# ARF projections



## Littlewillow (27 Aug 2019)

In a bid to try and figure out when my money runs out I'm using a withdrawal calculator and allowing for an average 5.5% annual interest on investment. Is this a reasonable expectation? Wondering could those of you currently receiving income from an ARF shed some light?


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## Steven Barrett (27 Aug 2019)

What are you investing in? I am presuming that is a net return, so what are the charges on top of that?



Steven
www.bluewaterfp.ie


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## Littlewillow (27 Aug 2019)

SBarrett said:


> What are you investing in? I am presuming that is a net return, so what are the charges on top of that?
> 
> 
> 
> ...


Nothing specific yet. Just trying to calculate how I may be fixed going forward. I haven't factored in any charges, taxes, etc. Currently have 320k in a BOB and expecting a one off lump sum of 80k in 8 years - now 59 - and hope to 'pay myself' 36k pa from age 60. online calculator indicates my money will run out when I'm around 90 assuming a 5.5% interest. wondering what are average ARF returns for somebody who is not inclined to fret when markets jitter knowing they 'even' out over time. Thinking about an ARF with a diverse global spread but this is purely exploratory at this stage.


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## Steven Barrett (27 Aug 2019)

If you are assuming a return of 5.5%, you will be looking at an equity based investment, which fell by -40% in the last recession. If that happened and you continued to pay yourself €36,000 from your fund, there is a real chance of your fund running out. When managing an ARF, you have to adjust your income as the fund fluctuates in value. Also remember that you are likely to spend more when you are 60 than when you are 80. 


Steven
www.bluewaterfp.ie


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## Littlewillow (27 Aug 2019)

Thanks Steven. Is it a realistic assumption? If you were setting up an ARF for a client, would you expect an average return of 5.5% or more? 

Littlewillow


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## Steven Barrett (27 Aug 2019)

No, I don't think it is a realistic assumption. You would need to add another 1% in fees too.

I do an assessment of clients needs and other sources of income in creating an investment strategy for them. If your only source of income is the ARF, the risk of a -40% fall is probably too great to go all in with an all equity strategy. While they produce superior returns over the long run, it's handling the rollercoaster ride along the way that's the hard bit.

Don't use growth projections to fit the income you want. Adjust your income to the volatility you can handle and afford.

Steven
www.bluewaterfp.ie


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## moneymakeover (27 Aug 2019)

If you choose annuity starting age 60
What would be the annual payment?


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## Conan (27 Aug 2019)

A single life Annuity from age 60 (no widows benefit, no indexation) is unlikely to exceed 4% pa. With Bond rates now so low, Annuity rates are also falling. 
I think Littlewillow is being very optimistic in his assumptions. With a fund of €320k at age 60, I don’t think a drawdown rate of €36k pa is realistic, just as an investment return of 5.5% ( net of say 1% management charges). To expect a gross 6.5% annual return will require a high equity strategy and that involves accepting a higher risk (which at times will pay off but at other times will not pay off).


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## moneymakeover (27 Aug 2019)

Draw down of 36k is 11.25% first year

If growth was 5% then year 2 would start with 298

Then after 36k withdrawal it would be at 262

Decreasing rapidly


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## Gordon Gekko (27 Aug 2019)

Any plan needs to be sustainable; €36k from a €320k pool isn’t sustainable by any stretch of the imagination.


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## Sarenco (28 Aug 2019)

@Littlewillow

In my opinion, a realistic (if somewhat conservative) assumption is that your money will keep up with inflation - but no more that that - if invested in a balanced manner.

So, if you want your savings to last for 25 years, you need to have saved the equivalent of 25 years' worth of expenses.

Put another way, the maximum you could draw and spend is 4% per annum, adjusted for inflation.  So, you would need €250k for every €10k of "income" per annum.


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## Littlewillow (28 Aug 2019)

Sarenco said:


> @Littlewillow
> 
> In my opinion, a realistic (if somewhat conservative) assumption is that your money will keep up with inflation - but no more that that - if invested in a balanced manner.
> 
> ...


Thanks  I'm obviously not au fait with the financials. However, I'm wondering what, when deciding on a fund for an ARF, what the expected interest would be when annualised over a 20-year timeline? Allowing for glitches, which are to be expected in a historical context, overall are not funds 'expected' to weather these storms? Volatility is to be expected and I don't mind being on a more 'aggressive' fund. Bearing that in mind, where am I going wrong expecting an equity-based fund to achieve an average of 5/6% over that length of time. I'm factoring in an injection of 80k on year 8 and the state pension for two people at 67.


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## Conan (28 Aug 2019)

Completely different. 
If you are assuming a State Pension of say €24k (couple) and drawdown from the ARF of €12k (total €36k) that is much more realistic. 
Is that what you are saying?


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## moneymakeover (28 Aug 2019)

When you say you don't mind being 'aggressive' are you saying you don't mind losses?
Do you have another source of money?

If not then you probably have to be conservative. If only for your own peace of mind.

What if you put 250k into annuity? Guaranteed 10k per year.

Live on that and spend the remaining 70k until age 68 and the state pension. And the additional 80k.


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## Littlewillow (28 Aug 2019)

Conan said:


> Completely different.
> If you are assuming a State Pension of say €24k (couple) and drawdown from the ARF of €12k (total €36k) that is much more realistic.
> Is that what you are saying?


Essentially yes. But for the first 7 years I will drawdown 36k (and earn 14k interest). When state pension kicks in for a couple (26kappx) I won't be drawing 36 but around 10ish - to make up shortfall. Target year is at 60 so pension should kick in at 67.




moneymakeover said:


> When you say you don't mind being 'aggressive' are you saying you don't mind losses?
> Do you have another source of money?
> 
> If not then you probably have to be conservative. If only for your own peace of mind.
> ...


I expect there will be losses but over the 20 years the 'gains' should balance things out. Don't want annuity as rates are too low. 
Littlewillow


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## Daddy Ireland (28 Aug 2019)

You can always switch to annuities in 10 years time if rates improve.


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## Littlewillow (28 Aug 2019)

Daddy Ireland said:


> You can always switch to annuities in 10 years time if rates improve.


Yes Daddy Ireland it may be more favorable then.


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## Sarenco (28 Aug 2019)

You are planning to draw down €252k (from a €320k pot) over the first seven years of your retirement?  That's sheer madness.

What happens if the market drops 50% in the first year of your retirement and takes 5 years to recover?  

Sorry to be blunt but you can't afford to retire at 60 with a pension pot of €320k if you need €36k a year to live on.


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## Littlewillow (28 Aug 2019)

Sarenco said:


> ... What happens if the market drops 50% in the first year of your retirement and takes 5 years to recover?
> ...


Yes I agree that would not be good. When last did markets drop 50% and take 5 years to recover?


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## Conan (28 Aug 2019)

If you go back to 2007 to 2009, Equity markets fell c40%. By early 2009 (the market low) many pension investors “could not take it anymore “ and switched to Cash , only for markets to recover over the following 3 years. 
As Warren Buffett said” you only know who is wearing swimming trunks when the tide goes out”. Lots of investors say that they would not panic if markets suffered a big hit, but experience suggests otherwise. 
I must agree with Sarenco, what you are now saying is your preferred drawdown plan is not sustainable. I think you need to either review your drawdown rate or your retirement age.


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## Sarenco (28 Aug 2019)

The key point is that average long-term returns are only part of the picture - the sequence of returns is also critically important when you're drawing down your savings.  Average long-term returns hide some pretty wild short-term swings.

If you are unlucky and get lousy returns early on in your retirement, it doesn't really matter that returns are much better later on in your retirement because you won't have enough money at stake to really benefit from the upswing.  10% of bugger all is, well, bugger all!

But I don't think you should feel too disheartened - you're not miles off reaching your target.  You just need to adjust your expectations somewhat.

What's more important to you - retiring at 60 or having an income of €36k a year in retirement?  Could you postpone retirement for a few years?  Or live comfortably on somewhat less than €36k?


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## Steven Barrett (29 Aug 2019)

Littlewillow said:


> Yes I agree that would not be good. When last did markets drop 50% and take 5 years to recover?



If you bought into equities in July 2007, the market fell close to -50% and took 5 years to recover. It's not that long ago. 

You need to look at all your assets and adjust the income you draw down from the ARF accordingly. Do you get a tax free lump sum from it or have you waived it? 

The year you get €80,000, you need to reduce your ARF income as you need to do when you get your State pension. 

But most importantly, you need to adjust the income you take out when markets are down. Taking a fixed amount over these periods puts pressure on the fund. Your fund isn't big enough to sustain that level of income for the rest of your life but you can make adjustments.


Steven
www.bluewaterfp.ie


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## Colm Fagan (30 Aug 2019)

SBarrett said:


> Don't use growth projections to fit the income you want. Adjust your income to the volatility you can handle and afford.


Nicely put, Steven.
My investment experience is (largely) in the public domain through my diary http://www.colmfagan.ie/investments.php
Taking Steven's quote, I'm lucky that I'm able to handle the volatility of equity investment.  I started my ARF in December 2010, withdrew 5% a year (or more) in the first three years,  6% a year (or more) since then.  The fund is now worth more than when I started.  My investment decisions weren't particularly inspired.  The main reason why the fund has increased in value is that it is almost 100% in equities.  Yes, I've been lucky that the last nine years have generally seen good equity returns but I still think it's reasonable to expect an average return of more than 5% a year in future by investing 100% in equities - provided you can handle the volatility.


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## moneymakeover (30 Aug 2019)

Or is the reason because the market bottomed out completely in 2008
And has been recovering since in one of the longest bull runs in history


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## elacsaplau (31 Aug 2019)

Sarenco said:


> The key point is that average long-term returns are only part of the picture - the sequence of returns is also critically important when you're drawing down your savings.  Average long-term returns hide some pretty wild short-term swings.



This is, indeed, the key point. 

In the long-term, one can expect equities to out-perform BUT people can be and have been mushed by the sequence of returns. Excessively high or low allocation to return seeking (as opposed to defensive) assets should be a minority sport. I don't mind those in this minority enjoying their fetish so long as they acknowledge that their extreme position is not appropriate for the majority!


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## Oisin19 (31 Aug 2019)

This is why I feel the short term income need should be in cash. The rest of the pot be it pension or personal investments can then be invested in equities. At this stage there should also be a higher allocation to income generating assets so as to replenish the yearly the cash drag. In doing so you'd hope that you would then be in a better position to ride out market swings. 

The spending stage is by far the most important and the scariest stage for an investor. When accumalating funds you can take the hits or ride out "mistakes" but in the drawdown stage these can put too much pressure on the pot and can in some cases lead to critical mistakes. We have all seen clients who made these errors and panicked and went to cash where if they had a good strategy or listened to good advise would have been fine. Sometimes its better to switch the channel when the news is on. Sure remember last Christmas? How many ARF holders panicked and went to cash when the market sold off only for it to rebound in January and they were left with a real loss! 

Care should be taken to get the strategy right and then just look out the window when the news is on


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## Colm Fagan (31 Aug 2019)

moneymakeover said:


> Or is the reason because the market bottomed out completely in 2008
> And has been recovering since in one of the longest bull runs in history


I agree.  That's why I wrote:


Colm Fagan said:


> Yes, I've been lucky that the last nine years have generally seen good equity returns


but I added that


Colm Fagan said:


> I still think it's reasonable to expect an average return of more than 5% a year in future by investing 100% in equities - provided you can handle the volatility


Despite my advancing age, it is still the right strategy.  There's been a lot of talk about the need to have a different investment strategy in the drawdown stage e.g.


Fergal19 said:


> When accumalating funds you can take the hits or ride out "mistakes" but in the drawdown stage these can put too much pressure on the pot and can in some cases lead to critical mistakes.


In my experience, those fears are exaggerated.  In any 12-month period, only 6% (or 4%) of the fund is withdrawn;  the other 94% (or 96%) remains untouched.  Dividend receipts further reduce the risk of having to sell when prices are on the floor.

The maths are simple.  I expect to earn an average 4% (or more) a year from equities compared to bonds or cash.   Say that I have 95% in equities and someone else has 45%, with the rest in bonds/cash.  Therefore, I can expect to earn (95%-45%)*4% = 2% a year more than them, on average.  Advisers would be shouting from the rooftops if there was a 2% pa difference between the management charges of two funds.  Why don't we hear the same uproar when people put too much money in low-yielding assets?


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## Sarenco (31 Aug 2019)

What if you hadn't been so lucky with your timing?

So far this century, the MSCI World Index has returned just over 5% per annum.  That includes dividends.

If you retired at the start of 2000 and drew down 5% per annum from your ARF (ignoring costs) you would now be skint.

Why?  The sequence of returns was lousy.

Incidentally, a balanced portfolio of equities and government bonds would have outperformed a 100% equity portfolio over this time period - with far less volatility.

@elacsaplau is right - the 100% equity fetish is an extreme position that is not appropriate for the vast majority of retirees.


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## Colm Fagan (31 Aug 2019)

Sarenco said:


> What if you hadn't been so lucky with your timing?


This is where I get back to Steven's excellent advice, which I quoted at the start of my first contribution on this topic, namely to adjust your income to the volatility you can handle and afford.  I would simply have adjusted my income expectations from the fund.  I would still have done better than leaving my money in bonds or cash (see below for my comment on bonds).



Sarenco said:


> Incidentally, a balanced portfolio of equities and government bonds would have outperformed a 100% equity portfolio over this time period - with far less volatility.


Do you realise how misleading this statement is?  Do you realise that government bonds have delivered good returns since 2000 for precisely the same reason that they'll deliver lousy returns in future?  To explain to people not well-versed in finance, in 2000 the yield on a German 30-year bond was around 5.25%.  A bond with a coupon of 5.25 a year would be priced at 100.  Now, yields on 30-year bonds have fallen to zero, so you would now have to pay 257.50 (30*5.25+100) for a bond delivering a coupon of 5.25 for 30 years.   Someone who invested 100 in a 30-year German government bond in 2000 would have got 5.25 every year, and could now sell the bond for 157.75 (11*5.25 +100).  They would have a capital gain of 57.75% in addition to their running yield of 5.25% a year for the last 19 years.  But someone starting off now can expect to earn precisely zero from that bond - and that's before paying their financial adviser for telling them that government bonds have delivered excellent returns over the last 19 years.


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## Gordon Gekko (31 Aug 2019)

The median earnings yield of the MSCI World is currently circa 6.5% (Earnings / Price basically).

So somebody sitting in equities in perpetuity can, on average, expect to earn that return annually.

In a world where cash and bonds deliver nothing, one could argue that it is reckless not to invest in equities.

Where I differ from Colm is diversification. I do not subscribe to his concentrated approach.


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## Duke of Marmalade (31 Aug 2019)

30 year German bonds at 0%.  It is hard to contemplate the enormity of that.  I know we see negative yields on some bonds but there has to be a limit to this.  It can only be technical reasons that banks and maybe insurance companies have to "invest" in these instruments, rather pay money to hold them.  There simply cannot be any capital upside left in holding these bonds.  So the best you can hope for is that things stay steady and you earn zero per cent for 30 years.  But if yields went any way back to "normal" levels capital losses of 50% or more can be expected.
No retail investor could possibly invest in bonds at these levels and that includes through the medium of PRIIPS.
But this totally unreal interest rate environment must be spilling over into other asset valuations - surely the whole caboodle is a massive bubble.  Cash is yer only man!


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## Sarenco (31 Aug 2019)

Gordon Gekko said:


> So somebody sitting in equities in perpetuity


The problem is that nobody has an infinite investment horizon - hence the sequence of returns issue.


Duke of Marmalade said:


> But this totally unreal interest rate environment must be spilling over into other asset valuations...


Exactly.  Remember the "taper tantrum" a few years ago?  There's a strong relationship between low yields and high equity valuations.


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## Gordon Gekko (1 Sep 2019)

Sarenco said:


> The problem is that nobody has an infinite investment horizon - hence the sequence of returns issue



That’s slightly pedantic; I probably have a 60 year time horizon in respect of my pension monies. My youngest child hopefully has a 100 year time horizon.

These are more than long enough to ride out any volatility.


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## Sarenco (1 Sep 2019)

@Gordon Gekko 

A retiree drawing down from an ARF doesn't have anything remotely like a 60 year investment horizon.

Back-testing suggests that adding an allocation to government bonds actually improves the amount that can be safely drawn down from a portfolio on an annual basis.  That's important even if you view your ARF as a possible vehicle for passing wealth to the next generation because of imputed distributions.


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## Gordon Gekko (1 Sep 2019)

Sarenco said:


> @Gordon Gekko
> 
> A retiree drawing down from an ARF doesn't have anything remotely like a 60 year investment horizon.
> 
> Back-testing suggests that adding an allocation to government bonds actually improves the amount that can be safely drawn down from a portfolio on an annual basis.  That's important even if you view your ARF as a possible vehicle for passing wealth to the next generation because of imputed distributions.



That’s a straw-man argument; I never claimed otherwise.


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## Sarenco (1 Sep 2019)

What’s a straw-man argument?!

Your personal investment horizon has nothing to do with the appropriate strategy for an ARF, which is what we’re talking about on this thread.


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## Gordon Gekko (1 Sep 2019)

Sarenco said:


> What’s a straw-man argument?!
> 
> Your personal investment horizon has nothing to do with the appropriate strategy for an ARF, which is what we’re talking about on this thread.



You’re at it again Sarenco. I explained earnings yield as average expected return into perpetuity. Suddenly you’re stating that an ARF-holder doesn’t have a 60 year time horizon. Nobody ever claimed that they do. That is the very essence of a straw-man argument.


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## Sarenco (1 Sep 2019)

At what again?!

We’re talking about managing ARFs and you start talking about investing in perpetuity!

Totally irrelevant to the topic under discussion.


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## Gordon Gekko (1 Sep 2019)

Sarenco said:


> At what again?!
> 
> We’re talking about managing ARFs and you start talking about investing in perpetuity!
> 
> Totally irrelevant to the topic under discussion.



I didn’t “start talking about investing in perpetuity”; I invoked earnings yield, which as you know is one’s likely total return over time. The “investing in perpetuity” reference was purely to explain the concept for people.

I find it gas that you’re forever trying to talk about shorter investment time horizons when, in reality, most people’s are far longer than they think. A typical retiree at at 65 probably has a least a 25 year time horizon. You are a little to quick to frighten other contributors who generally have too little equity content in their portfolios to start with.


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## NoRegretsCoyote (2 Sep 2019)

Gordon Gekko said:


> I find it gas that you’re forever trying to talk about shorter investment time horizons when, in reality, most people’s are far longer than they think. *A typical retiree at at 65 probably has a least a 25 year time horizon*. You are a little to quick to frighten other contributors who generally have too little equity content in their portfolios to start with.



The latest CSO life tables show life expectancy at 65 is just under 18 for men and just under 21 for women, *or an average of about 19 years*.

You can probably adjust up a year or two as someone with a typical pension fund will live longer, rich people generally do.

Your time horizon at 65 is not likely to be a quarter of a century though, particularly for men.



> I probably have *a 60 year time horizon *in respect of my pension monies.



An Irish man with a 60-year life expectancy is currently aged 19.

I have a feeling very few of us posting here are that young


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## Gordon Gekko (2 Sep 2019)

NoRegretsCoyote said:


> The latest CSO life tables show life expectancy at 65 is just under 18 for men and just under 21 for women, *or an average of about 19 years*.
> 
> You can probably adjust up a year or two as someone with a typical pension fund will live longer, rich people generally do.
> 
> ...



Those stats are slightly misleading. Life expectancy stats are from birth and take account of early death. The life expectancy of someone who has reached 65 is not the same as general life expectancy. And in the case of an ARF, we’re generally talking about the life expectancy of two people, one of whom is female. That’s the key point with an ARF. See the link below. There is a 51% chance that, at age 65, at least one spouse will live at least another 24 years.


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## NoRegretsCoyote (2 Sep 2019)

Gordon Gekko said:


> Those stats are slightly misleading. Life expectancy stats are from birth and take account of early death.* The life expectancy of someone who has reached 65 is not the same as general life expectancy*.



I know. That's why I clearly referenced *life expectancy at 65, *not life expectancy at birth minus 65*.*




Gordon Gekko said:


> That’s the key point with an ARF. See the link below. There is a 51% chance that, at age 65, at least one spouse will live at least another 24 years.



That's a different argument. As you add member to a group, the probability that one member will have a long life increases. You clearly referenced a typical retiree (singular).


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## Sarenco (2 Sep 2019)

Gordon Gekko said:


> A typical retiree at at 65 probably has a least a 25 year time horizon.


If you start drawing down your savings at 65 at a rate of, say, 4% per annum, adjusted for inflation, how much of the portfolio do you think will remain invested for anything like 25 years?


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## Gordon Gekko (2 Sep 2019)

Sarenco said:


> If you start drawing down your savings at 65 at a rate of, say, 4% per annum, adjusted for inflation, how much of the portfolio do you think will remain invested for anything like 25 years?



That depends how it’s invested and how returns look early on.

Take Colm...he reckons his will always be invested. i.e. may never dip below par


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## Gordon Gekko (2 Sep 2019)

NoRegretsCoyote said:


> I know. That's why I clearly referenced *life expectancy at 65, *not life expectancy at birth minus 65*.*
> 
> 
> 
> ...



No I didn’t. You just missed the nuance around the fact that the typical retiree is married or in a relationship. With the ARF, your investment time horizon is not just your own life expectancy given its treatment on death; it’s one of the key aspects of an ARF and it’s why concepts such as ‘lifestyling’ or older people avoiding risk are somewhat redundant.


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## NoRegretsCoyote (2 Sep 2019)

Gordon Gekko said:


> No I didn’t. You just missed the nuance around the fact that the typical retiree is married or in a relationship. With the ARF, your investment time horizon is not just your own life expectancy given its treatment on death; it’s one of the key aspects of an ARF and it’s why concepts such as ‘lifestyling’ or older people avoiding risk are somewhat redundant.



I didn't miss any nuance. You made the case for retiree (singular) and then implied that I didn't notice that life expectancy lengthens with age (I had).


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## cremeegg (2 Sep 2019)

Guys, this is an interesting thread, less of the "you said" "no I didn't" or you will derail it.


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## cremeegg (2 Sep 2019)

Duke of Marmalade said:


> 30 year German bonds at 0%. ... But if yields went any way back to "normal" levels capital losses of 50% or more can be expected.
> No retail investor could possibly invest in bonds at these levels and that includes through the medium of PRIIPS.





Colm Fagan said:


> Do you realise that government bonds have delivered good returns since 2000 for precisely the same reason that they'll deliver lousy returns in future?  To explain to people not well-versed in finance, in 2000 the yield on a German 30-year bond was around 5.25%.  A bond with a coupon of 5.25 a year would be priced at 100.  Now, yields on 30-year bonds have fallen to zero, so you would now have to pay 257.50 (30*5.25+100) for a bond delivering a coupon of 5.25 for 30 years.   Someone who invested 100 in a 30-year German government bond in 2000 would have got 5.25 every year, and could now sell the bond for 157.75 (11*5.25 +100).



Hi Guys

I have a pension fund partly invested in some "safe" assets. Its called a pension stability fund with Irish Life

Can anyone tell me if I am likely to be exposed to losses of this nature. The bumpf says "The Stability Fund invests mostly in bonds and cash with a small amount in shares."

If interest rates rise, will the value of the bond elements fall precipitously.

I understand the maths, but if rates go back to 5.25% how much of my pot is likely to fall in value from €157 to €100 (to use the above figures).

This was sold as a low risk investment, but is that just lazy thinking "bonds = low risk".  Is it in fact very high risk.

Thanks


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## NoRegretsCoyote (2 Sep 2019)

Sarenco said:


> If you start drawing down your savings at 65 at a rate of, say, 4% per annum, adjusted for inflation, how much of the portfolio do you think will remain invested for anything like 25 years?



To take a simple example where bad performance is frontloaded. Assume your fund loses 7% for five years, then grows at 2% for the remainder of the 25 years. Rounding a little, you are basically back to where you started if you take nothing out

The issue is that if your drawdown in the early years is too aggressive you won't have enough left in the fund to grow yourself back out of trouble.


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## moneymakeover (2 Sep 2019)

I think the question being asked by creme egg,
Is if yields increase what will happen to the bond portion of pension?

Currently yields are dropping both Europe and USA

But if/when this turns around are bond holders exposed?
And to what extent


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## Duke of Marmalade (2 Sep 2019)

cremeegg said:


> Hi Guys
> 
> I have a pension fund partly invested in some "safe" assets. Its called a pension stability fund with Irish Life
> 
> ...


_cremeegg_ This is the make up of the Stability Fund as of July.  60% bonds, 25% cash and 15% equities  A key missing statistic is the duration of the bonds.  I think anything over 5 years has a very asymmetrical capital outlook - no upside left but considerable downside potential. Any sovereign bonds under 5 years are on negative yields.  I note that only 17% are AAA and there is exposure to BBB etc.  So there might be some pick up in yield there but that is compensation for risk.  The theory goes that you cannot diversify this risk away.  I really can’t see any justification for individual investors being exposed to bonds.  Ok, they may be scared of equities, but then I’m afraid the refuge is cash.


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## Sunny (2 Sep 2019)

You don't get any idea of how the bonds are being managed from a interest rate perspective. It is unlikely that the fund is fully exposed to rising and falling interest rates and the managers have taken steps to manage the duration of the portfolio. Remember we are talking duration here, not maturity date of the bonds.


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## Sarenco (2 Sep 2019)

Gordon Gekko said:


> That depends how it’s invested and how returns look early on.


Exactly.

And the best way to mitigate against a devestating stock market crash early on in the drawdown phase is to hold an allocation of fixed income instruments within the portfolio.


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## moneymakeover (2 Sep 2019)

In relation to bonds

And people are saying with yields so low bonds are a bad idea

But it only matters what direction yields go

So long as yields drop, the value of the bonds will increase

I would think


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## Conan (2 Sep 2019)

moneymakeover said:


> In relation to bonds
> 
> And people are saying with yields so low bonds are a bad idea
> 
> ...


But how much lower can yield go? Whilst yields are probably not likely to increase in the near term (some prospect of “negative yields”) over the long term (if an ARF investor is taking a longer term view) it is perhaps more likely to expect yields to increase. 
So with a drawdown rate of say 4% p.a. (plus management fees), Bonds don’t currently look attractive for ARF investors.


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## NoRegretsCoyote (2 Sep 2019)

There is a theoretical upper limit to bond prices. If interest rates hit -3% I think people would just consume more or put money into fixed assets. Interest rates can still fall a bit more from where they are now, but there has to be a lower bound.

Equity prices are different as they are ultimately a function of corporate profitability. And there there is no upper limit to equity prices in the same way that there is for bond prices.


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## Colm Fagan (6 Sep 2019)

My name has been mentioned a few times in dispatches, so it's probably best to clarify where I stand on the various issues:


Gordon Gekko said:


> Take Colm...he reckons his will always be invested. i.e. may never dip below par


Not quite right, Gordon.  My ambition is to spend every cent that's in the ARF by the time my other half and myself say our final goodbyes.  I have set up a spreadsheet specially for that purpose.  It allows for future investment returns (at what I hope is a reasonably conservative rate) and future outgoings, so that there is zero left at the end.

This brings me to the next question: when is the end?


Gordon Gekko said:


> And in the case of an ARF, we’re generally talking about the life expectancy of two people, one of whom is female. That’s the key point with an ARF. See the link below. There is a 51% chance that, at age 65, at least one spouse will live at least another 24 years.


Life expectancy is meaningless when it comes to an ARF.  There won't be 51% of either me or my other half alive in 24 years.  Either one, both, or none of us will be alive.  My little spreadsheet, discussed above, assumes that we will both live into our nineties.   If we croak before then, there will be something for the next generation(s) to squabble over; if we live beyond 95 or so, I'm hoping that one of our children, grandchildren or great-grandchildren will look after us for our few remaining years.   In reality, I try to add a couple of months of possible future existence to the spreadsheet every year.



NoRegretsCoyote said:


> To take a simple example where bad performance is frontloaded. Assume your fund loses 7% for five years, then grows at 2% for the remainder of the 25 years. Rounding a little, you are basically back to where you started if you take nothing out
> 
> The issue is that if your drawdown in the early years is too aggressive you won't have enough left in the fund to grow yourself back out of trouble.



This is a re-run of the "sequence of returns" risk that's been discussed ad nauseam on this forum.  People know my views by now.  For what it's worth, I looked back at the early experience of my ARF.  I took it out in December 2010.  At the end of 2011, it was down 13% from what I invested a year earlier (that's after withdrawing 5% in 2011).  At this remove, it's all ancient history.  There has been plenty of time since then to recover from that initial fall.  The ARF is now worth considerably more than the initial contribution, despite the fall in the first year.  It would be a very different story if I had invested a significant proportion of my savings in bonds, or kept them in cash, at the start.



cremeegg said:


> If interest rates rise, will the value of the bond elements fall precipitously.
> 
> I understand the maths, but if rates go back to 5.25% how much of my pot is likely to fall in value from €157 to €100 (to use the above figures).


As @Duke of Marmalade says, the key issue is the duration of the bonds.  You're right that the value of the bond elements falls from 157 to 100 if interest rates increase from 0 to 5.25% -  if the duration of the bonds is 11 years, as in the example I used earlier.

Interest rates are currently at zero (more or less).  That makes the maths simple.  My guess at a reasonable "worst case" scenario is for interest rates to increase to (say) 3%, with an average bond duration of 7 years.  Suppose you hold a 3% coupon bond.  Its value at 0% interest is 7*3+100 = 121.  Its value at 3% interest is 100, so the fall in market value of the bond element of the portfolio in that "worst case" scenario is 17.3%. (1-100/121).


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## moneymakeover (6 Sep 2019)

I think you meant (121 -100)/121


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## Colm Fagan (6 Sep 2019)

They're the same!   (121 - 100)/121 = 121/121 - 100/121 = 1 -100/121


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## NoRegretsCoyote (6 Sep 2019)

Colm Fagan said:


> , I looked back at the early experience of my ARF.  I took it out in December 2010.  At the end of 2011, it was down 13% from what I invested a year earlier (that's after withdrawing 5% in 2011).  At this remove, it's all ancient history.  There has been plenty of time since then to recover from that initial fall.  The ARF is now worth considerably more than the initial contribution, despite the fall in the first year.  It would be a very different story if I had invested a significant proportion of my savings in bonds, or kept them in cash, at the start.



So over a nine-year horizon you've done really well with equites. Good for you!

I bought a house with a 90% mortgage in 2013 and have seen my equity stake increase by a factor of six.

Neither of these events proves that we are exceptionally good investors. We've been quite lucky, and our (narrow) experience shouldn't be used to draw wide conclusions.


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## Colm Fagan (7 Sep 2019)

No, I'm not saying that I'm an exceptionally good investor.  What I AM saying is that equities are expected (in the mathematical sense) to deliver a far superior return to bonds and cash.  That's true in theory and in practice.   There are bumps in the road, of course, but give the probabilities enough time to do their thing and the superior returns will come through.  My ARF is invested on the assumption that we could be around for 30 years from my "retirement" nine years ago.  That's plenty time for the probabilities to work in my favour.


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## elacsaplau (7 Sep 2019)

Colm Fagan said:


> My ARF is invested on the assumption that we could be around for 30 years...…...That's plenty time for the probabilities to work in my favour.



There's a good chance that there were lads in Japan who had similar beliefs 30 years ago - no more fancy cameras for dem fellas.

The thing is that one anticipates the equity risk premium because, well, one is taking risk.

Certain ARFers will be able to withstand a prolonged slump in equity returns by, as suggested, drinking lower grade Pinot. Others simply will have insufficient scope to withstand a bad sequence of investment returns. There is a material difference in one's capacity to take risk if one has an ARF of €400,000 versus investable assets of, say, €4 million. I don't know what the average ARF size is for retirees but I'd suspect it's a lot closer to €400k than €4 million and hence more representative of the considerations of the broader population.


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## NoRegretsCoyote (7 Sep 2019)

Colm Fagan said:


> *What I AM saying is that equities are expected (in the mathematical sense) to deliver a far superior return to bonds and cash. * .......My ARF is invested on the assumption that we could be around for 30 years from my "retirement" nine years ago.  That's plenty time for the probabilities to work in my favour.



That's a more general, and defensible point.

Your strategy is a long-term one and as such it's probably still too soon to be citing events as supportive of it. 

Let's talk again when you're in your mid-90s


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## Colm Fagan (7 Sep 2019)

elacsaplau said:


> There's a good chance that there were lads in Japan who had similar beliefs 30 years ago - no more fancy cameras for dem fellas.


I can't understand why people keep grasping at straws to defend investment strategies that are patently wrong.   Some of them should know better.

The Japanese market in the decade or more from 1990 was unique.  Have you studied the background to it, and the fallout?  I have.  I refer you to my presentation of 7 February 2018 to the Society of Actuaries in Ireland
http://www.colmfagan.ie/documents/33_Document.pdf?d=September 07 2019 10:21:29.

Slide 42 studies the circumstances in Japan at that time.  Just to take a couple of examples from that slide: Before the crash, the Imperial Palace in Tokyo was supposedly worth more than the entire state of California.  Nippon Telephone & Telegraph was floated at a P/E of 250 in 1987, and the price kept going up until the crash started on the first day of trading in 1990.  It's a utility.  They normally trade on P/E multiples of less than 10, less than 20 in the raciest of markets.  We're nowhere near that sort of territory.
As an aside, a Japanese saver who invested in the Japanese stock market at the height of the boom, even at those crazy prices, would probably be better off now than if they left their savings in cash.


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## elacsaplau (7 Sep 2019)

Colm Fagan said:


> I can't understand why people keep grasping at straws to defend investment strategies that are patently wrong.



I am very patient man but yet again am frustrated by your comments. And please lets try to take the emotive language away. I am as convinced that you are "wrong" as you are that I am so please lets park de handbags!

What specific investment strategy are you accusing me of defending?

Additionally, please answer another specific question.....do you accept my belief that people have different levels of scope to take investment risk?


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## Sarenco (7 Sep 2019)

A Japanese retiree that withdrew 4% of the opening balance of an all-Japanese equity portfolio every year from 1990 would have been flat broke in less than 15 years.

A sobering example of the dangers of running an all-equity portfolio within an ARF.


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## cremeegg (7 Sep 2019)

Colm Fagan said:


> Before the crash, the Imperial Palace in Tokyo was supposedly worth more than the entire state of California.  Nippon Telephone & Telegraph was floated at a P/E of 250 in 1987, and the price kept going up until the crash started on the first day of trading in 1990.  It's a utility.  They normally trade on P/E multiples of less than 10, less than 20 in the raciest of markets.



Did no one call a bubble.

Probably lots of people called a bubble, but funds kept investing because there mandate was to invest as broadly as possible.

Have we a bubble in bonds today.

Will people in 30 years time look back and say "bonds had negative yields and still people invested in them"

Or what I really want to know, and I will start a thread if i can phrase the question, is how exposed am I as an investor in a pension medium risk fund, to a collapse in bonds. Thanks by the way to Colm for addressing that in post  above.


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## NoRegretsCoyote (7 Sep 2019)

Colm Fagan said:


> As an aside, a Japanese saver who invested in the Japanese stock market at the height of the boom, even at those crazy prices, would probably be better off now than if they left their savings in cash.



Not true.

The Nikkei 225 is worth a little over 50% of its peak in yen terms.

Purchasing power of the yen has only fallen in 11% since 1990, due to very low inflation.

Keeping yen under your mattress would have appreciably outperformed Japanese equities over the last 30 years.


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## Sarenco (7 Sep 2019)

Short of an outright default, you can't really have a collapse in bonds.

If there's a sharp uptick in yields then there will be a sharp downturn in bond prices.  However, the increased yields will quickly overwhelm and supersede the capital losses within a bond fund.

What impact will a sharp uptick in the cost of debt have on equities (bearing in mind that corporates now carry a lot more debt than was the case 10 years ago)?  And what impact will a sharp increase in the cost of debt have on property prices?


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## Colm Fagan (7 Sep 2019)

elacsaplau said:


> What specific investment strategy are you accusing me of defending?


I don't want to sound harsh, but one anonymous poster is much the same as another.  As an aside, why do people feel the need to write under the cloak of anonymity?
As it happens, though, you have defended the strategy I'm unhappy with, of excessive belief in so-called "defensive" assets  and "sequence of return" risk:


elacsaplau said:


> people can be and have been mushed by the sequence of returns. Excessively high or low allocation to return seeking (as opposed to defensive) assets should be a minority sport. I don't mind those in this minority enjoying their fetish so long as they acknowledge that their extreme position is not appropriate for the majority


You also asked:


elacsaplau said:


> Additionally, please answer another specific question.....do you accept my belief that people have different levels of scope to take investment risk?


Of course.  My initial post under this thread was to praise Steven Barrett's (thank you Steven for using your real name) comment:


SBarrett said:


> Don't use growth projections to fit the income you want. Adjust your income to the volatility you can handle and afford.


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## cremeegg (7 Sep 2019)

Sarenco said:


> Short of an outright default, you can't really have a collapse in bonds.



But people see bonds as safe investments, even a small loss would be unexpected.

Colm has outlined how a fairly significant loss could be made under circumstances which are hardly unforeseeable.



Colm Fagan said:


> Interest rates are currently at zero (more or less).  That makes the maths simple.  My guess at a reasonable "worst case" scenario is for interest rates to increase to (say) 3%, with an average bond duration of 7 years.  Suppose you hold a 3% coupon bond.  Its value at 0% interest is 7*3+100 = 121.  Its value at 3% interest is 100, so the fall in market value of the bond element of the portfolio in that "worst case" scenario is 17.3%. (1-100/121).



I have no idea what the average maturity of the bonds in my pension is.

Am I the only investor who does not understand the risks I am exposed to in bonds.



Sarenco said:


> However, the increased yields will quickly overwhelm and supersede the capital losses within a bond fund.



Can you explain this. I would have thought that in the case outlined above the income I receive on the bond is unaffected.



Sarenco said:


> What impact will a sharp uptick in the cost of debt have on equities (bearing in mind that corporates now carry a lot more debt than was the case 10 years ago)?



This is a good point, although companies have the potential to adapt their strategies to changing circumstances, something that does not happen with.



Sarenco said:


> And what impact will a sharp increase in the cost of debt have on property prices?



Less than you might think. The interest element of the repayments on a new mortgage are small. If the increase in the cost of debt occurs along with an increase in inflation then property prices may even increase.


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## Colm Fagan (7 Sep 2019)

NoRegretsCoyote said:


> Not true.
> 
> The Nikkei 225 is worth a little over 50% of its peak in yen terms.


I don't have the figures to hand, but your 50% ignores dividends.    With dividends, the conclusion is different.  Also, I was using "cash" as a short-hand for money on deposit in Japan, earning negative interest.
In any event, I have already argued that Japan was a one-off, and shouldn't be used as an example of what might happen in the long-term with a pure equity-based strategy.  Even I, who favour a concentrated portfolio, would not put all my eggs in one basket in one country, and at values that I could never justify in projected cash flow terms.  For all of my bigger investments, I  do the DCF calculations to check that they will deliver real value in the long-term on plausible assumptions for how the future might unfold.  Referring back to @cremeegg 's question above, many of us DID recognise a massive bubble in Japan back in the late 1980's, in exactly the same was as we recognise a massive bubble in bond prices today.


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## elacsaplau (7 Sep 2019)

Colm,

Why say things that are not true?

Firstly,



Colm Fagan said:


> I don't have the figures to hand, but your 50% ignores dividends.    With dividends, the conclusion is different.  Also, I was using "cash" as a short-hand for money on deposit in Japan, earning negative interest.



Since January 1990 to date, the Nikkei has returned -19.06%...….that is with dividends reinvested. Thus, the central conclusion remains valid.

Note: Even before getting the figures, I knew that this would be the case. You can't have it both ways by claiming earlier that Japanese prices were in the stratosphere relative to earnings and that a portion of these same miserable earnings would subsequently be distributed as dividends and would somehow save the day.

Secondly,



Colm Fagan said:


> As it happens, though, you have defended the strategy I'm unhappy with, of excessive belief in so-called "defensive" assets:



I don't have an excessive belief in defensive assets. I actually said the opposite in relation to holding excessive levels of defensive assets - as in: "excessively high or low allocation to return seeking assets should be a minority sport."

It follows that you made an accusation that was completely without foundation and that rather than acknowledge this, regrettably, you have tried Boris-like to deflect the issue by stating that I had said something that I hadn't said and by questioning my anonymous status! That bates Banagher so it does....

Finally, I am pleased that you have acknowledged that that people have different capacities to take risk. It follows that they need to determine an appropriate asset allocation based on their capacity to take investment risk. In designing this strategy, especially in respect of the income drawdown phase, sequence of risk is a real consideration...……...


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## Sarenco (7 Sep 2019)

@cremeegg 

A few points:-

1.  (Intermediate-term) bond funds don't have a stable value - but they're nowhere near as volatile as equity funds.  Bond funds can certainly suffer drawdowns over any short-term period.

2.  Bond fund portfolios are not static, their composition changes constantly.  So, if there's a spike in yields, the portfolio manager would reinvest bond income in the now higher-yielding bonds or would use the principal value of a maturing bond within the portfolio to buy such higher-yielding bonds, etc.  

3.  The effective duration of the aggregate Eurozone bond market is a little over 7 years so it's fair to assume your bond fund has a broadly similar term exposure.  

4.  The last time we saw a spike in borrowing costs equities and real estate got crushed.  

5.  Finally, the correlation between different asset classes is important.  When stocks suffer a drawdown, there is often a "flight to safety" causing bond prices to rise.


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## NoRegretsCoyote (7 Sep 2019)

Colm Fagan said:


> I don't have the figures to hand, but your 50% ignores dividends.    With dividends, the conclusion is different.



Agreed. But even with reinvesting earnings, you still have a -12% negative return August 1989 to date on the Nikkei 225.




Colm Fagan said:


> Also, I was using "cash" as a short-hand for money on deposit in Japan, earning *negative* interest.



But short-term interest rates have been *positive* almost the whole period since 1989 in Japan! See chart.







However way you cut it, cash on deposit over the last 30 years has performed better than equities in Japan. Sorry for the pedantry but you are making throwaway claims that are demonstrably false. You say you dislike pseudonymous posting. Fair enough. I find it bizarre that someone whose website trumpets their actuarial qualifications would be so loose with basic facts about financial history.



Colm Fagan said:


> In any event, I have already argued that Japan was a one-off, and shouldn't be used as an example of what might happen in the long-term with a pure equity-based strategy.



Japan is and was a large, industrialised, diversified economy. It wasn't a small island which had struck oil prone to boom and bust. It's a useful cautionary example to what can happen to equities. 



Colm Fagan said:


> in exactly the same was as we recognise a massive bubble in bond prices today.



If it's a bubble, how much is it overvalued by, and when will it adjust? It's easy to toss around the word 'bubble', but without specifics it's not a meaningful term.


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## NoRegretsCoyote (7 Sep 2019)

Sarenco said:


> 5.  Finally, the correlation between different asset classes is important.  When stocks suffer a drawdown, there is often a "flight to safety" causing bond prices to rise.



True, there is greater demand for bonds when equities are on the slide. But that was when interest rates were higher and in positive territory. There is a natural floor to interest rates. No one knows where it is, but we are close to it. A world of a -2% risk-free rate is not impossible to envisage.

So my question is who will buy all these bonds with a guaranteed negative return? My guess (and it's just a guess) is that any correction in equity prices could see property prices go up, as people chase yield.


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## Duke of Marmalade (10 Sep 2019)

Sarenco said:


> @cremeegg
> 
> 3.  The effective duration of the aggregate Eurozone bond market is a little over 7 years so it's fair to assume your bond fund has a broadly similar term exposure.


_cremeegg _with 7 year duration a "crash" in bond prices is not going to happen but it is not terribly important if it does.  In 7 years time the 30% of you current holdings which are in 7 year bonds will be worth what they are today, as they have a "guaranteed" yield of c. 0%. So it is dead money rather than money waiting to fall off a cliff.  So what purpose does dead money serve?  None as far as I can see.  Cash might be viewed as dead money but it is ready to pounce into life on an uptick in interest rates.  7 year bonds are zombies for the next 7 years.


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