# Retirement Plan - Average return?



## Gordon Gekko (2 Nov 2016)

Folks,

I'm drawing up a personal retirement plan.

My pension is invested 100% in equities and will always be (even post-retirement in the ARF). Reason being that volatility doesn't scare me and lifestyling is now redundant in my view. By equities, I obviously mean diversified high quality equities via two managed funds with management fees of 0.5% per annum.

My spreadsheet assumes an average real return of 4.5% per annum after fees. Is that reasonable? My thinking is 7% from equities, 2% inflation, and the 0.5% fee.

Is the above reasonable or naive?

Many thanks.


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## Steven Barrett (2 Nov 2016)

7% is about right for a 20 year term average.

I would reduce your return slightly: 7% - 0.5% = 6.5%
(1.065/1.02)-1)*100 = 4.41% annualised return

...if you went purely US equity, the return over that period is 10%!!

Steven
www.bluewaterfp.ie


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## martin (2 Nov 2016)

Are your investments held in a PRSA or similar Irish pension account? If so, don't forget that the PRSA provider will have an annual fee as well. The lowest that I'm aware of is 0.75%.


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## Gordon Gekko (2 Nov 2016)

martin said:


> Are your investments held in a PRSA or similar Irish pension account? If so, don't forget that the PRSA provider will have an annual fee as well. The lowest that I'm aware of is 0.75%.



They're in a structure where the total cost is 0.5% (including the fund management charge).


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## Merowig (2 Nov 2016)

Create several scenarios - worst case - most likely and best case

One assumption could be calculating with 2.5%, 3% or 3.5%

http://blogs.wsj.com/moneybeat/2015/03/27/the-new-era-of-low-stock-returns/

http://fortune.com/2015/06/03/stock-market-returns/

[broken link removed]

[broken link removed]


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## Sarenco (3 Nov 2016)

Gordon Gekko said:


> My spreadsheet assumes an average real return of 4.5% per annum after fees. Is that reasonable? My thinking is 7% from equities, 2% inflation, and the 0.5% fee.
> 
> Is the above reasonable or naive?



According to the 2016 Credit Suisse Investment Yearbook, the annualised real return on a globally diversified portfolio of equities since 1900 was 5%.



However, you really have to look at holding periods of 40+ years to get close to that historical average.  Equities are obviously highly volatile and the average return over shorter periods has diverged sharply from the long-run average.  For example, the annualised real return on a diversified portfolio of global equities so far this millennium (2000-15) has only been 1.6% (again per Credit Suisse).

Also, most main-stream commentators take the view that the expected return on global equities over the coming decade will be lower than the long-run average given current valuations.

These returns obviously exclude investment costs (and taxes).  Bear in mind that a pension fund's AMC does not include all fund expenses or portfolio trading costs.

I strongly disagree that reducing investment risk as an investor approaches retirement has somehow become redundant but you are obviously entitled to your view in this regard.


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## Gordon Gekko (3 Nov 2016)

Thanks Sarenco. I was particularly interested to hear your view. I always thought that dividend yield (say 3%) plus dividend growth (say 4%) should approximate one's return (plus a little bit maybe for the reinvestment of surplus cashflows). 

My view around retirement is that other than the 25% lump sum, the ARF endures, so "retirement" is a non-event. Take a fund of €3m; the lump sum will be €500k regardless of whether there's a 33% drawdown the day before or not. The rest endures, and if it's of sufficient quality and diversified, it will recover.


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## Steven Barrett (3 Nov 2016)

An article written by the owner of the risk profiling company I use on sequence risk that made be of interest to you Gordon.

http://citywire.co.uk/new-model-adv...-the-sequencing-risk-debate-rages-on/a828084/


Steven
www.bluewaterfp.ie


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## Sarenco (3 Nov 2016)

Gordon Gekko said:


> The rest endures, and if it's of sufficient quality and diversified, it will recover.



Well, presumably from retirement there will be ongoing distributions (or imputed distributions) from the ARF so I can't share your view that retirement is a "non-event".

Where there are no contributions to, or distributions from, a portfolio, an investor can simply sit back and wait for long-term returns to show up, without being unduly concerned about the dispersion of returns in the intervening period.  However, the _sequence_ of returns becomes very relevant where there are cash flows moving in or out of a portfolio.

When saving for retirement, the returns on the portfolio (whether positive or negative) in the later years will obviously have a more meaningful impact on the ultimate size of the retirement pot than returns in the early saving years (simply because of the increasing size of the portfolio).  

Conversely, when a retiree starts to drawdown their savings, the return on the portfolio during the early years of retirement will have a more significant impact on the durability of the portfolio than the return in the later years of retirement (because of the reducing size of the portfolio).

Obviously nobody can control (or reliably predict) the sequence of returns on a portfolio but an investor can _manage_ this risk by transitioning to a more conservative asset allocation in the run up to retirement.  Whether (or to what extent) an investor chooses to do so is obviously a personal decision based on individual circumstances.

Finally, for planning purposes, I think you should at least allow for the _possibility_ that you will become more conservative as you get older.


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## Gordon Gekko (3 Nov 2016)

Thank you Sarenco.

My issue is this; say someone is retiring at 65 and the de-risking process really kicks in at age 60 which happens to be 2009. That person misses out on the big recovery.

Alternatively, say the same person is retiring at 65 in 2009 and has €3m in their fund. No de-risking happens. The fund drops by 40% to €1.8m. His lump sum is net €400k instead of net €440k. A fairly meaningless differential. The ARF of €1.35m has grown to approximately €3m based on returns since then.

Had derisking happened, the position is far far worse.


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## Sarenco (3 Nov 2016)

Well, I personally think that 6 years out from retirement is far too late to start de-risking a retirement portfolio.

Say the retiree in your example started (very) gradually de-risking his portfolio 20 years out from his targeted retirement date.  2008 rolls around and, with one year left to retirement, 33% of his portfolio is now in bonds, with the balance in equities.  The bond allocation then jumps to 55% of his portfolio following the stock market crash and the retiree now has ample "dry powder" to buy back into the stock market at hugely reduced prices to gradually rebalance his portfolio back to its original 66/33 stock/bond allocation.

There is actually a good argument for allowing the equity allocation to gradually drift higher post-retirement as the sequence of returns risk starts to recede.

Sure the bonds can be expected to be a drag on the performance of the portfolio prior to the stock market crash but they help to smooth the sequence of returns - particularly when it matters most.

Also, don't discount the emotional impact of seeing 50%+ of the value of your life savings simply vanish the year before you are due to retire and having no idea when your portfolio will recover.  It's only with the benefit of hindsight that we now know that equities recovered as quickly as they did following the 2008/09 crash.

What if equities took 20 years to recover and you were effectively forced to crystallise losses by drawing from your equity portfolio throughout those 20 years?


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## Gordon Gekko (23 Aug 2017)

Sarenco said:


> Well, I personally think that 6 years out from retirement is far too late to start de-risking a retirement portfolio.
> 
> Say the retiree in your example started (very) gradually de-risking his portfolio 20 years out from his targeted retirement date.  2008 rolls around and, with one year left to retirement, 33% of his portfolio is now in bonds, with the balance in equities.  The bond allocation then jumps to 55% of his portfolio following the stock market crash and the retiree now has ample "dry powder" to buy back into the stock market at hugely reduced prices to gradually rebalance his portfolio back to its original 66/33 stock/bond allocation.
> 
> ...



Hi Sarenco,

What would you think of the following as a strategy?

Take a €3m ARF. €180k a year has to be withdrawn per the rules. The income yield is (say) 2%. Stick €650k aside in cash. That plus the dividends will cover the mandatory distribution for a period of five years.

Thanks.

Gordon


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## cremeegg (23 Aug 2017)

Past returns are not a useful guide to future returns.

The risk free rate of return at present is less than 1%, add a risk premium of 2% that gives a real return before fees of 3%. In my opinion anything more is optimistic.


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## Sarenco (23 Aug 2017)

Gordon Gekko said:


> What would you think of the following as a strategy?
> 
> Take a €3m ARF. €180k a year has to be withdrawn per the rules. The income yield is (say) 2%. Stick €650k aside in cash. That plus the dividends will cover the mandatory distribution for a period of five years.


Hi Gordon

It's a difficult question to answer in the abstract because it really depends on your financial objectives.

Personally, my goal for my pension savings is pretty straightforward - to fund my living expenses in retirement with the lowest possible risk of running out of money.  I'm not particularly concerned about leaving behind a financial legacy.

There are different ways of approaching this issue but my plan is to have around 20 years of my residual expenses in "safe" assets (cash & bonds) at retirement.  By residual expenses, I mean what I think I will "need" to live a modestly comfortable lifestyle, taking account of any State contributory pension (assuming such a thing still exists at that stage!).  Everything else will remain invested in "risky" assets (essentially equities). 

I have a pretty good idea what 20 years' worth of my residual expenses will look like (at least in 2017 terms) and I am allocating my pension contributions to different assets accordingly.  I'll keep an eye on my portfolio as I go along and adjust as necessary.

I fully appreciate that many (most?) posters will find my approach to be overly, even recklessly, conservative.  That's absolutely fine - it's called personal finance for a reason! 

Finally, bear in mind you are already gradually de-risking if you are paying down a mortgage - even if you are retaining a 100% allocation to equities in your pension fund.  It's your overall financial position that really matters.


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## Gordon Gekko (23 Aug 2017)

Thanks Sarenco. My wish is to create value for the kids through my pension fund; I don't expect to need the income per se, but will be forced to take it by virtue of the ARF mandatory distribution regime.


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## Sarenco (23 Aug 2017)

Well, it looks like 20 years' worth of your residual expenses (as I have defined it) will be zero in that case - as you don't expect to "need" to withdraw anything from your ARF to meet your living expenses in retirement. Following my logic that would imply that you could remain 100% invested in equities, in perpetuity.

However, bear in mind that your "needs" might change...


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## Gordon Gekko (23 Aug 2017)

In such circumstances, I wonder whether there's merit in not taking the drawdown. Instead of 6% coming out, 3% would. The other 3% then stays in gross roll up land, and even gets inherited on slightly better terms (30% vs 33%).


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## Gordon Gekko (24 Aug 2017)

Wollie said:


> I recall doing the sums on this some time ago, and concluding that it made no sense not to take the draw-down: you're taxed as if you have taken it.  I'm not a tax expert, so I could be wrong.



Let's assume a 50% tax rate and a €1m ARF in a family where the Group A threshold (€310k) will be comfortably used up.

Say I'm 62 and therefore forced to take out 4%. €20k lands into my current account net of tax. If I die, my kids pay 33% tax on the €20k.

Say I don't take the 4%; my ARF is raided for the tax anyway, so I lose €20k but I've an extra €20k in my ARF. 

If I die, the extra €20k in the ARF is taxed at 30% if inherited by my kids.

And the €20k has remained in an environment where no tax arises on any investment growth.


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## Conan (24 Aug 2017)

Gordon
I don't agree with your strategy.
You say "if I die" - well you will eventually. But if you were 62 then your average life expectancy is some 20 years. So I think it is more reasonable to assume you will spend the net €20k.
But also remember that if you don't take the net drawdown of €20k (but leave it in the ARF) it will be taxed again when you do draw it down (as income) . So in effect you get taxed twice on the same amount.
Your strategy suggests that you will never need any net income from the ARF and that you intend to leave as much as possible of the ARF to your children when you die. Not a typical strategy I suggest.


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## North Star (24 Aug 2017)

Gordon as a suggestion if you dont anticipate needing the income and anticipate leaving the funds for generational planning, would you not consider taking the ARF income and use the proceeds to avail of the annual small gift exemption of €3k per annum for as many beneficiaries as you wish? This and the CAT thresholds will reduce the overall CAT liability for the estate. Just a thought...


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## Steven Barrett (24 Aug 2017)

Gordon Gekko said:


> Hi Sarenco,
> 
> What would you think of the following as a strategy?
> 
> ...



Where does the €3m come from Gordon? €1m of that is going to be taxed twice for going over the Standard Fund Threshold. Surely not a tax efficient method of saving? 


Steven 
www.bluewaterfp.ie


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## Gordon Gekko (24 Aug 2017)

SBarrett said:


> Where does the €3m come from Gordon? €1m of that is going to be taxed twice for going over the Standard Fund Threshold. Surely not a tax efficient method of saving?
> 
> 
> Steven
> www.bluewaterfp.ie



Hi Steven,

My sense is that in 30 years time, the SFT will be higher.

But you are absolutely correct.

Gordon


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## Steven Barrett (24 Aug 2017)

jbrenn11 said:


> New poster
> If I retire end of November  2017 and take out arf will I have to take 4% out before end of 2017,



If you are 61 or older, yes you will. 


Steven 
www.bluewaterfp.ie


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## Steven Barrett (24 Aug 2017)

Gordon Gekko said:


> Hi Steven,
> 
> My sense is that in 30 years time, the SFT will be higher.
> 
> ...



Could go the other way. The UK is much lower. 

Net present value of €3m in 30 years, assuming 2% inflation is €1.65m, well within the limits.


Steven
www.bluewaterfp.ie


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## Gordon Gekko (24 Aug 2017)

Yes, but they have ISAs etc in the UK. And a lower SFT would bring a lot of mid-ranking public servants into Chargeable Excess Tax territory. My money would be on a higher SFT.


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## Sarenco (24 Aug 2017)

Yep, a lot a high earners in the UK's public sector face significant tax bills as a result of the reduction of their maximium lifetime allowance to £1million (from £1.25m) last year.  

Money invested in ISAs would already have been taxed so it's not really comparable to a (tax deferred) contribution to a pension scheme.

FWIW, I don't expect the SFT to be reduced to the level of the UK's lifetime allowance but I would be very surprised if it was actually increased, at least in real terms.


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## Gordon Gekko (25 Aug 2017)

Sarenco said:


> Money invested in ISAs would already have been taxed so it's not really comparable to a (tax deferred) contribution to a pension scheme.



ISAs are very relevant in the context of any comparison between the retirement planning environments in Ireland and the UK.


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## Gordon Gekko (25 Aug 2017)

Conan said:


> But if you were 62 then your average life expectancy is some 20 years. So I think it is more reasonable to assume you will spend the net €20k



I view my pension fund as "jam". My wife's pension, our rental income, and my State Pension would be more than enough for us to live well.


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## Sarenco (25 Aug 2017)

Gordon Gekko said:


> ISAs are very relevant in the context of any comparison between the retirement planning environments in Ireland and the UK.



Indeed.  And the considerably less generous State pension in the UK would also be highly relevant to any such comparison.

But my point was that money invested in ISAs would already have been taxed so it's not really comparable to a tax-deferred retirement saving vehicle.


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