ARF projections

[Sarenco]

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

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

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

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

 

[Steven Barrett]

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

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

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

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

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


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[Colm Fagan]

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

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

 

[moneymakeover]

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

 

[elacsaplau]

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

This is, indeed, the key point.

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

 

[Oisin19]

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

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

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

 

[Colm Fagan]

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

I agree. That's why I wrote:

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

but I added that

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

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

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

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

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

 

[Sarenco]

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

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

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

Why? The sequence of returns was lousy.

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

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

 

[Colm Fagan]

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

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

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

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

 

[Gordon Gekko]

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

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

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

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

 

[Duke of Marmalade]

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

 

[Sarenco]

So somebody sitting in equities in perpetuity

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

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

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

 

[Gordon Gekko]

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

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

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

 

[Sarenco]

@Gordon Gekko

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

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

 

[Gordon Gekko]

@Gordon Gekko

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

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

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

 

[Sarenco]

What’s a straw-man argument?!

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

 

[Gordon Gekko]

What’s a straw-man argument?!

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

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

 

[Sarenco]

At what again?!

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

Totally irrelevant to the topic under discussion.

 

[Gordon Gekko]

At what again?!

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

Totally irrelevant to the topic under discussion.

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

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

 

[NoRegretsCoyote]

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

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

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

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

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

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

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