My name has been mentioned a few times in dispatches, so it's probably best to clarify where I stand on the various issues:
Take Colm...he reckons his will always be invested. i.e. may never dip below par
Not quite right, Gordon. My ambition is to spend every cent that's in the ARF by the time my other half and myself say our final goodbyes. I have set up a spreadsheet specially for that purpose. It allows for future investment returns (at what I hope is a reasonably conservative rate) and future outgoings, so that there is zero left at the end.
This brings me to the next question: when is the end?
And in the case of an ARF, we’re generally talking about the life expectancy of two people, one of whom is female. That’s the key point with an ARF. See the link below. There is a 51% chance that, at age 65, at least one spouse will live at least another 24 years.
Life expectancy is meaningless when it comes to an ARF. There won't be 51% of either me or my other half alive in 24 years. Either one, both, or none of us will be alive. My little spreadsheet, discussed above, assumes that we will both live into our nineties. If we croak before then, there will be something for the next generation(s) to squabble over; if we live beyond 95 or so, I'm hoping that one of our children, grandchildren or great-grandchildren will look after us for our few remaining years. In reality, I try to add a couple of months of possible future existence to the spreadsheet every year.
To take a simple example where bad performance is frontloaded. Assume your fund loses 7% for five years, then grows at 2% for the remainder of the 25 years. Rounding a little, you are basically back to where you started if you take nothing out
The issue is that if your drawdown in the early years is too aggressive you won't have enough left in the fund to grow yourself back out of trouble.
This is a re-run of the "sequence of returns" risk that's been discussed ad nauseam on this forum. People know my views by now. For what it's worth, I looked back at the early experience of my ARF. I took it out in December 2010. At the end of 2011, it was down 13% from what I invested a year earlier (that's after withdrawing 5% in 2011). At this remove, it's all ancient history. There has been plenty of time since then to recover from that initial fall. The ARF is now worth considerably more than the initial contribution, despite the fall in the first year. It would be a very different story if I had invested a significant proportion of my savings in bonds, or kept them in cash, at the start.
If interest rates rise, will the value of the bond elements fall precipitously.
I understand the maths, but if rates go back to 5.25% how much of my pot is likely to fall in value from €157 to €100 (to use the above figures).
As
@Duke of Marmalade says, the key issue is the duration of the bonds. You're right that the value of the bond elements falls from 157 to 100 if interest rates increase from 0 to 5.25% - if the duration of the bonds is 11 years, as in the example I used earlier.
Interest rates are currently at zero (more or less). That makes the maths simple. My guess at a reasonable "worst case" scenario is for interest rates to increase to (say) 3%, with an average bond duration of 7 years. Suppose you hold a 3% coupon bond. Its value at 0% interest is 7*3+100 = 121. Its value at 3% interest is 100, so the fall in market value of the bond element of the portfolio in that "worst case" scenario is 17.3%. (1-100/121).
