4% safe withdrawal rate?

[Marc]

There are a couple of themes developing on this thread.

I will address a few here

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

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

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










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

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







• Certainty comes at a cost

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

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

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

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

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

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

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

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

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

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

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

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

I consulted with both senior counsel and the UK FCA :

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

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

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

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

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

 

[elacsaplau]

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

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

 

[RedOnion]

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

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

 

[elacsaplau]

Point taken, RedOnion - apologies to all

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

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

 

[RedOnion]

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

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

 

[Colm Fagan]

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

Are the questions meant for me?

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

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

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

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

Unfortunately, I haven't seen any of the

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

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

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

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

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

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

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

 

[elacsaplau]

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

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

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

 

[Sarenco]

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

This way of thinking really puzzles me.

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

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

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

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

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

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

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

 

[Colm Fagan]

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

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

 

[Sarenco]

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

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

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

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

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

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

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

Are we in a different position on Monday evening?

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

 

[Colm Fagan]

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

Let's go back to your earlier posting:

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

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

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

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

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

Straightforward, isn't it!?

 

[WhiteCoat]

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

 

[Sarenco]

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

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

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

 

[Marc]

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

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

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

 

[elacsaplau]

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

Yes - but who will you be shouting for?

 

[Marc]

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

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

 

[elacsaplau]

Marc,

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

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

 

[Colm Fagan]

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

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

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

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

 

[WhiteCoat]

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

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

 

[Sarenco]

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

I think you are fooling yourself.

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

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