# How much of an ARF should be in equities?



## elacsaplau (4 Jun 2018)

Marc said:


> The “traditional” rule for age based bond allocations is 100% stock less current age but as an asset allocation model it’s not great, especially if you intend to ARF in retirement you’ll end up being too light in equities.



Marc - how high an allocation to equities would you advocate for the "normal" individual with just an ARF - by "normal" I mean someone without extreme wealth, health concerns or other factors, etc. and by "just an ARF" I mean without a DB promise/annuity in addition?


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## Brendan Burgess (4 Jun 2018)

If they have "just an ARF" , then they should cash as much as possible and buy a home.  The house would be ignored for means testing purposes so they would get the Non Contributory OAP. 

If they own their own home without a mortgage and if they qualify for the Contributory OAP, then it would be a different matter.  As this is a very good basic income, they should invest the rest of their wealth in equities - assuming that they have at least a 20 year life expectancy.

If they are coming towards the end of their life, they should discuss it with their beneficiaries as it's their investment horizon which is most relevant. 

Brendan


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## Sarenco (4 Jun 2018)

elacsaplau said:


> Marc - how high an allocation to equities would you advocate for the "normal" individual with just an ARF


Good question.

I'm some way off having to make any decisions in this regard (and I may well adapt my position over time) but my current plan on retirement is to have roughly 15 years' worth of residual expenses in cash and fixed-income investments, with the balance (if there is a balance!) in equities.  By residual expenses, I mean the amount I think I will need to fund a comfortable lifestyle, less any State pension, etc.

I also plan to draw down the cash/fixed-income portion of the ARF first, so that I effectively increase my allocation to equities over time.  That might seem counter-intuitive but I think it's a reasonable way of balancing inflation and sequence of return risk.

I certainly don't have a firm opinion on this issue and would be very interested to read the views of others.


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## elacsaplau (4 Jun 2018)

Thanks Sarenco,

That's exactly the angle I've been wondering about - my question got distorted slightly as it was moved from another thread.

Rather than commenting right now on your approach, just to explain further where I'm coming from. I suppose the question was prompted by Marc's view that "age in bonds" is passé so I was seeking Marc's views on an acceptable upper range for equities (for ARFers).

Meanwhile, Brendan has chimed in that the ARF investor "should" invest 100% in equities (so long as the house has been paid off, etc. which is kinda what I meant by "normal" investor - figuring it to be a reasonable working assumption).

So, in essence, Marc is saying 35% equities (at 65) and reducing thereafter as one's age increases is too low - (which, incidentally, I agree with) and Brendan is broadly saying 100% equities (which I think is too high - certainly for most people).

What I'd like is for all posters, and particularly the financial adviser community, to address this asset allocation question. [Obviously - given the thread of the weekend, we all know where our resident tax guru stands!]

I think this is a really important question and I have asked it before but do not recall ever seeing an answer from the adviser community. The bottom line is I'd like to know how advisers deal with this asset allocation question in practice, the basis for subsequent re-balancing, etc.

I suppose if we divide assets between defensive and return-seeking, where do people invest their defensive assets in current market conditions?

Finally, what I'm really, really interested in is:

1. The data such advice is based on; and
2. What specific guidance is given by the relevant professional bodies that advisers belong?


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## Gordon Gekko (4 Jun 2018)

Hi elacsaplau,

You probably don’t know where I stand to be fair! The position with an ARF is different, and even then it depends on the status of the ARF-holder.

I’ve come across 50 year old ARF holders with 11 years to go before the mandatory drawdown kicks in. 

Then you’ve ARF holders who are subject to 4/5/6% mandatory drawdowns; that changes the analysis quite a bit. It all comes down to sequencing of returns; basically, if you’re 100% invested in equities and you start drawing down from your ARF at 4% or 6% and markets tank, you have a problem, because you’re taking money out whilst the capital value of your ARF is falling and that capital never has the chance to recover.

It’s very different to my strident view regarding someone with a 20 year time horizon and no need to access the cash.

Gordon


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## elacsaplau (4 Jun 2018)

Fair enuff, Gordon!!

I agree with your points.

[In my feeble defence - and let's leave it at that please! - I was (a) kinda half joking and (b) did have a recollection of a previous post of yours to the effect that you'd personally be pretty much all-in equity when your ARF times rolls around! However...…...I accept my joke may not have been funny and my recollection may not be accurate! ]

Just to add: I accept that there are a whole pile of variables (like the age 50 scenario described by Gordon above.) For the purposes of this thread, probably best to maintain as typical a scenario as possible - so let's consider the ARFer has arrived at "compulsory" drawdown age. Whilst I'm at it, let's assume it's an ARF based on current legislation - this last caveat may save me a lot of grief later!


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## Gordon Gekko (4 Jun 2018)

It wouldn’t be a great idea to be 100% invested in equities in such circumstances because initial market weakness would have a detrimental effect longer term. I’m referring specifically to circumstances where the individual is basically reliant on the ARF for income in retirement.


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## Sarenco (4 Jun 2018)

I think the size of the pension pot is a pretty important consideration.

For discussion purposes, maybe we should assume a pension pot of €1million, with lifestyle expenses of €40k per annum.  

So, my tentative formula of having 15 years' worth of residual expenses in cash/fixed-income investments at retirement (ignoring the State pension for simplicity) would result in an equity/fixed-income split of 40/60.  

Coincidentally, that's "age in bonds" for somebody retiring at 60 but my suggestion is that the proportion in equities would gradually increase as the retiree ages, perhaps with an upper limit of, say, 60% in equities.

Interested to hear the thoughts of others on what I agree is a very important question.


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## Gordon Gekko (4 Jun 2018)

Hi Sarenco,

What’s your view on someone not taking their mandatory distribution?

For a 61 year old, an ARF of €1m can have a mandatory distribution of €40k or just pay tax of circa €20k.

If someone negotiatied a very cheap QFM charge and bought a really cheap ETF for example (say 40bps all in).

Gordon


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## Marc (4 Jun 2018)

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## Sarenco (4 Jun 2018)

Marc said:


> 5) the annuity forgone should also be used as a hurdle for measuring how “successful” the arf strategy is. You’re not keeping up the Jones’s you are trying to do better than your own annuity rate after costs


The only snag is you won't know whether your strategy has been successful until it's too late!

Which brings us back to the original question - what's a reasonable yardstick for determining your initial allocation in an ARF in a "normal" scenario?  Age in bonds, 100/110/120 less your age in equities, a static allocation (maybe 60/40) for life, a multiple of your residual expenses in fixed-income or something else entirely?

I fully appreciate that there is no universally correct answer here but I'm interested to know how others are approaching this issue.


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## Marc (4 Jun 2018)

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## Marc (4 Jun 2018)

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## Gordon Gekko (4 Jun 2018)

But say I’ve the potential to have an ARF of (say) €1.5m or a simple annuity of €45k a year.

Most people I’ve come across are more concerned about the succession planning aspects of the ARF (i.e. becomes a spouse’s ARF and then 70% of its value paid to the kids without impacting their CAT thresholds).


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## Sarenco (4 Jun 2018)

Marc said:


> Not true.


What's not true?

Are you telling us you can accurately forecast the return on a portfolio of equities and bonds over an indeterminate time period?


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## Marc (5 Jun 2018)

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## mtk (5 Jun 2018)

Gordon Gekko said:


> I’ve come across 50 year old ARF holders with 11 years to go before the mandatory drawdown kicks in


Hi Gordon how come this happens in your experience if I may ask ?


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## Gordon Gekko (5 Jun 2018)

Hitting the threshold or move jobs basically


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## Duke of Marmalade (5 Jun 2018)

Marc said:


> As time goes on and people get older, the pool of people who die early gets smaller until the life company is just left with those annuitants who aren’t going anywhere soon. They get a relatively worse annuity rate for their age than they would have received when they were younger.


In practice in current conditions annuity rates become relatively better value as you get older.  From the Irish Life annuity calculator the annuity rates are as follows:  65 year old 4% p.a.,  75 year old 6% p.a. and 85 year old 10% p.a.  So assuming we can fairly safely earn 2% p.a. we have the following alternative scenarios:
1) 65 year old buys annuity now to earn 4% p.a.
2) He postpones until age 75 dipping into his fund to provide that 4% p.a., then buys an annuity with the remaining c.78; that would give an annuity of 4.7% p.a.
3) He postpones until age 85 then buys an annuity with the remaining 51; that would give an annuity of 5.1%

Postponing taking out longevity insurance (annuity) is very much to be recommended to a 65 year old.  Unlike other risks there is no danger of suddenly finding it uninsurable.  Yes longevity in general might improve but expectations of longevity improvements are already well built into current annuity rates and surely the interest rate environment must improve at some stage.  Also postponement provides some hedge against inflation which is totally absent the annuity route.  

I presume these days nobody advises a 65 year old to take out an annuity.


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## Sarenco (5 Jun 2018)

Marc said:


> This personal benchmark, the guaranteed annuity income given up to buy the ARF, is known with certainty by all ARF investors and is the real hurdle against which they should be measuring their account


I don't agree that beating the return on an annuity should be the measure of success of an investment strategy for an ARF. 

But even if you want to view this issue through that lens, you will only know for certain that your strategy has been successful with the benefit of hindsight. 

That brings us right back to the original question posed – what's the optimum way of determining a reasonable allocation of assets within an ARF in a typical scenario?

At this point, I would guess that many financial advisers would turn to portfolio optimisation software that projects the return on a portfolio comprising various assets classes.  While these models might appear sophisticated, I am deeply sceptical about the ability of anybody to predict portfolio returns over an indeterminate, or even an assumed, time period with anything even approaching precision.


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## Duke of Marmalade (5 Jun 2018)

Sarenco said:


> That brings us right back to the original question posed – what's the optimum way of determining a reasonable allocation of assets within an ARF in a typical scenario?


I'm afraid this does not have an answer.  It's like asking when does a foetus become a citizen, if you pardon the topical analogy.  As O'Bama said that question is above his pay grade and so too is the ARF question despite many getting paid handsomely for pretending to have the answer.

The answer is personal in both cases.  I came right up against this in recent times.  The deferred pensioners of Zurich are all being offered handsome pay offs to switch from DB to ARF.   Some whom I know of old have come to me for advice.  Whilst the sums point to definitely taking the soup, I get completely stumped by the supplementary - where should they invest the ARF?  

They are all getting free advice from Mercer which they are sharing with me.  The Mercer method:  *Q:* what is your attitude to risk?  *A: *Low to medium in all cases; Advice - invest in the Prisma 3 (risk rating) fund which is about 40% equity/property/alternatives.  It is simplistic but what else can you advise?  I certainly am not pointing them in any alternative direction.  

I know Colm Fagan is currently on a mission to persuade folk like this to be 100% equity and his arguments are powerful - I just don't have sufficient faith myself to promulgate that message.


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## Sarenco (5 Jun 2018)

Thanks Duke.  I think that's a fair, if somewhat frustrating, response.

Interestingly, the Mercer recommendation would also have a 60-year-old at "age in bonds".


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## Marc (5 Jun 2018)

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## elacsaplau (6 Jun 2018)

Apologies in advance - what's to follow may be a bit rushed - waiting to be called for my flight.

It is probably fair to say that Mercer would be generally considered in the top tier of advisers. (I am aware of criticisms of their administration capabilities which is a separate issue). I also have seen samples of their reports which the Duke has accurately summarised.

In essence, their advice seems quite basic in nature, as in:
- what's your risk rating?
- here's the fund for you.

Is this symptomatic of the level of advice out there? I suspect the answer is yes and I believe this for a number of reasons.

1. It's a very, very complex question (there is no one size fits all answer and as Sarenco correctly pointed out the right strategy may not give the right results!)
2. The approach taken by the likes of Mercer is compliant with Central Bank directions (a bit like the old one of no one ever gets fired for buying IBM)
3. There simply has not been sufficient debate/analysis/guidance on this by the professional bodies (do a google on this and you will not get very, very little Irish material)
4. The low response rate and the absence of detailed content to the key question from the adviser community in this and related threads.

I think that we can all agree that asset allocation is a primary determinant of investment performance so the lack of detailed commentary on the implications of the investment decision (as say in the Mercer report) is concerning.

For example - (admittedly going from memory) what was missing from the Mercer report that I have seen were meaningful details:

- about sequence of risk implications
- on appropriate withdrawal levels and strategy
- of the opportunity costs of an overly conservative asset allocation
- why "alternatives" are included in the asset allocation
- the implications of having a high bond allocation (especially in current markets)

The bottom line is that there must be a more evolved approach to the question than lumping someone into an off the shelf product equating to their risk rating. The report I have had sight of was in respect of a client with just over €1m in his ARF. The Mercer charge was 1.5% and I think for €15,000 clients deserve more for this spend than "lob it in to Prisma 3 and you'll be grand". There were additionally on-going costs - I can't recall the level - probably 0.25% or 0.5% p.a. - presumably to provide an update on how Prisma 3 got on during the year?

With the inexorable demise of DB plans, this will become a more and more common question and people will need better solutions. Realistically, advisers may not be able to add 3% p.a. to the returns of their clients - as has been the subject of another thread - but they should be able to add some value to a reasonably sophisticated ARF investor and I'd love to understand how!


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## Duke of Marmalade (6 Jun 2018)

Yep, same Mercer report alright.  The central graph was to illustrate the run off of the ARF under 3 assumptions, central assumption of 2% p.a., a lower one of 1% p.a. and a higher one of 3% p.a.  I think the ARF ran out at ages 86, 84 and 88 resp. and then they had the throw away comment that the cash lump sum would last another 8 or 9 years. Same graph for my three friends.  I developed a somewhat more sophisticated Excel model which tried to illustrate the stochastic risks such as sequence of return risk.  However it didn't seriously challenge the Mercer recommendation. I told my friends of the Colm Fagan message but they are not willing to take the risks, so fair enough.  (Glad to share my "App" with AAM if I knew how to upload Excel spreadsheets.)

And yes Mercer were weak on ARF withdrawal strategy.  At a minimum they should have advised to minimise ARF withdrawals and use their cash fund if necessary as this is likely more tax efficient.


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## Duke of Marmalade (6 Jun 2018)

Gordon Gekko said:


> Hi Sarenco,
> 
> What’s your view on someone not taking their mandatory distribution?
> 
> ...


This question can be summarised as would you prefer to have €20k in hand or €20k behind ARF gates.  Since you almost certainly have to pay some tax when you or your children exit the ARF it seems to me better to have it in hand.  There is gross roll up behind the gates but this shouldn't be over egged - it is not tax free interest, still have to pay tax on exit and after all there is 8 year gross roll up outside the gates.


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## Duke of Marmalade (6 Jun 2018)

Marc said:


> 1) AmRF not subject to same drawdown requirements should have a more aggressive investment strategy than the ARF.


This strategy leads to systematic increases in overall equity exposure, which seems counterintuitive.


Marc said:


> 2) 100% equities is a sub optimal strategy due to volatility drag


Colm Fagan doesn't agree.  "Optimality" is personal not objective.


Marc said:


> 3) The size of the fund and the variable requirement to take imputed distributions should inform the asset allocation decision 6% is materially different to 4%.


Other than transaction costs compulsory distributions are a red herring.  You can always reinvest.


Marc said:


> 4) the charges incurred are another factor for consideration


Absolutely.  A report commissioned by the DoF suggests that combined provider/distributor costs on ARFs can be as high as 1.5% p.a.  Only the most aggressive of strategies can expect to overcome that sort of burden.


Marc said:


> 5) the annuity forgone should also be used as a hurdle for measuring how “successful” the arf strategy is. You’re not keeping up the Jones’s you are trying to do better than your own annuity rate after costs
> 6) I don’t think leaving money in the ARF and paying the tax from personal resources makes sense. If the value of the ARF falls you will have paid tax on money you lost.


I have covered these two points elsewhere.


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## Marc (6 Jun 2018)

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## Duke of Marmalade (6 Jun 2018)

Marc said:


> Volatility drag is a mathematical effect not a personal question


I said "Optimality" was personal.  I agree that all mathematics is objective.

I read the interesting paper you signposted.  It is a development of the theme that the arithmetic average is greater than the geometric average, and somewhat more mundane than stochastic analysis. The stochastics only come in when demonstrating that the formula is accurate for a lognormal distribution.  AM > GM is a mathematical truism without any economic implications, despite the best efforts of the pound cost average brigade.  

Mindlin does refer to its relevance to asset allocation strategy for pension funds.  But this is only to advise them to be careful in interpreting past performance figures.  For example, say they are targeting a 5% return, they really mean they are targeting a 5% geometric return and therefore they could be misled if they look at past arithmetic average returns.  

It is a very theoretical though interesting observation.  I suggest it is of no relevance whatsoever for an individual's ARF allocation strategy.  In any case all references to past performance that I have seen correctly refer to the average geometric performance.


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## elacsaplau (6 Jun 2018)

Thanks Duke,

I, very literally, couldn't have put it better myself ........let's not get caught up in these particular weeds please!

In fairness to Marc - the style of Kitces' analysis is attractive - just nay time to read the detail right now. BUT, and a big, big BUT - this is US based stuff (and thus only applicable to a point because of the level of bond yields in these here parts). I am aware that there is a debate in the US on this topic (loads of contributors in the public domain). I'm looking for, dare I say it, an Oirish solution to well, yes....


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## Protocol (6 Jun 2018)

In my parents case their ARF is approx 10% of their combined real and financial wealth.

It has held its value over the last 5-10 years, after the annual income drawdown.

The annual income is 7% of their gross income.

I'm not sure of the exact asset split, it's invested 50/50 in two IL/Cornmarket funds, I think a Consensus fund and something else.

Even if it's 100% in shares, I'm not worried.

If it halved in value, and the annual income halved, it would have absolutely no impact whatsoever on their lifestyle


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## Colm Fagan (6 Jun 2018)

Duke of Marmalade said:


> I know Colm Fagan is currently on a mission to persuade folk like this to be 100% equity and his arguments are powerful - I just don't have sufficient faith myself to promulgate that message.



The Duke is right: I am on a mission to persuade people to invest far more in equities than is currently the norm for ARF’s.  I've been struggling to understand why I am so much of an outlier in my views; I think I have finally found the answer.

Most people think of equities as numbers that bounce around, sometimes going up, sometimes going down, often for no apparent reason.  They take those numbers seriously.  I don't.  For me, equities are companies that I have researched and that I think represent good value in the long term.  I don't particularly worry about share prices bouncing up and down; I just look at the fundamentals of the business, generally every half year after results announcements, and if things are going broadly as I had expected, then I don't give a fig for what the market says is the current value of the share.

Most people in Ireland live outside the rarefied world of finance and a significant number of intelligent, well-to-do people don't go near investment advisers, ARF’s or PRSA’s when planning their retirement .  Their pension savings consist of a house or an apartment or two (or more if they’re lucky), the rental income from which they hope will generate a good income for them in retirement.  I feel more akin to one of those people than to my fellow finance professionals.

My wife and I own our own home; we don't have any investment properties, but the eight shares that account for 94% of my ARF are my equivalent of rented out apartments.  Those eight shares (think apartments) generate a rental income (sorry, dividend income) of between 0 (for just one of the eight, because it reinvests all the income from “tenants” into “refurbishments”, which increase the value of the “property”) and 6.5% a year.   I keep only a small amount in cash (currently 4%, which is a higher than normal proportion, because one of the companies will be having a rights issue soon and I want to take up at least some of my rights).

I am obliged by law to take an income of 6% every year, but there has always been sufficient cash in the ARF to generate the required income.  (I am now in my eighth year of drawdown).  I don’t recall ever having to sell a portion of any of my holdings to generate the required cash.  Most of the 6% comes from dividends, some from the cash balance in the account, and the remainder of the required 6% from occasional minor adjustments to the holdings; such minor adjustments are normal for an actively managed portfolio and are not done for the purposes of generating cash for the compulsory "income".  In this regard, it's important to remember that shares have one big advantage over apartments: I can sell a portion of my holding in a share at any time, and at a low cost; that would not be possible for a portfolio consisting of eight apartments.  My eight "apartments" are also in different "cities" (i.e. different businesses, different countries), some are up-market (low dividend yields), some are down-market (high dividend yields).

I think of quoted share prices as the equivalent of estate agents dropping notes in my letterbox every day telling me what price they would buy or sell one of my apartments for on that particular day.  Most of the time, I just throw their notes in the bin; sometimes, if they quote a price that is markedly different from the one they quoted yesterday or last week, I may do the equivalent of calling around to the apartment to see if the tenants have smashed it up since I last saw it.  Normally they haven't so I just go back to sleep.  Occasionally, of course, there is a problem, but they are few and far between, and are more than compensated for by the attractive rental income and the growth in income as years go by.

Against that background, statements such as 





Marc said:


> 100% equities is a sub optimal strategy due to volatility drag


 are double Dutch, and references to


Sarenco said:


> my current plan on retirement is to have roughly 15 years' worth of residual expenses in cash and fixed-income investments, with the balance (if there is a balance!) in equities.


make no sense whatsoever, nor does


Gordon Gekko said:


> It all comes down to sequencing of returns; basically, if you’re 100% invested in equities and you start drawing down from your ARF at 4% or 6% and markets tank, you have a problem, because you’re taking money out whilst the capital value of your ARF is falling and that capital never has the chance to recover.


If the property market tanks (remember that my investments are in different "countries", so we should think in terms of property markets rather than a single market) and my tenants in the eight apartments are still paying their rents on time, I don't care a whit about the market tanking; in fact, I may see it as a good opportunity to buy another apartment.


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## Duke of Marmalade (6 Jun 2018)

Colm,  OP refers to a "normal" individual.  Your personal story is nonetheless fascinating but not really a model solution for my recently acquired "clients".  You would surely fail your QFA exams with only 8 stocks


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## Colm Fagan (6 Jun 2018)

Duke of Marmalade said:


> Your personal story is nonetheless fascinating but not really a model solution for my recently acquired "clients"


Duke, I agree that my approach is only of interest to high net worth individuals, but the concept is valid irrespective of the size of the pot.  My smoothing proposal, which also involves close to 100% investment in "real" assets, is designed for people like your "clients".  It gives a very small weighting to current market values, which avoids the stupidity of estate agents pestering them every day.


Duke of Marmalade said:


> You would surely fail your QFA exams with only 8 stocks


Agreed also, but I'm not interested in passing QFA exams, only in getting a reasonable return on my investments.


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## Marc (6 Jun 2018)

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## Bob2018 (6 Jun 2018)

Marc - Why not continue the debate here where all the people that use this site can benefit? In my opinion taking this off-line sort of undermines Askaboutmoney.

Colm


Colm Fagan said:


> My approach is only of interest to high net worth individuals, but the concept is valid irrespective of the size of the pot.



I'm a bit confused by what you wrote here. I'm not sure what the quote above means. Are you saying everything in equities is or is not suitable for "normal" people? If yes, can you also explain why there is no need to be concerned  "sequence of returns" risk?

Also, can you also explain whether you are advocating a very small number of shares - again for normal people?

I admit that I'm new to managing my finances (my brother used to do it for me) but from what I've read on other sites, there is such a thing as sequence of return risks and also that holding a small number of shares just adds to that risk. And how realistically could a "normal" person know which stocks to pick when professional managers have a hard time beating benchmark returns in the long haul?


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## Colm Fagan (6 Jun 2018)

I’ve already presented my proposals for ARF’s invested completely in real assets, including equities (quoted and unquoted), property, infrastructure, etc to the Society of Actuaries, the Pensions Management Institute and the IAPF.  I am quite happy to present to other fora.


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## Colm Fagan (6 Jun 2018)

Bob2018 said:


> I'm a bit confused by what you wrote here.


Hi Bob, I've clocked off for the night - shop steward's orders.  I'll come back to you in the morning.


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## Sarenco (6 Jun 2018)

@Bob2018 

We had a pretty decent discussion a few months back on sequence of return risk starting on page 3 of Colm's "Diary of a Private Investor" thread that you might find of interest -

https://www.askaboutmoney.com/threa...ure-diary-of-a-private-investor.195710/page-3


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## Steven Barrett (7 Jun 2018)

A lot of very interesting points and yes, there has been a lack of Advisor input (except Marc). There is no one fixed ARF investment model because there is no one fixed human approach to investing and lifestyle costs. There are a 


How old the client is
How old their spouse is
Level of income required
Size of pension fund
Other assets/ sources of income
Capacity for loss (overriding factor) 
Attitude to risk
If you have a relatively small ARF, you need to take more investment risk to be able to take a bigger income from the ARF. But these people usually have a low capacity for loss (will a worse case scenario have a detrimental impact on your lifestyle?). As an advisor, I can't tell someone to invest 100% in equities if a 40% fall in value have a detrimental impact on their lifestyle. 

High net worth clients can afford to take more investment risk but why should they if they don't need to? If I go through the financial planning process with them with lifelong cashflows, we can calculate the level of risk they need to take with their money. As people get older, they tend not to want to take lots of investment risk with their money as they feel vulnerable with not having the safety net of a regular salary that they can earn. This is part of an advisor's job to manage people's behaviours as well as their money. 

Explaining investment risk is another issue. Most people think of it as how much they can lose and never get back. We have to explain about being part owners (no matter how small) of large global companies such as Apple, Google, Disney etc and sharing in the rewards and losses of those companies. 

I've just started a trial using a piece of software called Timeline which is marketed as "the sustainable withdrawal rate app". You enter client details, asset allocation, investment amount and withdrawal amount (there's other metrics there too). Based on returns going back to 1900, it shows the worst case, median and best case scenarios. The creator, Abraham Okusanya, is top notch and comes out with great research, so I'm interested to see how the trial goes and whether it is worth using with retirees full time. 


Steven
www.bluewaterfp.ie


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## Duke of Marmalade (7 Jun 2018)

Steven,

I will email you my own home made App (Excel spreadsheet).  I wish I knew how to share it with AAM in general.


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## Steven Barrett (7 Jun 2018)

Thanks Duke. My email is steven@bluewaterfp.ie


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## Colm Fagan (7 Jun 2018)

I've extricated myself from the arduous task of sunning myself in the garden in order to answer Bob's questions!



Bob2018 said:


> I'm a bit confused by what you wrote here.



I reckoned that the Duke's "clients" have relatively small pension pots and so couldn't incur the overhead associated with asking a stockbroker to set up an ARF for them.  It is a long time since my ARF was set up, I don't recall the precise costs, but I doubt very much if it would be worth the associated overhead for a smaller pension pot.

My comment on the validity of the concept irrespective of size of pot was saying that, if fixed overheads were not a concern, the approach I've been adopting for the last 7 1/2 years with my ARF (and for the previous dozen or so years during the accumulation stage) will be equally applicable for smaller pension funds.



Bob2018 said:


> can you also explain whether you are advocating a very small number of shares - again for normal people?



I recognise that I am an outlier in terms of my approach to concentration risk, and I would not necessarily recommend a similar approach by others.  I was simply telling what I have done.   I started off 20 years or so ago by following a conventional approach, with a portfolio of 20 or 30 stocks.   I eventually recognised that I just bought many of the stocks on a whim and decided to focus my attention on companies that I could be reasonably confident about, having researched them.  I'm not a full-time investor, so have limited time for research.  This obviously limits the number of stocks in the portfolio.  The relative performance of my portfolio has improved significantly since then.

As an aside, I think much the same is true of professional portfolio managers.  I recall reading a report somewhere that the good performance of high performing portfolios is concentrated in about five or six stocks, and that the rest are basically fillers.  I also recall attending an investment conference a few years ago at which the manager of a particular portfolio said that stocks the managers classified as "winners" accounted for 20% of the portfolio.  He didn't have a satisfactory answer when I asked why "winning" stocks it didn't account for 100% of the portfolio.

Comparing my approach to investing with that of the amateur investors who have decided to eschew the rarefied world of insurance companies, investment advisers, et cetera in favour of doing their own thing by buying a few houses or apartments for investment purposes, they would be more than happy with a portfolio of eight apartments, rented out to different customer types in different cities across the world.  That's how I look at the portfolio of a small number of different companies’ shares in my ARF.  The biggest investments are in companies that I am confident will stand the test of time: they have sound balance sheets; projected dividends and profits are such that I expect to get a good return even if I never decide to sell; they are unlikely to be driven out of business by Amazon, Facebook, or whoever. 

I’m not pushed if I don’t beat the index; all I want is the risk-free rate plus 4% to 6% in the long-term.  I’m happy that my portfolio will deliver that long-term return.  I invest smaller amounts in shares that I think will deliver, but which I’m not yet certain about.  In time, as I get more familiar with the company, I may decide to increase my holding.



Bob2018 said:


> can you also explain why there is no need to be concerned "sequence of returns" risk?



“Sequence of returns” risk is only a cause for concern if it is necessary to sell stocks when they’re down.  Obviously, falls in market values concern me as much as they do anyone else, but I have a very low turnover rate on my portfolio and, as I indicated in my previous post, I don't ever recall having had to sell a stock in order to meet the "income" requirement (because of dividend receipts, cash balances in the portfolio, etc.).   Back to my earlier analogy of an amateur investor who has a portfolio of apartments, I just throw the notes from the estate agents into the bin if I don't like the prices they are offering for the apartments at any particular time.




Bob2018 said:


> And how realistically could a "normal" person no good stocks to pick when professional managers have a hard time beating benchmark returns in the long haul?


As I said earlier, I have no particular desire to beat benchmarks; all I want is to earn a real return of 4% to 6% per annum.  Experience over many years has shown that an average portfolio would have achieved that objective.  As it happens, my long-term track record compares well with that of professional managers but I recognise that most of my long-term success can be attributed to one company that I was lucky to discover 20 years ago and which I have stuck with since then.


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## Steven Barrett (7 Jun 2018)

Colm Fagan said:


> As I said earlier, *I have no particular desire to beat benchmarks; all I want is to earn a real return of 4% to 6% per annum.*  Experience over many years has shown that an average portfolio would have achieved that objective.  As it happens, my long-term track record compares well with that of professional managers but I recognise that most of my long-term success can be attributed to one company that I was lucky to discover 20 years ago and which I have stuck with since then.



And there is the secret to your success. You know what you want and you are not bothered by all the noise that goes on around you. You have holdings in companies you are confident in and leave it at that. A bit of luck always helps of course! 

Investors chopping and changing investment strategy all the time costs money. Pick quality from the outset and stick with it. Too many people and especially advisors feel they have to change their investment strategy all the time. It doesn't work. 

It'll be interesting to see how all these risk adjusted funds the life companies have out will perform in the next real downturn. They all reduce equity exposure when volatility increases and move back when it's more settled. Sounds like market timing to me and if they are all using the same metrics, the movements should be the same amongst all the life companies. I have a feeling we'll see very different results. 


Steven
www.bluewaterfp.ie


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## Bob2018 (7 Jun 2018)

Thanks to Colm for explaining his position. I think thanks are also due Elacsaplau for setting out this whole question so well and to SBarrett who explained brilliantly the real human aspects of all this.

I don't think Colm's approach is for me. My fund size would not be big enough and I would not be able to decide which stocks to buy. I suspect that I will not be alone in this view. The entire elderly population are not going to become mini-investment managers when they hit retirement. It's just not a solution for the "normal" person.

Even Colm, who is obviously an expert, recognises that he was lucky ("most of my long-term success can be attributed to one company") and I'd prefer not to overly depend on luck with my retirement money. It seems to me that when someone with lots of skill says that he was lucky, there's much less chance for the ordinary man. I'm the "normal" guy (unlike Protocol's lucky parents) and I will need the money! I also don't want to overly think about this stuff when I am retired and I know that having all my money invested in shares would cause anxiety for me, not to mention the missus (the boss). I agree with SBarrett when he says that one should just have a long-term strategy and stick with it. Another problem, I see with Colm's approach is that even for experts like Colm, one's capacity to act might reduce with age. Not alone would I not have a clue now of the right stocks to buy and sell but I'd imagine I'd have even less of a clue if I'm still above ground 20 years for now. Also, my beautiful wife would have zero interest in any of this stuff.

So whatever my level of equities will be, it is likely to be invested in some fund. If all my ARF is invested in equities, it would mean that I would have to sell units to pay for withdrawals and that as a result I would be subject to sequence of risk if I am understanding this correctly. Can readers advise whether this understanding is true or not please?

Putting all my money in equities is out and just wouldn't make any sense for me. What seems much more sensible to me is that I put somewhere between 60% to 80% of my money in an equity fund. In this way, I'd have effectively 5 to 10 years in safer assets and I wouldn't have sell my equities when markets are bad as I'd be able to allow my equities sufficient time to bounce back. I know I could still get hurt if Japan-like event happens but I'm trying to find the happy medium.

What I've written just above is a real layman's view. What I'd like is for advisers to show how they can improve on this (setting out whatever assumptions or caveats that they need to). As my old man used to say, there's no point in having a guard dog and doing the barking yourself.
We need advisers to guide us through this maze by showing us realistic sample solutions to these questions.


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## Steven Barrett (7 Jun 2018)

Bob

The unit linked/ fund ARF operates under the gross roll up method, so any dividends or profits are reinvested into the fund. Colm has a self directed ARF with individual stocks where the dividends are paid out and sit in cash. So yes, any withdrawal from a unit linked ARF will mean the sale of units. That will be the case whether you are invested in a cash fund or an equity fund, they are all unit linked. 

Different life companies have different methods in deducting income from ARFs. Some will accept instructions that your withdrawals come solely from your cash fund and to leave the equity portion alone. Others will split the withdrawal evenly amongst your different funds. 


Steven 
www.bluewaterfp.ie


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## Bob2018 (7 Jun 2018)

Thanks Steven,

So just so I'm sure that I've got it. If all my money was invested in equities, I would be exposed to a sequence of return risk?


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## Steven Barrett (7 Jun 2018)

Aren't you always exposed to sequence risk in any asset class? And any unit linked fund has always had the management charge taken from the fund by deduction of units. 

Good article here on sequence risk which I've linked to before. 


Steven 
www.bluewaterfp.ie


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## Bob2018 (7 Jun 2018)

Hi Steven,

I'm just trying to get a straight answer to a straight question. I feel I'm just going around in circles with you financiers! I asked Colm this question yesterday and he said in his answer today that he personally wasn't worried this risk because of the make-up of his fund. The reason that I had asked that question is because earlier in the thread when Gordon Gekko mentioned sequence of return risk at a general level - Colm dismissed this as making "no sense whatsoever". To be honest, I'm still not really sure what Colm is saying here and since he obviously really knows his stuff, I'm confused and that's the reason that I was hoping for confirmation one way or the other.


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## Steven Barrett (7 Jun 2018)

Yes, you would be exposed to sequence risk. But studies have shown that sequence risk shouldn't be a factor.  

If you have €1m in an ARF and take out €40,000 a year. The higher expected return you get from being wholly invested in the market will more than cancel out the lows and still allow you to take out €40k a year. You will be no better off by investing a portion in equities and the rest in bonds/ cash and exhausting that asset class before spending your equity portion (see the table in that link for examples under different scenarios). 


Steven
www.bluewaterfp.ie


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## Marc (7 Jun 2018)

.


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## Colm Fagan (7 Jun 2018)

Bob has asked some good questions and made some interesting comments.  I'll try to deal with them to the best of my ability, whilst qualifying my answers by stating that I am not an adviser.


Bob2018 said:


> Even Colm, who is obviously an expert, recognises that he was lucky ("most of my long-term success can be attributed to one company") and I'd prefer not to overly depend on luck with my retirement money.


I was lucky in being able to outperform the selected benchmarks.  By just investing in the index, I would have still beaten my target return of risk-free plus 4% to 6% over the long term.  That option is available to anyone - if they're prepared to accept the associated volatility.  I have proposed a solution to the volatility problem, by smoothing returns over a long period.
Bob, you make a valid point when you mention the concern about what might happen as I get older and/or depart completely from this life.  I do think about it occasionally, especially as my dearest and dearest doesn't have a clue about investments and doesn't want to learn.  I hope that the stocks I've picked for my ARF will do well in the longer term whether I'm around to monitor them or not.  In that regard, I was very encouraged by a posting on this forum (by Sarenco, I think) which referred to a "Sloth Fund".  This fund (I think it is an actual fund) is invested in the top stocks from 50 years ago, with no active changes in the investment mix since then.  This fund's performance has matched (or possibly even done better than) the S&P index over the entire period.  I'm hoping that the same could be true for my fund.  I have of course made other contingency plans in that I'm giving enduring power of attorney to someone whose judgement I trust, to be invoked if I go ga-ga (some on this forum will claim that I already have!). 
You're also correct, Bob, in that someone who is invested in a unit fund will have to cash units to meet income requirements in retirement.  That exposes them to the sequence of return risk.   They won't have the option that's available to me of taking the income (or the vast bulk of it) from dividends, from assets being turned over within the fund, and from the cash content of the fund.  There is a simple solution:  insurers and fund managers could offer funds that distribute income rather than reinvest it to buy more units.  Such funds would primarily be aimed at ARF holders.  At the risk of repeating myself for the nth time, my "smoothed fund" proposal also deals with the problem.


Bob2018 said:


> What seems much more sensible to me is that I put somewhere between 60% to 80% of my money in an equity fund.


Of course, putting (say) 40% in bonds reduces the short-term volatility of returns, but it also reduces the expected return by about 1.5% a year (assuming that equities are expected to generate a return of almost 4% per annum more than bonds).  That's a lot of money.  I don't know about you, but I don't fancy throwing away 1.5% of EXPECTED return every single year.  And for what are you prepared to sacrifice that return?  For lower short-term volatility, I presume.  And why should short-term volatility matter to you if your expected investment horizon (even at my age) is still over 20 years?


Bob2018 said:


> earlier in the thread when Gordon Gekko mentioned sequence of return risk at a general level - Colm dismissed this as making "no sense whatsoever".


What I dismissed as "making no sense whatsoever" was Gordon Gekko's suggestion that you should keep 15 years' of residual expenses in cash if you were going to be receiving regular rental income from apartments (or dividends from stocks).  Why would you keep so much cash rotting in deposit accounts (or nearly as bad, in low-yielding bonds) if you're getting a nice steady income from the rentals/ dividends?


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## Duke of Marmalade (7 Jun 2018)

I want to give my tuppence worth on sequence of return risk.  This arises precisely because you plan to sell equities.  So let us take a 65 year old considering the investment of his ARF.  He wants to maximise his expenditure on this side of veil.  He reckons 30 years should do.  He also reckons that equities will earn 6% p.a. over that 30 years. After contacting his local actuary he is told that using an annuity rate at 6% p.a. he can afford to withdraw 7.3% p.a.   The problem is that if after 15 years equities have earned only 1% p.a. he is in the poor house.  After 15 more years in the poor house he gets the double whammy that he was right after all, equities did grow by 6% p.a. for 30 years.

If he gets off to a bad start there is no real strategy for avoiding this risk.  In fact let's say equities fall 20% in the first year, a phone call to that actuary friend will tell him that he must now cut his budget by 20% if he still believes that equities will earn 6% p.a.

Sequence of return risk does not arise in Colm's case because he is not budgeting to spend all his ARF before departing this mortal coil.  But for Mr. Normal it will be necessary to plan for exhausting his ARF if he is to maximise standard of living.  Going for a more balanced investment approach will indeed mean expected future returns will be less than on equities and the budget must be adjusted accordingly but there will be a much reduced sequence of return risk.

So I am not at all sure that Mr. Normal should have 100% of the ARF in equities.  For sure he can expect it to be the best performer over the long term but the problem is that he can't spend that premium without exposing himself to serious sequence of return risk.


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## Bob2018 (7 Jun 2018)

Colm,

Thank you! Thank you sincerely. I very much appreciate your time. Of course, thanks to me, you won't have got sunburnt!

As you were so fair in your comments and in the interests of good debate, I will just shoot from the hip with my honest thoughts about the parts of what you have said that I might "wonder about". Maybe these are a bit silly but at the same time they may provide insights into what Joseph Soap thinks about this ARF puzzle and in this way help you communicate your ARF proposals to the masses.

1. Recent performance is just that and it can change for better or for worse ( 7 or 8 years does not seem that long to me). I'd actually prefer to be retiring if the last 7 years had dismal returns if that makes sense!

2. Your group ARF proposals sound great and you are to be applauded for them. I'm sorry that I am unaware of what their current status is and when they will be available. I am also not sure whether I will have access to them as I thought you mentioned having employers involved -
which doesn't apply to me. So it might be best to focus this thread on the right approach at an individual level.

3. "Equity investment is available to everyone if they are prepared to accept the associated volatility". I did eventually find a good adviser recently. One thing that he said that struck me was that a person needs to be "willing, able and need" to take on a certain level of risk. It seems to me that the acceptance of volatility only considers the "willing" part of this triangle and SBarrett addressed the total requirements very well.

4. You are clearly far more qualified than me to evaluate the merits of funds distributing dividends. Will it really make a material difference? In any event, like the group ARF proposals, it's probably best to deal with what is available to invest in now rather than what might be available. It's a bit like I read somewhere that buying a pension now that only pays out later (say at age 80) could be a useful tool but this option is also not available in Ireland but does exist in other countries I think.

5. I don't fancy throwing away 1.5% a year! But I don't fancy a Japanese style meltdown either. And if that happens, it is not a short-term volatility issue. Put it like this, the extra 1.5% a year means when I go to the restaurant, I wouldn't have to ask for a bottle of the house red, I could go down the list a bit. If Japan happens, not alone will the wine be replaced by tap water but the visit to the restaurant would be at risk. This adviser asked me an interesting question: what would you prefer to have: 100% of your needs or risk 25% of your needs to achieve 100% of your wants? That's the real dilemma for the "normal" guy and all I'm trying to do is to get a sensible balance. As I said earlier, I want to be relaxed and not anxious about my income in retirement.

Let me finish with a small quibble. I think Sarenco was the 15 year in cash man and I think that I quoted accurately your reaction to what Gordon said! No big deal.


Duke,

I get most of what your saying but my head is now completely fried. I remember being told once (by a good friend) "normally I say there's no such thing as a stupid question but honestly, Bob, there are times when you come very close." So apologies in advance but I'm struggling with the bit quoted below:



Duke of Marmalade said:


> After contacting his local actuary he is told that using an annuity rate at 6% p.a. he can afford to withdraw 7.3% p.a.



Tell me this is a typo PLEASE!


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## Gordon Gekko (7 Jun 2018)

Colm Fagan said:


> What I dismissed as "making no sense whatsoever" was Gordon Gekko's suggestion that you should keep 15 years' of residual expenses in cash if you were going to be receiving regular rental income from apartments (or dividends from stocks).  Why would you keep so much cash rotting in deposit accounts (or nearly as bad, in low-yielding bonds) if you're getting a nice steady income from the rentals/ dividends?



Hi Colm,

Point of Information if I may; I never said that!

When I get to your stage, my ARF will be 100% invested in equities.

All the best,

Gordon


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## Marc (7 Jun 2018)

.


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## Colm Fagan (7 Jun 2018)

Gordon
Sincerest apologies.  In my original posting, I correctly attributed that comment to Sarenco.  Also, in fairness to Sarenco,  I qualified my "making no sense" comment by putting it in the context of someone having their money in eight apartments rented out (or eight shares producing dividends).

Bob
It was the 15-year cash proposal that I said made no sense, not what Gordon said.  Gordon mentioned the sequence of return risk, which I accept is very real if the only investment option is accumulation only funds.

I agree that the last few years have been good for my portfolio, but my estimate of 4% to 6% per annum over bonds has been achieved by the average market participant over very long periods, and expert opinion is that the *prospective *Equity Risk Premium is still in that range.  Therefore, if I were an adviser, I would be advising someone to put the maximum possible into real assets (including equities, property, similar).  We've had the discussion previously about what the "maximum possible" means.
The "willing, able and need" to take a certain level of risk is an interesting thought.  The Duke expanded on this aspect in a previous post, when he made the point that, if you *need *to get (say) 10% on your savings, then you have to put the money into emerging equities.  I can make a similar argument at the other end of the risk spectrum.  Thankfully, I don't "need" to take risks.  We have a nice home that's fully paid off; we have other investments, in addition to my ARF (but I don't have any DB pension entitlement).  I could survive by putting my money into a "safe" asset such as an annuity or bonds, but I can afford to take the risk, which (so far) has enabled me to enjoy a more comfortable lifestyle than I might have otherwise.  If things go badly, we will have to trim our expenditure somewhat, but so what?  We can afford to cut back if necessary.
By the way, I don't think the Duke's comment about 6% and 7% was a typo.  What he means (I think) is that, if interest rates are 6%, then the annuity payout could be 7.3% a year.


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## Gordon Gekko (7 Jun 2018)

Hi Colm,

I’m slightly confused; say I’ve a €2m ARF; I’m compelled to take 6% out per year which I’m not going to get by way of income yield on the portfolio. So surely I will be disposing of shares in order to meet my mandatory distribution, making weak markets a problem for me in the context of sequencing of returns.

Or am I missing something?

Many thanks.

Gordon


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## Bob2018 (7 Jun 2018)

Colm Fagan said:


> What he means (I think) is that, if interest rates are 6%, then the annuity payout could be 7.3% a year.



Ah, I see interest rate but he said annuity rate - I had understood that they were different.


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## Colm Fagan (7 Jun 2018)

Gordon, the missing link is that I'm allowing for a (low) level of turnover on the portfolio.  I reckon that my turnover rate is much lower than average, but yet I make a few changes a year to the distribution of my ARF portfolio.  Sometimes it amounts to little more than trimming at the edges: reducing my exposure to one share by a few percentage points and increasing my exposure to another one by a few points; at other times it's more radical:  I may decide to get out of one share completely (as happened recently with WPP, which was featured in my "Diary of a Private Investor").  Those adjustments to the portfolio can be used to generate more cash.  Remember too that only a small amount extra will be required.  The current dividend yield on the FTSE All-Share Index (which is my main benchmark) is 3.8%, so only another 1.2% is needed to produce 6% (OK, we have to allow for costs, but I have managed to keep them to a minimum).


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## Colm Fagan (7 Jun 2018)

Correction:  WPP wasn't in my ARF; it was in one of my spread bet accounts.


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## Duke of Marmalade (7 Jun 2018)

Bob2018 said:


> Duke,
> 
> I get most of what your saying but my head is now completely fried. I remember being told once (by a good friend) "normally I say there's no such thing as a stupid question but honestly, Bob, there are times when you come very close." So apologies in advance but I'm struggling with the bit quoted below:
> 
> ...


Colm has already addressed this but I accept that it is ambiguously written.  We assume our assets (equities) can earn 6% p.a. so an annuity based on these returns will be higher than that, reflecting the dissipation of the initial capital.  Over 30 years this asset dissipation adds 1.3% extra return. Use Excel and calculate 100/(PV(.06,30,1)

I think some of the discussion is missing the essentials of Ms. Normal.  Ms. Normal goes through an accumulation phase and then goes through a decumulation phase.  Those lucky enough to be able to live off their property rentals or equity dividends are not decumulating.  They might argue that they have the perfect balance between living expenses and estate planning but this is somewhat post hoc and society could not afford this luxury to Ms. Normal.  So in society moving from DB to DC we have to accept the fact that in many situations the pension pot will extinguish over the lifetime of the pensioner.  The pensioner needs to budget for the maximum expenditure compatible with surviving the course.  Over investment in equities will expose her to unacceptable sequence of returns risk.

_Note to kind moderator:  I think my Excel ARF "App"  could be very helpful in informing this debate.  What are the chances of me emailing the App to a moderator and then s/he onward emailing it to the participants in this discussion?_


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## Colm Fagan (7 Jun 2018)

Duke
Have I mentioned to you my proposal for a smoothed fund, invested 100% in equity type instruments, that would be ideal for Ms. Normal??


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## Bob2018 (7 Jun 2018)

Thanks Duke,

That's so well put about Mr Normal's decumulation and I do agree that the thread is moving away from the best currently available solutions for Mr. Normal. Like I've no idea if I'll ever have access to Colm's group proposals so I'd prefer to concentrate on the here and now and if Colm's proposals become available that will be a welcome bonus. What I'd really like is to see actual sample proposals from advisers. I think the challenges are well known at this stage. But we 60+ posts in and still waiting?


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## Steven Barrett (7 Jun 2018)

Bob2018 said:


> What I'd really like is to see actual sample proposals from advisers.



But a proposal can't be given without understanding an individual's personal circumstances. 


Steven
www.bluewaterfp.ie


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## Bob2018 (7 Jun 2018)

Sorry Steven,

I don't think that's fair. I think you could easily assume a profile and present something on that basis. We're talking about Mr. Normal! Otherwise, we are just rehearsing non stop the problems and not the solutions.


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## Sunny (7 Jun 2018)

To be fair to Stephen and other advisors who post on this site using their real identity, they already contribute a lot. Asking them to do case studies for mr and miss normal that people might take as formal advice is unfair. Even if they write all disclaimers in the world, I don’t think it is fair to ask them.


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## Gordon Gekko (7 Jun 2018)

Bob2018 said:


> Sorry Steven,
> 
> I don't think that's fair. I think you could easily assume a profile and present something on that basis. We're talking about Mr. Normal! Otherwise, we are just rehearsing non stop the problems and not the solutions.



Hi Bob,

How much do you have available to invest?

Gordon


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## Duke of Marmalade (7 Jun 2018)

Colm Fagan said:


> Duke
> Have I mentioned to you my proposal for a smoothed fund, invested 100% in equity type instruments, that would be ideal for Ms. Normal??


Colm I agree with you that we are facing a quite serious societal issue in the shift from DB to DC for Mr and Ms Normal.  Your smoothing suggestion is possibly the way forward but it must involve cross generational subsidies.  With Profits used to do that but has somehow fallen into disrepute.  The solution might come from the market but it might require state intervention.


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## Bob2018 (7 Jun 2018)

Sunny said:


> To be fair to Stephen and other advisors who post on this site using their real identity, they already contribute a lot. Asking them to do case studies for mr and miss normal that people might take as formal advice is unfair. Even if they write all disclaimers in the world, I don’t think it is fair to ask them.



I must admit that this is a fair criticism and I don't like it (because it's completely justified!). Fair play, Sunny and I'm sorry Steven!

I probably should be gracious and leave it at that. I suppose that I pushed a little hard but it's really just because I'd like to understand smart and practical solutions to this problem for Mr. Normal. My sense is that advisers could possibly say something like for a given risk profile one could do x and y and z and then people would be able to adjust such a template up or down the risk curve depending on their personal circumstances.

Like all we have to date is very polarised positions of 15 years in cash or all equity. I'd just like to know what the middle looks like other than as one of the posters said lobbing it into blah blah fund.

I'm enjoying this debate but it would just be nice if some solutions could be suggested. I'm not asking them to specially prepare case studies, I simply asking them to share some solutions with us.


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## Gordon Gekko (7 Jun 2018)

Rather than start another thread, what are people’s thoughts on the optimum investment strategy where someone in the pre-retirement world has accumulated €2.15m but cannot take their retirement benefits or escape any other way (e.g. offshore)?


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## Colm Fagan (7 Jun 2018)

Duke of Marmalade said:


> Your smoothing suggestion is possibly the way forward but it must involve cross generational subsidies.


Duke, why the "but"?  There's no problem with cross-generational subsidies, provided they're not biased in one direction or the other.  Actually, I think they're more in the nature of what I might call "temporal adjustments" (I'm sure there's a better term, but it's late for an auld fella like me) for the same generation, i.e. Ms Bloggs gets a lower than market return in year t, in return for a higher than market return in year t+r.     Also, I don't see why there's a requirement for state intervention.


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## moneymakeover (7 Jun 2018)

@Colm Fagan 

What was involved in setting up your ARF?

Presumably you directed all the decisions

Were there any costs involved?



Colm Fagan said:


> It is a long time since my ARF was set up, I don't recall the precise costs, but I doubt very much if it would be worth the associated overhead for a smaller pension pot.


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## Colm Fagan (8 Jun 2018)

moneymakeover said:


> What was involved in setting up your ARF?


On reflection, it wasn't that difficult or expensive.  The costs and difficulties came much earlier, when I set up a one-man company pension scheme in 1996.   At that time, I had to establish a Trust Deed and Rules, get a Pensioneer Trustee, an actuarial assessment of the required funding rate, set up accounts for the scheme, arrange for the transfer of my deferred entitlement from my former employer's scheme, appoint investment managers (I was/am my own investment manager, but I do all my trades through a particular firm of stockbrokers, who I've been with from the start, through a couple of incarnations).  When I set up the ARF (and an AMRF, as I don't have any other pension entitlements) at end 2010, it was simply a case of transferring assets from the company pension scheme to the ARF/ AMRF (and to a separate portfolio for the tax-free lump sum that I was able to take on "retirement").  I think my stockbroker completed all the formalities at relatively little cost, in recognition of the business I'd given them in the past, and which they anticipated (correctly) would continue to come their way in the future.


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## Colm Fagan (8 Jun 2018)

In relation to portfolio concentration, which was discussed earlier in this thread (and elsewhere), I came across an interesting paragraph from a paper by Falkerson & Riley (2017), which reflects my conclusions on this topic (after threshing around for years before stumbling on the right approach):
*"We contend that mutual fund managers are compensated for holding more concentrated portfolios through a concentrated portfolio’s ability to give disproportionate weight to a fund manager’s most valuable information. If a fund manager has no information of significant value, then holding a fully diversified portfolio is preferable, since there would be no expected performance benefit from concentrating to offset the risks. Conversely, if the fund manager does have information of significant value, then concentrating the portfolio on those securities most affected by that information should increase the expected performance of the fund and potentially justify the risks of increased concentration. Some fund managers could have means other than increased portfolio concentration to take advantage of valuable information. However, in our analysis, we focus on the investment behavior of common equity funds that rarely use shorting, leverage, or derivatives, so increasing portfolio concentration is typically the only available route to leverage information of value."*
To this, I would add that a professional manager takes a high risk, in terms of the longevity of his or her career, by straying too far from the benchmark.   My own experience, which I'm sure would also be replicated by anyone running a concentrated portfolio, is that one can under-perform relative to whatever the chosen benchmark happens to be for a protracted period.  That is balanced by equally long periods of out-performance.  I have learned to live with both extremes.  Someone who's paid to manage relative to an index wouldn't be allowed that luxury.


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## spanners (8 Jun 2018)

Hi Colm, I've reading this thread and am interested in your smoothed fund proposal but cannot find details of the actual proposal, did you post it somewhere?


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## Bob2018 (8 Jun 2018)

To me, this thread started out full of promise but as it lengthens, I'm getting an uneasy feeling that I'm actually getting further away from getting valuable, practical nuggets as to how best to manage my ARF. Maybe all this will be of no consequence if the I have access to Colm's group ARF. 

Colm - can you give a brief update on the expected timescale here and whether self-employed people will have access to it please?


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## Colm Fagan (8 Jun 2018)

I’m out at the moment and I’m not great at posting links, but you can access a discussion of my proposals on the Pensions Forum of AAM under “New Proposals for Pensions Drawdown”.  The last posting was around March 22.


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## Sarenco (8 Jun 2018)

I thought I might expand somewhat on my tentative proposal for discussion purposes – all criticism is very much encouraged!

By way of a recap, my current plan on retirement is to have roughly 15 years' worth of residual expenses in cash and fixed-income investments, with the balance (if there is a balance!) in equities. By residual expenses, I mean the amount I think I will need to fund a comfortable lifestyle, less any State pension, etc.  I also plan to draw down the cash/fixed-income portion of the ARF first, so that I effectively increase my allocation to equities over time (with a ceiling of no more than, perhaps, 80% of my ARF in equities at any point in time).

To put some numbers around this, let's say I'm retiring today at 66, with a paid for house and I qualify for the full State (Contributory) Pension.  I have DB pension income of €3kpa from an old employer and an ARF with a value of €600k.  For simplicity, let's say I have no material savings outside my ARF (I used the tax-free lump sum to pay off my mortgage) and I have no desire to hold an AMRF.

I estimate that I will need around €25kpa to have a comfortable lifestyle.  Importantly, €25kpa isn't necessarily what I would spend on my desired or target lifestyle - it's pretty much a floor as to what would be acceptable to me.

So, using my proposed formula, I would set the initial allocation within my ARF at €150k in cash/fixed-income investments and the balance (€450k) would be invested in equities. I get the impression that most posters think this is very conservative, which I must admit surprises me.

Why roughly 15 years' worth of residual expenses in cash and fixed-income investments?  Well, I freely admit that 15 years is something of an arbitrary figure but my objective is to avoid having to sell equities during a drawdown if I can avoid it, particularly during the early part of my retirement (thus mitigating the sequence of returns issue).

A few notes:-

I'm only interested in the total return on the investments in my pension pot – I'm entirely agnostic as to whether those returns are derived from income or capital gains.

My overarching investment philosophy is to try to reach my financial objectives (in this case, funding my retirement) while taking the least amount of risk possible.

I've zero interest in stock picking – the equity investments in my ARF will all be in index funds.
Thoughts?


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## Duke of Marmalade (8 Jun 2018)

_sarenco  _finding it a bit difficult to follow your figures.  150K is 15 years residual expenses?  I take this to mean that you target to live on 10k + State Pension + 3k (other DB). Or in other words your target pension income from your current situation is 10k p.a.

Annuity rates are c.4% for a 66 year old.  So your 600k could buy an annuity of 24k p.a. more than comfortably meeting your target.  The proposed strategy seems to be going all in to have the prospect of having a wail of a time in your 80s/90s.


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## Sarenco (8 Jun 2018)

Duke of Marmalade said:


> _sarenco  _finding it a bit difficult to follow your figures.  150K is 15 years residual expenses?  I take this to mean that you target to live on 10k + State Pension + 3k (other DB). Or in other words your target pension income from your current situation is 10k p.a.


Oops - error corrected above, the "comfortable lifestyle" target should of course have read €25kpa.

On the more substantive point, I very much accept that a rising allocation to equities in retirement is very unconventional but I think it strikes a reasonable balance in trying to address sequence of return and inflation risk.  I certainly haven't firmed up my thinking on this (or really any!) aspect of my retirement plan.


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## Duke of Marmalade (8 Jun 2018)

Sarenco said:


> Oops - error corrected above, the "comfortable lifestyle" target should of course have read €25kpa.
> 
> On the more substantive point, I very much accept that a rising allocation to equities in retirement is very unconventional but I think it strikes a reasonable balance in trying to address sequence of return and inflation risk.  I certainly haven't firmed up my thinking on this (or really any!) aspect of my retirement plan.


I'm being a bit slow here.  150k is 15 years of "residual expenses".  That suggests 10k p.a. is your requirement for these expenses.  But an annuity would give you 24k p.a. safely and comfortably meeting your requirement.


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## Sarenco (8 Jun 2018)

Sorry Duke, I'm obviously not expressing myself very clearly.

The €10k of residual expenses is simply an input in my home brew formula for determining an appropriate initial asset allocation for my hypothetical ARF.  I would still take the minimum annual drawdown from the ARF, which I hope would always be significantly higher than €10k pa.

Hopefully that makes sense.


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## Duke of Marmalade (8 Jun 2018)

Sarenco said:


> Sorry Duke, I'm obviously not expressing myself very clearly.
> 
> The €10k of residual expenses is simply an input in my home brew formula for determining an appropriate initial asset allocation for my hypothetical ARF.  I would still take the minimum annual drawdown from the ARF, which I hope would always be significantly higher than €10k pa.
> 
> Hopefully that makes sense.


no, what is your requirement for residual expenses post retirement?  If it is only 10k then 600k retirement fund at 60x protects you from the three main risks:  longevity, sequence of returns and inflation.  It means that either you have over provided for your retirement or that you plan an overly monastic lifestyle in your golden years


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## Sarenco (8 Jun 2018)

I think we're talking at cross-purposes.

My residual expenses (as I've defined it) is what I _need _(to live a comfortable life in retirement).  But I'm hoping that the stock market will give me what I _want _(a retirement full of travel, fine wine, etc.).

I'm very clear what risks I would be protecting myself against by simply buying an annuity.

I'm also clear about the potential upside that I (and my estate) would be foregoing.

So, I'm trying to land on a "goldilocks" allocation within an ARF.  

I may well annuitise a portion (or even all) of my retirement savings at some point.  But I wouldn't do so immediately if I was retiring today. 

Would you?
_
_


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## moneymakeover (8 Jun 2018)

Just to spell it out clearly because the numbers probably are similar for others


3k DB
12k state pension
10k from pension plan

Next to understand what you're saying, 150k cash drawdown immediate. That covers 15 years@10k per annum

Meanwhile the 450k is invested and draws down at 6% per year

Face value, after 15 years that has drawn down .06 x 15 x 450k = 405k 

I'm probably getting it all wrong


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## Gordon Gekko (8 Jun 2018)

Sarenco,

I’m not convinced that’ll be enough for you to live on as you’ll be hosting me for booze-fuelled debates when we’re too old for this malarky.

Gordon


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## Duke of Marmalade (9 Jun 2018)

Ok, I think I know where _sarenco _is coming from.  He (apologies if she) has thrown me off kilter with this reference to "residual expenses".  So getting back to OP and reframing the question.

"What is the best ARF strategy for achieving a target subject to an acceptable level of risk?"

Still very woolly. So to get some focus let us consider a 65 year old retiree and make something a bit more concrete of this aspiration.

"For a 65 year old what ARF strategy maximises average level withdrawals over 30 years subject to a safety net that the risk of not lasting 20 years is less than 5%?"

Note that without the safety net caveat the answer is unquestionably 100% equities. But that introduces sequence of return risk.  Putting in a safety net raises the possibility that optimality will involve less than 100% equity exposure.

Note also that every aspect of the reframed question is personal, the 30 year target, the level withdrawals,  the 20 year and 5% risk calibration etc.  However in breaking the elephant up into these pieces Mr/s Normal might be able to give plausible answers where s/he would be staring into a fog faced with the generic question posed at the start of this post.

Finally I come to _sarenco_.  As I understand it the _*sarenco conjecture* _goes as follows:


			
				sarenco conjecture said:
			
		

> The optimum strategy for achieving the ARF objective involves a mix of cash* and equities and in particular withdrawal of the cash before decumulating the equities.



_* For simplicity I assume only two asset classes - equities and cash. 
If this is a misinterpretation of sarenco let the conjecture be called the Marmalade Conjecture._

As _sarenco _points out the conjecture leads to the counter-intuitive notion that equity exposure increases during the decumulation phase.  Also it is not _a priori _clear that the conjecture is correct.  The strategy involves exposure to equities for longer and this cuts two ways - it increases average expectations but it also increases risk.

If the conjecture is correct the supplementary is what is the cash/equity split?  _sarenco _posits 15 years of residual expenses in cash and the rest in equities.

To answer these questions needs the use of generally accepted stochastic methods.  I am on the case.


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## Sarenco (9 Jun 2018)

That's a fair description of my tentative proposal Duke.


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## Bob2018 (9 Jun 2018)

Sarenco and the Duke - my frustration of yesterday is giving way to hope again


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## Duke of Marmalade (9 Jun 2018)

These are the preliminary results from my investigation into the _sarenco conjecture_
Assumptions:  Equities earn on average 6% p.a. but with an annual volatility of 20% p.a.; cash earns 0.5% p.a.
ARF Objective:  To maximise annual level withdrawals over 30 years subject to a safety net of 5% chance of bomb out before 20 years

The _sarenco _strategy (Cash out first/Equities out last) gets optimised with a 85% initial cash allocation and the level withdrawal is 5%

First thing we note is that the 5% safety net is dominating, giving rise to a high cash allocation; nonetheless we are here to test the _sarenco conjecture  _so we optimise the alternative strategy of withdrawing equal percentages of cash and equity each year.  The results are that this strategy gets optimised with a 71% cash allocation and provides an annual withdrawal of 4.8%.  Slightly less than the _sarenco _optimum of 5% p.a. and so tentative evidence that there is some validity to the conjecture.

I then relaxed the safety to a 20% acceptance of bomb out at 20 years and got the following results:

_sarenco _optimisation kicks in at 75% initial cash allocation and provides a level withdrawal of 5.5% p.a.
constant allocation optimisation kicks in at 60% cash allocation and provides a level withdrawal of 5.2% p.a.

Further confirmation that there is at least some validity to the _sarenco conjecture_.

But of course this can't be the basis for the Holy Grail, _Bob2018_.  Any system that has 90 year olds 100% in equities would be laughed out of court.  It may be a basis for a dynamic strategy that steadily adjusts the safety net.  It has the merits that it appears to tap the potential for equity outperformance with a lesser opening exposure and without the immediate need to sell equities.

_Caveats:  this is a hugely simplified study to try and assess the validity of the conjecture.  It ignores all sorts of practical considerations such as tax, deemed distribution, other asset classes, costs, inflation etc._


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## Sarenco (9 Jun 2018)

Duke of Marmalade said:


> Any system that has 90 year olds 100% in equities would be laughed out of court.  It may be a basis for a dynamic strategy that steadily adjusts the safety net.  It has the merits that it appears to tap the potential for equity outperformance with a lesser opening exposure and without the immediate need to sell equities_._


On a point of detail Duke, I suggested an upper ceiling of, perhaps, 80% in equities.  

However, the gist of my argument is that it is less dangerous for a late retiree to have an equity heavy allocation than it is for an early retiree because of sequence of returns risk.


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## Bob2018 (9 Jun 2018)

Duke of Marmalade said:


> But of course this can't be the basis for the Holy Grail, _Bob2018_.



WHAT? WHAT'S THIS NONSENSE? You haven't found the Holy Grail? What the hell have you been doing all day?

I feel very "grown-up" having on-line discussions about "generally accepted stochastic methods"! If only I could follow it all! (in fairness, I think your writing style helps!) How can we learn more about your analysis (like what is the Holy Grail)?

I read this today. It seemed interesting to me but I'd be interested in what the experts think.

https://www.7im.co.uk/-/media/files/brochure/decumulation-discussion-paper.pdf


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## Duke of Marmalade (9 Jun 2018)

Bob2018 said:


> WHAT? WHAT'S THIS NONSENSE? You haven't found the Holy Grail? What the hell have you been doing all day?


Well think about it Bob.  If I had found the HG today would I announce it on AAM or would I be straight down to the patents office? So you will never know


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## Bob2018 (9 Jun 2018)

Two words










social entrepreneur!!

(people with your brains need to help out the rest of us!!)


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## elacsaplau (10 Jun 2018)

I know that deep down and very well hidden the Duke is a decent skin - so he will in time, like the financial advisory community, share his full wisdom with us all!  On a serious note Duke, can you use the "upload a file" facility to share either your previous or current spreadsheet?

The point I'd like to make now is a bit peripheral to Sarenco's question but probably worth mentioning. If I understand Sarenco's situation correctly, he "has" an ARF of €600k and "needs" €10k p.a. to cover required expenses.

On the one hand, the "Authorities" are trying to promote pension provision (e.g. the introduction of mandatory PRSAs) but on the other hand, they are placing unwelcome hurdles on Mr. Normal in the form of imputed distributions. I accept that Mr. Normal does need to take money from his ARF during his decumulation phase. However, it's the almost compulsory requirement to withdraw funds on an annual basis that is problematic.
The problem is that these forced withdrawals increase sequence of returns risks and associated concerns.

In Sarenco's case, with €600k in an ARF, presumably he could take €150k as a tax free lump sum thereby providing him with multiple years of guaranteed income with the number of such guaranteed years being a function of his preferred asset allocation, i.e. investing in cash, more or less, gives him 15 years.

If Sarenco had this security (that his base needs were covered for many years and that he wasn't forced to withdraw funds at "the wrong time"), he would be so much freer to be more expansive in the asset allocation of his residual ARF investment of €450k. In simple terms, sequence of return risk would have a significantly diminished impact if Sarenco was afforded greater freedom in the timing of withdrawals in his decumulation phase.

There is a lot of data showing that the asset allocation of ARFers is too conservative given the probable long-term lifespan of such investments. It is possible that the introduction of the 3% distribution requirement in 2008 (and subsequent increases) has not been of helpful in this regard. Whatever the case, if you were to try to find a worse time to introduce this requirement, you'd be hard pressed to do so!


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## Sarenco (10 Jun 2018)

@elacsaplau 

In my hypothetical fact pattern, I had already taken my TFLS and used it to pay off my mortgage.  


Sarenco said:


> To put some numbers around this, let's say I'm retiring today at 66, with a paid for house and I qualify for the full State (Contributory) Pension.  I have DB pension income of €3kpa from an old employer and an ARF with a value of €600k.  For simplicity, let's say I have no material savings outside my ARF (I used the tax-free lump sum to pay off my mortgage) and I have no desire to hold an AMRF.
> 
> I estimate that I will need around €25kpa to have a comfortable lifestyle.  Importantly, €25kpa isn't necessarily what I would spend on my desired or target lifestyle - it's pretty much a floor as to what would be acceptable to me.


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## LDFerguson (10 Jun 2018)

elacsaplau said:


> In Sarenco's case, with €600k in an ARF, presumably he could take €150k as a tax free lump sum thereby providing him with multiple years of guaranteed income with the number of such guaranteed years being a function of his preferred asset allocation, i.e. investing in cash, more or less, gives him 15 years.
> 
> If Sarenco had this security (that his base needs were covered for many years and that he wasn't forced to withdraw funds at "the wrong time"), he would be so much freer to be more expansive in the asset allocation of his residual ARF investment of €450k. In simple terms, sequence of return risk would have a significantly diminished impact if Sarenco was afforded greater freedom in the timing of withdrawals in his decumulation phase.



The required withdrawal certainly does imact on a person's investments within an ARF for the reasons you outline.  My understanding is that mandatory withdrawals were introduced because the Powers That Be looked at the ARFs that existed up to that point and discovered that there were some whopper ARFs out there - multi-million euro funds - from which no income was being taken at all.  Turned out that ARFs were being used as a vehicle by which wealthy business owners could extract millions from their companies through pension schemes, transfer them into ARFs, take no income from the ARFs (because they were minted anyway and didn't need it) and then pass the millions on to their descendants after death.  The Powers That Be were not happy.  The ARF was invented as an alternative to the annuity - an alternative form of drawing retirement income.  So using one to draw NO income was not the original intention.  Not to mention the fact that by forcing these lads with whopper ARFs to take even a small percentage income, it would still be a whopper income generating a whopper Income Tax return for the Revenue.  So mandatory income was born.  

Even though most of us won't have whopper ARFs in retirement, I can still see the point that if the ARF is an alternative to the annuity, then a mandatory income is justified.  

In the example you give above where an individual lives on their tax-free lump sum for the early years of their retirement, I suppose one way of avoiding sequence risk is to re-invest the mandatory ARF withdrawals into the same type of investments as the ARF itself.  A bit messy and there would be charges and taxes involved.


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## elacsaplau (10 Jun 2018)

Apologies Sarenco - I misunderstood.

Aaaggh Liam - most of what you've said is indisputably right! and the balance is not wrong! Should I just delete my last post?  [......I had thought the dodgy line was teasing the Duke but so far I seem to have gotten away with that one! I suspect that I'm not out of the woods there either...…._revenge est un plat mieux servi froid!_]

Whilst I have you on the line, as it were, Liam! - anything else to add (_solutions wise!_) on de subject?!


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## Duke of Marmalade (10 Jun 2018)

Well _elac _thanks for pointing the way to the Upload File facility.  I have duly uploaded the original version with an explanatory sheet added in. Corrections, comments and suggestions for improvement most welcome. 

LDF is totally right on the origins and rationale for mandatory withdrawals.  But other than its tax consequences it should be of itself irrelevant for asset allocation.  I'm surprised some company has not designed an arrangement whereby the mandatory withdrawal has no other impact rather than tax payment i.e. that the underlying assets remain invested exactly as before only now in an exit tax umbrella rather than a pensions vehicle.


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## LDFerguson (10 Jun 2018)

elacsaplau said:


> Whilst I have you on the line, as it were, Liam! - anything else to add (_solutions wise!_) on de subject?!



I will admit that I haven't read all five pages of this thread.  But let's go back to your example above of someone who has €600,000, takes the €150,000 tax-free lump sum, lives on it for as long as s/he can before touching the ARF, keeps the €150,000 in cash and invests the other €450,000 in equities etc., without worrying about sequence risk.  (I know that this is not Sarenco.  I guess this is Sarenco 2 - The Sequel.  And like so many sequels it's not as good as the original.  The original has €600,000 in the ARF.  The sequel only has €450,000.)  

Anyway, Sarenco has pointed out that he uses the tax-free cash to pay off the mortgage.  So he can't rely on the tax-free lump sum for income.  Perhaps it has been mentioned already but couldn't he invest 25% of the ARF assets (or any other percentage) into cash or other relatively safe, liquid assets and draw the mandatory income from that?  Invest the other 75% in equities without worrying about sequence risk.


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## Duke of Marmalade (10 Jun 2018)

I attach the spreadsheet to test the _sarenco conjecture_.  It is cruder than the ARF Projection and ignores complications such as tax and mandatory withdrawal.  However it does have Macros and these may be rejected by your system. 

If you enter the initial cash fund the initial equity fund will be the balance of €1M.  Press Ctrl + s to run the 100 simulations.  Two methods of withdrawal strategy are modelled.  Method 1 withdraws cash first whilst the alternative would withdraw from cash and equities in equal proportions.


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## Sarenco (10 Jun 2018)

LDFerguson said:


> Perhaps it has been mentioned already but couldn't he invest 25% of the ARF assets (or any other percentage) into cash or other relatively safe, liquid assets and draw the mandatory income from that?  Invest the other 75% in equities without worrying about sequence risk.


That's pretty close to what I'm suggesting Liam, except that I use a multiple of residual expenses, rather than a crude %, to determine the proportion of the ARF to be held in "safe" assets.

I'm proposing that the equity allocation be allowed to gradually drift higher (as safer assets are withdrawn), subject to a ceiling, but in some ways that's a detail.  Retaining a static allocation would be another reasonable approach.


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## Colm Fagan (10 Jun 2018)

I haven't been following the more recent posts, but surely the allocation to equities is dynamic, depending on past performance at any point in time.  In my own case, performance in the early years was good, so I was able to be braver, knowing that, even if the value were to fall (by x%), I should still be able to derive an adequate income.  I'm now 100% in equities.  Maybe I would have arrived there anyway, given my confidence in the Equity Risk Premium, but my decision was helped by past results (achieved when the allocation was less than 100% to equities).


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## Duke of Marmalade (10 Jun 2018)

Colm Fagan said:


> I haven't been following the more recent posts, but surely the allocation to equities is dynamic, depending on past performance at any point in time.


Absolutely.  The strategy should be to optimise expected drawdown subject to some measure of safety.  At regular points the drawdown would be recalculated based on the portfolio's performance and an update of the safety net.  What _sarenco _raises is the likelihood that the optimal strategy will involve drawing down cash first but obviously this cannot be the whole story as we surely don't want 90 year olds 100% in equities.  In a sense Colm, you have been following the _sarenco conjecture_ as the last port of call for your required living expenses seems to be actual decumulation.


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## Colm Fagan (10 Jun 2018)

Thanks Duke.  Another observation is that most draw-down models assume that the amount required for "living expenses" each year is independent of the fund's performance.  I think that's too simplistic.  Assuming that the recipient is living above the breadline, there is some ability to flex each year's income, depending on performance, in much the same way as someone in employment or running their own business will have good years and bad years.  In the good years, they can splurge a little, in the bad years they have to tighten their belt.  It's the same post retirement.


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## LDFerguson (10 Jun 2018)

This is perhaps veering a little off the main road of this thread, but when I'm chatting with someone who is actually about to set up an ARF, there are a number of fundamental questions to ask.  One of them will have quite an impact on this thread and indeed Sarenco's strategy, I think.  

Is it important to you to leave behind a residual fund to your kids after your death?  

Broadly I get two answers to this: - 

(1) Yes.  I want to try to draw only the investment growth from the ARF, thus making it a perpetual ARF which will be worth at least as much when I die as it is now, if not more.  If possible, I don't want to eat into the original capital.   

(2) Hell no.  Those kids have got more than enough from me.  I fed them, clothed them, schooled them, gave them a college education etc.  They'll get the house, the holiday home and the priceless collection of porcelain wombats when I go, so the ARF is going to be spent by me before I die.  (Another version of this answer is simply "I have no kids".) 

If one is going for answer number (2) then there's an argument in favour of really living it up in the early years of the ARF, while you're still young and healthy enough to do all the things you promised yourself, even though this will involve eating into your original ARF capital.  Perhaps in the Sarenco model, this answer would dictate a higher allocation to cash than answer number (1).


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## Bob2018 (10 Jun 2018)

Hi Liam,

Interesting comments. The purpose of the thread, as I understand it, is to assume that the ARF is needed to provide income in retirement for the normal person and how best to achieve this. You might have to read all the back pages!

I know it's my own fault for asking the Duke to share his work with us but I must admit to be struggling with lognormal, etc. Up until this point in my life, this would have meant something that I'd lob into the fire which didn't have any remarkable features.


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## Duke of Marmalade (10 Jun 2018)

Bob2018 said:


> I know it's my own fault for asking the Duke to share his work with us but I must admit to be struggling with lognormal, etc. Up until this point in my life, this would have meant something that I'd lob into the fire which didn't have any remarkable features.


Correction, I provided the spreadsheet in response to a request from _elac_.  I hope you are not struggling with the illustrations which were designed to be comprehensible by the most numerically challenged of folk.  But perhaps you are the sort of guy that doesn't drive a car because you can't understand how the internal combustion engine works.  Perhaps your brother can explain the lognormal to you

_Bob _I have to be honest, I find your contributions a tad confusing, even to the point that I suspect you of being a troll, a suspicion reinforced by your recent membership.  I don't like trolls and so to be on the safe side I will be making no further contributions to this thread.


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## Bob2018 (11 Jun 2018)

Bob2018 said:


> I know it's my own fault for asking the Duke to share his work with us but I must admit to be struggling with lognormal, etc. Up until this point in my life, this would have meant something that I'd lob into the fire which didn't have any remarkable features.



I think this post is very unfair. I did ask you to share your work (the Holy Grail) with us (we even joked about it). The other joke about lognormal was at my expense.


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## Duke of Marmalade (11 Jun 2018)

Bob2018 said:


> I think this post is very unfair. I did ask you to share your work (the Holy Grail) with us (we even joked about it). The other joke about lognormal was at my expense.


Okay _Bob_, I guess I just haven't got used to your style yet.  Anyway the thread had run its course so far as I was concerned.


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