similar given currency union and economic integration with the UK.


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## Colm Fagan (26 Jul 2021)

Gordon Gekko said:


> Would you consider just paying the tax in a ‘down year’ and not taking the full distribution?


Hi Gordon.  No is the quick answer.  I recall once looking at this option briefly and concluding that it was equivalent to throwing money down the drain.  It's too late for me to revisit my logic, but if no-one else responds, I'll try to get back to you in the morning.
In any event, as I said in a previous post, I've never been 'embarrassed' into having to sell investments in order to withdraw the ARF income.  I keep a small cash float, generally in the region 2% to 5%.  That, plus dividend receipts, plus the occasional share sale (decided on for portfolio reasons,  because the share has fallen out of favour) have always proved sufficient to generate the necessary funds.  As I think I said earlier, I withdraw monthly.  That was not always the case, especially when I earned a reasonable income from part-time work (which is no longer the case).  I withdrew at odd times during the year, but always withdrew what was required for tax purposes.


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## Sarenco (26 Jul 2021)

Colm Fagan said:


> I re-did the sums, assuming the portfolio was rebalanced each year-end, aiming always for a 50:50 distribution between bonds and equities (but purely by splitting the total withdrawal between bonds and equities, not by selling bonds).


But how do you rebalance back to a 50/50 allocation without selling bonds to buy equities at the end of Year 1?  I don't follow.


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## Duke of Marmalade (26 Jul 2021)

Sarenco said:


> But they cannot be disconnected to any extent - dividend payments simply come off of the share price (as determined by the market).
> 
> We are obviously talking at cross purposes so I will leave it there.


Yes we'll leave it there.  You cannot or will not see the point.  Maybe my pedagogical shortcomings.
I will take the opportunity of the last word.
Taking a dividend is not in any way economically the same as selling the shares no more than receiving rents is economically the same as a part sale of a property.


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## Gordon Gekko (26 Jul 2021)

Colm Fagan said:


> Hi Gordon.  No is the quick answer.  I recall once looking at this option briefly and concluding that it was equivalent to throwing money down the drain.  It's too late for me to revisit my logic, but if no-one else responds, I'll try to get back to you in the morning.
> In any event, as I said in a previous post, I've never been 'embarrassed' into having to sell investments in order to withdraw the ARF income.  I keep a small cash float, generally in the region 2% to 5%.  That, plus dividend receipts, plus the occasional share sale (decided on for portfolio reasons,  because the share has fallen out of favour) have always proved sufficient to generate the necessary funds.  As I think I said earlier, I withdraw monthly.  That was not always the case, especially when I earned a reasonable income from part-time work (which is no longer the case).  I withdrew at odd times during the year, but always withdrew what was required for tax purposes.


Thanks Colm.

I wonder about the logic of it.

Say my ARF is worth €2m and to keep things simple my marginal rate of tax is 50%.

I can take my 6% as normal, i.e. €120k, net €60k.

Then my ARF is worth €1.88m and I’ve €60k in cash.

If I invest the €60k, my returns will be subject to CGT and marginal rate income tax.

Assuming their CAT thresholds will be used up, my kids will pay 33% CAT if they inherit the €60k.

Alternatively, I could just ask my QFM to pay 3% of the value of the ARF, i.e. €60k to Revenue, leaving €1.94m in my ARF.

The ‘other’ €60k is now still in the ARF so it can grow tax-free. And if my kids inherit it, they’ll only pay 30% tax.

Regards,

Gordon


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## ArthurMcB (26 Jul 2021)

Isnt the rent analogy somewhat incorrect because rent is not paid out of the value of the house - its an income derived from the house but its payment doesnt reduce the value of the house.

Whereas, If share value is based on value of the company and if distributing cash dividends from that company to shareholders reduces cash reserves in the company would that not mean the value of the company and therefore the share value is reduced by the dividend amount?


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## Duke of Marmalade (26 Jul 2021)

ArthurMcB said:


> Isnt the rent analogy somewhat incorrect because rent is not paid out of the value of the house - its an income derived from the house but its payment doesnt reduce the value of the house.


Dividends are paid from income earned by the real assets of the company not by sale of those real assets.  Totally analogous.


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## Colm Fagan (26 Jul 2021)

Sarenco said:


> But how do you rebalance back to a 50/50 allocation without selling bonds to buy equities at the end of Year 1? I don't follow.


Do you realise how petty you're being?  I already wrote: "I re-did the sums, assuming the portfolio was rebalanced each year-end, aiming always for a 50:50 distribution between bonds and equities (but purely by splitting the total withdrawal between bonds and equities, not by selling bonds)."
I'll say it again, slightly differently in case you didn't get it the first time:  I'm AIMING for a 50:50 distribution, but not to the extreme of selling bonds to achieve that aim.  That means taking the withdrawal entirely from the bond portfolio for the first three years.  
I really don't understand why you're labouring this point.  We have already seen that the first refinement you asked for makes very little difference.  The additional refinement of allowing for bonds to be sold in the first year would probably change the result by tuppence halfpenny.  So what?   
@Gordon Gekko   I haven't really looked at your latest note.  Sorry.  I'll get back to you on your far more sensible question tomorrow, if no-one else has addressed it in the meantime.


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## NoRegretsCoyote (27 Jul 2021)

Colm Fagan said:


> They have a choice of two investments:
> (a) 100% in equities, which return -30% in the first year, then 6% a year from there on.
> (b) 50% in equities, with the same returns as (a), the other 50% in bonds, which return a level 2% a year (i.e. an ERP of 4% after year 1).
> Each year, the withdrawal of 45k is taken from equities or bonds in proportion to their value at the time.
> ...


There is a bit of sleight of hand here Colm. You are putting all the equity losses into the period before most of the drawdowns have been made!

Spread the 30% loss over the first five years, then assume a more aggressive recovery to get the same average return over the period. So about a 7% negative return for 5 years, then a positive 7% return for the next 25 years.

In this scenario the residual value of the fund under (a) is -€113k, and (b) is -€24k. So basically there is too much drawdown in the yearly years for you to be able to grow your way out of trouble. In the scenario with 50% bonds they actually do have the effect of mitigating the sequence risk on the equity share of the portfolio, despite having a much lower average return, and you nearly break even.

Don't get me wrong. I am not a bond fanatic. An equity risk premium exists, and the younger you are the more heavily you should be invested in equities. At age 40 you should be thinking about the value of your portfolio in 50 years time, not in 25 when you'll retire and over that horizon equities will almost always do better. 

I've said earlier on this thread that there is basically no upside to bond prices right now given that yields are at or close to their natural floor given the zero lower bound for interest rates. So if bonds outperform equities in the near future it will very likely be because of falls in equity prices, not increases in bond prices.

But, and this is a big but, an all-equity investment strategy in retirement can have a nasty downside given the difficulty of growing your way out of a very bad set of returns earlier in the period as demonstrated. If it was me at 65 with a full SPC, mortgage paid off and kids through college I would aim to be in about 80% equities and gradually reduce that to 50% by 85. 

Otherwise I don't think that any ex ante strategy is totally robust to every set of circumstances. It makes sense to deviate if the world changes around you by rebalancing or changing your lifestyle. You've done every well - and I'm glad for you - but it's been a lucky time and place to do so and I doubt the next 11 years will be as fruitful as the last!


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## Colm Fagan (27 Jul 2021)

NoRegretsCoyote said:


> There is a bit of sleight of hand here Colm. You are putting all the equity losses into the period before most of the drawdowns have been made!


Yes!  That was what was asked of me!   I gave the history of how my ARF had performed, to be told that I was lucky not to have experienced a severe fall at the start.  I duly obliged by showing the result if I had experienced  that severe fall at the outset.


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## Colm Fagan (27 Jul 2021)

NoRegretsCoyote said:


> Spread the 30% loss over the first five years, then assume a more aggressive recovery to get the same average return over the period. So about a 7% negative return for 5 years, then a positive 7% return for the next 25 years


So you're asking me to assume a 12% loss relative to expectations each year for the first five years, a cumulative 60% loss relative to expectations (but bearing in mind my earlier comments about arithmetic calculations in such circumstances) ?
I don't need to do any sums to know that that would spell curtains!


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## kinnjohn (27 Jul 2021)

It is great to see posters on here prepared to get involved in the above discussion,

thanks to all of you for getting involved and not standing on the sideline,


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## Brendan Burgess (27 Jul 2021)

Guys
This is a very important issue.
Can we keep the discussion on topic. 
Feel free to disagree, but don't question each other's motivation or make personal attacks.

Brendan


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## Colm Fagan (27 Jul 2021)

Boss!  Noted!


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## Colm Fagan (27 Jul 2021)

Gordon Gekko said:


> If I invest the €60k, my returns will be subject to CGT and marginal rate income tax.
> 
> Assuming their CAT thresholds will be used up, my kids will pay 33% CAT if they inherit the €60k.


Hi Gordon.  It was at this point I came unstuck the last time someone tried to persuade me of the reasonableness of what you're proposing. 
Firstly, I'm not investing the €60k.  I'm spending it!  Secondly, even if I don't spend it all, I can always give some of it to the children and grandchildren.  As I recall, between the other half and myself, we can gift each of them €6k a year tax-free - not that I would want to claim to be that generous with them!  That immediately eliminates any problems of CAT and CGT!


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## Duke of Marmalade (27 Jul 2021)

NoRegretsCoyote said:


> There is a bit of sleight of hand here Colm. You are putting all the equity losses into the period before most of the drawdowns have been made!
> 
> Spread the 30% loss over the first five years, then assume a more aggressive recovery to get the same average return over the period. So about a 7% negative return for 5 years, then a positive 7% return for the next 25 years.


When I first read this I really had to scratch my head.  How could 30% loss eased in over 5 years be worse than 30% loss day 1?  Colm has already challenged the comparison.  The way I see it now is as follows.  The unstressed assumption is for a steady 5% p.a. return.  Colm's initial stress was for an immediate 30% hit which remains in place throughout.  The "30% over 5 years" stress in the above post is in fact a stress which peaks at 45% after 5 years!

There is indeed sleight of hand at work here and it initially threw me.  _NoRegrets_, I am not accusing you of a deliberate misrep as I find your posts very good in general.  Perhaps you "sleighted" yourself as you did me and possibly @Marc was also "sleighted" but I am sure he can speak for himself.


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## Colm Fagan (27 Jul 2021)

Duke of Marmalade said:


> There is indeed sleight of hand at work here and it initially threw me. _NoRegrets_, I am not accusing you of a deliberate misrep as I find your posts very good in general. Perhaps you "sleighted" yourself as you did me and possibly @Marc was also "sleighted" but I am sure he can speak for himself.


@NoRegretsCoyote.  I too believe that you weren't trying to pull a fast one with your post.  I also agree with the Duke on the quality of your posts.  I am sorry if I gave the wrong impression with my initial reply.   To be honest, I was more put out by the 'like' from @Marc .  It would be nice if he could engage with me on the questions I asked him on some of his posts, e.g. his learned references to lognormal distributions, volatility drag, arithmetic versus geometric means, etc.


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## NoRegretsCoyote (27 Jul 2021)

Thanks @Colm Fagan I greatly enjoy your posts and I think everyone is arguing in good faith. I'm on holidays and don't have hours to run scenarios in any case.

Maybe my assumption of a 30% cumulative loss of the first five years is unrealistic. Historically, you tend to get double-digit annual declines followed by more gradual growth. I think I still have a point that relatively small but sustained losses in the early years can leave you without enough remaining to grow yourself out of trouble. 



Duke of Marmalade said:


> The "30% over 5 years" stress in the above post is in fact a stress which peaks at 45% after 5 years!


You won't find this in the US experience, but you will find periods as bad in other equity markets. For example Japan.


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## Duke of Marmalade (27 Jul 2021)

@NoRegretsCoyote
I am not saying that 45% fall from ATH is outlandish.  It was just that the initial read of your post had me thinking that you were making a "timing" or, in the jargon, a "sequencing" point.
In reality your "30% over 5 years" versus Colm's 30% day 1 is fundamentally a stiffer stress, not related to sequencing or timing.  If you had said that a 45% fall after 5 years is worse than a 30% fall day 1 it would have elicited a "so what" from me.


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## Steven Barrett (27 Jul 2021)

I looked at returns going back to 1995 and picked different investment periods. I assumed an ARF of €1m invested in the MSCI World Index with 4% annual withdrawal and another with a €40,000 annual withdrawal. In the different time periods I looked at there was no bomb out of funds with the exception of one. 

If you invested before the crash in 2000 and made no adjustment to your withdrawal amount, continuing to take €40k a year, you would have run out of money...last year. 

If you had taken 4% of the fund, it would have fallen to €305,000 at its lowest point and your income would have been €12,200 but you would still have a pot. 

I am not advocating investing in 100% equities in retirement but taking income as a percentage instead a fixed amount will help you preserve the value of the ARF. Whether €12,200 is enough for you to live on is another issue. 


Steven
www.bluewaterfp.ie


*I would have stuck up graphs but the Insert Image icon asks for a url, which I don't have so if someone can tell me what to do instead, I'll put them up.


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## Duke of Marmalade (27 Jul 2021)

Steven Barrett said:


> *I would have stuck up graphs but the Insert Image icon asks for a url, which I don't have so if someone can tell me what to do instead, I'll put them up.


I presume the graphs are in Excel.  Either of two methods.
Attach the file.  This method is less immediate to the reader.
Copy Picture the graph and Paste into your post.  (Copy Picture works slightly differently for different versions of Excel, you may have to Google it.)
Actually I can't get Copy and Paste to work in this thread, it works in other threads.


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## Steven Barrett (27 Jul 2021)

Duke of Marmalade said:


> I presume the graphs are in Excel.  Either of two methods.
> Attach the file.  This method is less immediate to the reader.
> Copy Picture the graph and Paste into your post.  (Copy Picture works slightly differently for different versions of Excel, you may have to Google it.)
> *Actually I can't get Copy and Paste to work in this thread, it works in other threads*.


I was trying to copy and paste and it wouldn't work for me either. I don't see where the attached file is gone to either.


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## Duke of Marmalade (27 Jul 2021)

Steven Barrett said:


> I was trying to copy and paste and it wouldn't work for me either. I don't see where the attached file is gone to either.


Attach File has gone for me too.  Marc seems to be a dab hand at it, maybe he can help.


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## Colm Fagan (27 Jul 2021)

NoRegretsCoyote said:


> You won't find this in the US experience, but you will find periods as bad in other equity markets. For example Japan.


Ah, Japan starting in 1990!  It is the one that is always trotted out to prove that it's stupid to invest everything in equities!  Changing the subject slightly, I chose Japan in the 30 years starting from 1990 as the "adverse scenario" for my proposed smoothed equity approach to auto-enrolment (in the paper I presented in January last - Section 8).  The AE scheme I am proposing - with 100% in equities throughout - survived that simulated experience.  However, I don't have to do the sums to confirm that my ARF wouldn't have survived it.  It's not something that concerns me unduly, though.   
I prepared a couple of slides on Japan for a presentation a few years ago.   I can't copy them, but here is some of the text:   
*(a) Japan in the 1980’s: tulipmania on steroids*

Imperial palace in Tokyo supposedly worth as much as the entire state of California
In 1990, total stock of property in Japan was four times the value of US property stock
Topix Index more than trebled between December 1984 and December 1989
Nippon Telephone and Telegraph floated in 1987 at a P/E of 250
At end 1991, despite the already steep falls in stock prices and a rising tide of bad loans, Tokyo’s banks’ shares traded at an average P/E of c60
(*b) Japan in the 1990's:  the bust and the long hangover*

Index fell by over 70% from its peak in December 1989 to its nadir in March 2003
Hangover prolonged (for decades) by failure to deal with zombie banks and zombie corporates, which were kept on life support when it would have been far better to have let them die
As I wrote in the January paper, while a few stocks are in tulipmania territory at the moment, the market as a whole is far from where Japan was before the bust, so I think I'm OK.


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## Marc (27 Jul 2021)

Duke of Marmalade said:


> Attach File has gone for me too.  Marc seems to be a dab hand at it, maybe he can help.



Yes I noticed the new website made it impossible to cut and paste from the clip board.

I have created a landing page on my website where I drop image files

I then copy the image address into the insert image icon which only accepts a URL


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## Duke of Marmalade (27 Jul 2021)

Marc said:


> Yes I noticed the new website made it impossible to cut and paste from the clip board.
> 
> I have created a landing page on my website where I drop image files
> 
> I then copy the image address into the insert image icon which only accepts a URL


The weird thing is that some AAM threads do allow Attach File and Copy & Paste but not this thread.


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## NoRegretsCoyote (28 Jul 2021)

Colm Fagan said:


> Ah, Japan starting in 1990! It is the one that is always trotted out to prove that it's stupid to invest everything in equities!


I don't make that claim. It's just a useful example of an equity market getting detached from fundamentals for a sustained period.

Anyway if I am guilty of cherrypicking a time and place with awful returns you are equally guilty of "just so" storytelling to explain away why it was obviously a bubble _ex ante_


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## Colm Fagan (28 Jul 2021)

Hi @NoRegretsCoyote.  My remark wasn't aimed at you specifically.  It's just that I've had Japan in the 1990's rammed down my throat by various people over the last three years, ever since I first suggested a smoothed 100% equity approach to pension investment.  I took their challenge seriously and devoted an entire section (Section 8, pages 36 to 40) of my January paper to an exploration of how things would have worked out if the market were to suffer a Japan-style collapse just after the launch of auto-enrolment based on the smoothed equity approach I'm proposing.   As I showed in the paper, it would have come through it very well.  As I have also said, my ARF would not survive intact if that were to happen now.  On the other hand, if we were now in a pre-Japanese-crash scenario, I would not be enjoying a secure dividend yield of 7% a year on the top holding in my ARF portfolio, so the possibility doesn't concern me.  As far as cherry-picking is concerned, I have only one life and one ARF experience.  That's what I recounted.  I can't cherry-pick another life for myself.


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## Sarenco (28 Jul 2021)

Steven Barrett said:


> If you invested before the crash in 2000 and made no adjustment to your withdrawal amount, continuing to take €40k a year, you would have run out of money...last year.


Hi Steven

Deciding to start spending down an all equity portfolio from 2000 certainly turned out to be an unfortunate choice.

I wonder would it be possible to re-run the simulation based on a 60/40 portfolio of global equities and global bonds (euro hedged), ideally rebalanced annually?  

I don't have the data to run that simulation myself but I suspect a balanced portfolio of that nature would have produced a materially better outcome.


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## Steven Barrett (28 Jul 2021)

Sarenco said:


> Hi Steven
> 
> Deciding to start spending down an all equity portfolio from 2000 certainly turned out to be an unfortunate choice.
> 
> ...


I ran those figures based on 60/40 portfolio, rebalanced quarterly. If there was no adjustment of €40k annual income, you'd have €63,600 today and would be looking at bomb out. Reducing your withdrawals from the fund in severe downturns is key to surviving it. People who retired in 2000 were hit the hardest as they had two big recessions in one decade. 


Steven
www.bluewaterfp.ie


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## Sarenco (28 Jul 2021)

Steven Barrett said:


> If there was no adjustment of €40k annual income, you'd have €63,600 today and would be looking at bomb out.


So the portfolio would have survived a few more years.

Point taken that reducing withdrawals is key.


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## Steven Barrett (28 Jul 2021)

Sarenco said:


> So the portfolio would have survived a few more years.
> 
> Point taken that reducing withdrawals is key.


Just about, yes


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## SPC100 (29 Jul 2021)

But there is the forced withdrawals needed to pay tax on the required distributions. So their is a minimum required withdrawal.


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## SPC100 (29 Jul 2021)

Sequence risk seems to be mostly problematic with falls in asset values occur at the start of drawdown.

If you retire into growth years, assuming you are spending less than observed growth your fund builds up a buffer, which protects against later falls.

Keeping this in mind things I have considered to protect against selling, especially during falls in the first 5 years.

Create a 'temporary' cash/bond buffer to cover some of the initial years spending. Spend that first. If times are good rest of fund grows. If times are bad you are not selling your falling equity (which increases bomb out risk/reduced future income). You do give up the expected equity returns of this buffer during the temporary period though.

Have another income source e.g. annuity, rent, job, state pension. We all need some minimal spending to not starve. The more of that which comes from another source, the more we can choose not to drawdown during falling markets.  I think I include dividends here from shares that I would never sell, but I don't think either of ye clearly proved that. It's probably worth it's own thread.

Reduce lifestyle/withdraw less


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## Marc (29 Jul 2021)

SPC100 said:


> Sequence risk seems to be mostly problematic with falls in asset values occur at the start of drawdown.
> 
> If you retire into growth years, assuming you are spending less than observed growth your fund builds up a buffer, which protects against later falls.
> 
> ...



@SPC100 has this about 100% accurate

there is cash drag from keeping a cash buffer so you are generally better off with short term fixed income.

Research by Eugene Fama at the University of Chicago and other respected academicians has shown that longer-term bonds historically have had wide variances in their rates of total return without sufficiently compensating investors with higher expected returns.[1] In terms of variability of total return, long-term bonds look more like stocks than shorter-term fixed-income vehicles such as Treasury bills.

In a PENSION you need a reliable short-term *liquidity fund *which provides a positive correlation with inflation and a premium over an equivalent cash deposit







In the more recent past this still works perfectly well






Picking up a nice consistent premium over cash and a hedge against inflation but without going nuts with risk, which is the primary objective






[1] For example, see Edward L. Martin, “Intermediate-Term Bonds,” _AAII Journal_, January 1991, pp. 13-16.

The only tweaks that improve portfolio survival are to rebalance every time you withdraw as that captures any mean reversion in asset classes.

there is also a tax optimisation aspect which is peculiar to the Irish tax code and counterintuitive but otherwise a near perfect answer.

it’s all in here









						Demonstrating our value v8.0
					

Joomag digital interactive publication




					joom.ag


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## Gordon Gekko (29 Jul 2021)

Marc said:


> @SPC100there is cash drag from keeping a cash buffer so you are generally better off with short term fixed income


I don’t think this is accurate at all. The returns just aren’t there in fixed income. As an approach, it’s too overengineered. One can jump through a number of hoops to earn zero (or worse) in fixed income, or just keep the required amount aside in cash.


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## Sarenco (29 Jul 2021)

Gordon Gekko said:


> One can jump through a number of hoops to earn zero (or worse) in fixed income, or just keep the required amount aside in cash.


Institutional cash deposits are currently attracting an interest charge of around -0.60%, whereas the short bond fund cited by @Marc currently has a yield-to-maturity of around 0.13%, with an average duration of 3.82 years.


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## Gordon Gekko (29 Jul 2021)

Sarenco said:


> Institutional cash deposits are currently attracting an interest charge of around -0.60%, whereas the short bond fund cited by @Marc currently has a yield-to-maturity of around 0.13%, with an average duration of 3.82 years.


With a capital value that can move around


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## SPC100 (3 Aug 2021)

Colm Fagan said:


> Hi Gordon.  It was at this point I came unstuck the last time someone tried to persuade me of the reasonableness of what you're proposing.
> Firstly, I'm not investing the €60k.  I'm spending it!  Secondly, even if I don't spend it all, I can always give some of it to the children and grandchildren.  As I recall, between the other half and myself, we can gift each of them €6k a year tax-free - not that I would want to claim to be that generous with them!  That immediately eliminates any problems of CAT and CGT!


@Gordon Gekko 

Moderators, I think this stream of posts would be a good topic for a post on its own. Although it may only be applicable to a lucky minority.

If I expect (hope!) that my imputed distribution will be more than what I need, what should my strategy be for the exceed? I had initially assumed I would only take what I need and leave the rest in the fund. But in the fund, it suffers the annual tax on the imputed distribution. And potentially additionally marginal income tax if you need to withdraw for some large cost above the imputed distribution.

It's a good point that if you are very confident in fund longevity and your future needs, it may be better tax planning to withdraw all give to friends and family yearly up to tax free limit.

But maybe taking it out and investing outside of the fund would be better at least in some circumstances.


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## Duke of Marmalade (3 Aug 2021)

Gordon Gekko said:


> The ‘other’ €60k is now still in the ARF so it can grow tax-free.


The 60k will be subject to a deemed distribution of 6% p.a.  taxed at full marginal rate.  A bit of a stretch to describe this as tax free growth.  
Maybe the CAT thing changes things but other than that I can see no sense in leaving the 60k in the ARF.


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## Gordon Gekko (3 Aug 2021)

I don’t think so, but I’m open to correction.

The €60k that’s left in the ARF can then grow for a year, at which time circa 3% of it will go in the form of the imputed distribution tax. But if the person is pursuing an all-equity approach (like Colm) it should still be growing over time. And importantly, it should be growing more than €60k that’s taken out and invested personally. Although, now that I think about it, is that the case? €60k invested personally would only be subject to 50% tax on dividends and CGT on realised uplift. How does that compare with 3% on everything?


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## Duke of Marmalade (3 Aug 2021)

Gordon Gekko said:


> I don’t think so, but I’m open to correction.
> 
> The €60k that’s left in the ARF can then grow for a year, at which time circa 3% of it will go in the form of the imputed distribution tax. But if the person is pursuing an all-equity approach (like Colm) it should still be growing over time. And importantly, it should be growing more than €60k that’s taken out and invested personally. Although, now that I think about it, is that the case? €60k invested personally would only be subject to 50% tax on dividends and CGT on realised uplift. How does that compare with 3% on everything?


I looked at this from the point of view of a child (over 21) of the ARF holder who expects to receive the full €60k and its growth as an inheritance.  She also expects to pay the full 33% CAT if it is outside the ARF and 30% if it is inside the ARF.
Clearly if the ol' man were to be hit by a bus tomorrow she would marginally prefer that the 60k was left inside the ARF.  But suppose she reckons on him surviving 20 years.  Let us consider 6% annual growth.  If it is inside the ARF it doesn't matter if it is made up of capital gains or income.  The net inheritance is €72.1k.
If the money is outside the ARF it matters a lot whether the income comes by way of dividends or (unrealised) capital gains.  It is is all income the net inheritance is €71.3k, slightly worse than the alternative.  If it is 2% income and 4% unrealised capital gains the figure is €102.0k, clearly superior.

(I Googled the CAT interpretation and stand to be ejected.)


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## SPC100 (3 Aug 2021)

Thanks for the further thoughts on this.

We also need to look at it from the point of view of the old healthy poor man who is wondering if he will outlast his fund and has some ability to control his spending needs.

A lot of outside of fund investments will probably suffer from the deemed disposal tax treatment.

edit: This complicates the decision on wheter to withdraw the full deemed distribution. It appears people here are currently leaning towards outside ARF.


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## NoRegretsCoyote (3 Aug 2021)

SPC100 said:


> We also need to look at it from the point of view of the *old healthy poor man who is wondering if he will outlast his fund* and has some ability to control his spending needs.


What no one on this thread has talked about is that life expectancy itself is highly variable.

Take a 65-year old Irish male. The median life expectancy is 18, so living to 83. But there is a 10% chance he will die before he is 71, but a 10% chance he will live beyond 93. 

Below is a chart I worked up from CSO life tables.



https://imgur.com/MZy8eVJ


Suppose you are very risk averse and want your fund to last until you are 95. This would mean very conservative withdrawals and/or vulnerability to a bad sequence of returns early on.

Everyone tends to dunk on annuities because they are so expensive. But they allow you to insure against living a very long life.


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## Allpartied (3 Aug 2021)

NoRegretsCoyote said:


> What no one on this thread has talked about is that life expectancy itself is highly variable.
> 
> Take a 65-year old Irish male. The median life expectancy is 18, so living to 83. But there is a 10% chance he will die before he is 71, but a 10% chance he will live beyond 93.
> 
> ...



Without wishing to get too morbid, the reality of living life in your 90's is not the same as living your life in your 60's, 70's or even early 80's. 
To be brutally honest, you won't be able to do very much in your 90's, if you are lucky enough to live that long.  Travelling, eating out,  walking in Connemara, theatre trips, golfing, they require modest health, mobility and independence.  So, my advice, would be to bulk up your income in the active years and not worry too much about those years spent sitting in a chair, looking out the window. 
If you have family looking after you, it might be nice to give them a healthy check every month, but, hopefully, that won't be their main motivation. 
Nursing home care is provided by the state, as will medical bills and, if we remain a civilised social democracy, there will be continuing assistance for you when you are elderly and infirm.


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## Duke of Marmalade (3 Aug 2021)

NoRegretsCoyote said:


> Everyone tends to dunk on annuities because they are so expensive. But they allow you to insure against living a very long life.


Only if it is inflation linked.
Inflation capped at 7.5% pension for 65 year old €1m is €22,000 p.a.

But even this is very misleading.  A 95 year old's expense base is very, very different from a 65 year old's.  Could be a lot smaller (no holidays etc.) or a lot larger (medical).
Fair Deal changes the metrics somewhat.


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## Duke of Marmalade (3 Aug 2021)

Allpartied said:


> Without wishing to get too morbid, the reality of living life in your 90's is not the same as living your life in your 60's, 70's or even early 80's.
> To be brutally honest, you won't be able to do very much in your 90's, if you are lucky enough to live that long.  Travelling, eating out,  walking in Connemara, theatre trips, golfing, they require modest health, mobility and independence.  So, my advice, would be to bulk up your income in the active years and not worry too much about those years spent sitting in a chair, looking out the window.
> If you have family looking after you, it might be nice to give them a healthy check every month, but, hopefully, that won't be their main motivation.
> Nursing home care is provided by the state, as will medical bills and, if we remain a civilised social democracy, there will be continuing assistance for you when you are elderly and infirm.


Our posts crossed.


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## SPC100 (3 Aug 2021)

NoRegretsCoyote said:


> What no one on this thread has talked about is that life expectancy itself is highly variable.


I agree one's life expectancy is a key variable. 

I started a thread on the topic of predicted life expectancy a few days before this thread started. I agree it is a key variable. The strongest advice on that thread was i think to build a model from your own relations!

https://www.askaboutmoney.com/threads/life-expectancy-predictions-for-when-i-will-die.224178/ 

It might be good to duplicate your graph in that thread too!

I also agree it would be interesting to have stats on expected healthspan (part of life during which you are healthy)

I have read in the past that for healthy active people (runners), tend to have a healthspan which is a high percentage of their lifespan, i.e. if you are healthy and active you can expect to not have many years in ill health.

I think the stat came from a biblical sized book for runners; It was probably biased towards presenting benefits of running.


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## Marc (3 Aug 2021)

We use this one





__





						Longevity calculator
					

How long might your client live (and therefore need an income) for?




					www.justadviser.com
				




It allows a stab at current health impact on life expectancy based on current age


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## AJAM (5 Aug 2021)

The Vanguard Target Date series gradually moves you from Stocks to Bonds as you near retirement.
This is how they manage the derisking process.

_*TR Fund Asset Allocations - February 2021*_
​
Holding20652060205520502045204020352030202520202015Income90.3​90.3​90.2​90.6​90.6​83.2​75.6​68.1​60.5​50.4​36.1​30.4​9.7​9.7​9.8​9.4​9.4​16.8​24.4​31.9​39.5​49.6​63.9​69.6​


They start at 90% stocks and only start to reduce that 20 years from retirement (2040 on the table).
At retirement they have roughly 50:50 Stock:Bonds (2020 in the table).
5 Years into retirement they have 35:64 Stock:Bonds (2015 in the table).
The minimum amount of stock, (even 25 years into retirement), that they have allocated to stocks is 30%.

That's the US one. The UK one moves from 80% stock to 30% stocks (Again 50:50 at retirement), so a little more conservative.


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## time to plan (5 Aug 2021)

AJAM said:


> The Vanguard Target Date series gradually moves you from Stocks to Bonds as you near retirement.
> This is how they manage the derisking process.
> 
> _*TR Fund Asset Allocations - February 2021*_
> ...


Let's say the scenario is that I have a state pension, a small defined benefit occupational pension, and then a 'pension fund'. Would we expect this to decrease the % of pension fund held in cash / bonds? Given that in this example 30% (say) of a reasonable estimate of annual pension income is already de-risked?


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## NoRegretsCoyote (5 Aug 2021)

time to plan said:


> Given that in this example 30% (say) of a reasonable estimate of annual pension income is already de-risked?


Some consumption is de-risked too. Most people enter retirement with a roof over their heads and mortgage paid off, so don't have to pay out of pocket for shelter. Once you hit 70 most people get medical card, household benefits package, bus pass, etc....


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## SPC100 (5 Aug 2021)

time to plan said:


> Let's say the scenario is that I have a state pension, a small defined benefit occupational pension, and then a 'pension fund'. Would we expect this to decrease the % of pension fund held in cash / bonds? Given that in this example 30% (say) of a reasonable estimate of annual pension income is already de-risked?


Yes. You have more capacity to take risk. As you have some basic standard of living already guaranteed. Whether you want or need to take it is another question.


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## Sarenco (5 Aug 2021)

AJAM said:


> The Vanguard Target Date series gradually moves you from Stocks to Bonds as you near retirement.


The problem with target date funds is that they do not take account of assets held outside the fund.

For example, somebody with significant cash savings outside their pension may not have the same incentive to de-risk their pension fund as they approach retirement.


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