Key Post Does an ARF negate the need to lifestyle your pension plan?

Gordon Gekko said:
Hi Liam,

Are there not Bid/Offer spreads?

Thanks,

Gordon
Click to expand...

Bid/offer spreads are gradually being phased out of the pensions business. There's only a handful of older-style contracts available that still feature them, but the majority don't. Of course there's also a legacy of existing contracts that still have them too.
 
My experience of moving from a pension scheme to an ARF may be of interest.
I "retired" in December 2010 ("retirement" from my own business was purely notional; it was driven by tax considerations). My pre-retirement savings vehicle was a small self-administered pension scheme invested mostly in equities held directly, not through unit funds.
The transition to three new accounts: an ARF, an AMRF, and a non-exempt account for the tax-free "cash" was smooth (it helped that the new accounts were with the same stockbroker as had been looking after my pension fund investments on an execution only basis). As I recall (I don't have the details to hand), there was no need to sell shares in the pension fund and buy them again for one of the other three accounts, but there had to be a notional sale at prevailing market value, to create a base price for CGT purposes for the shares in the exempt account. I can't remember whether I had to pay stamp duty (1% for Irish stocks, 0.5% for UK stocks) on the notional purchases in the new account; a stockbroker can probably advise what the situation was here. In general, while I viewed the entire portfolio as a single entity, it was more advisable for tax purposes to hold the "value" stocks (i.e. the high dividend payers) in either the ARF or the AMRF, both to take advantage of the gross-roll-up and to generate a significant portion of the cash needed on a regular basis to fund the required "income" from the ARF, without having to sell shares, probably at an inopportune time, and the "growth" stocks (i.e. those that paid low or no dividends) in the non-exempt account, because CGT is lower than my tax rate on dividends.
The bottom line, referring back to OP's original question, is that there was no need to do any "lifestyle" planning in the run-up to "retirement". It was a seamless transition, with shareholdings simply shifting from one box to three others. As regular readers of my "Diary of a Private Investor" know, I detest the idea of lifestyling or feeling obliged to move to supposedly lower risk investments shortly before and in retirement. Now, nearly eight years later, I'm still 100% in equities (actually more than 100%) and very happy that I've taken this particular route.
 
Cervelo said:
Eireog007, am I correct in thinking that you are going to invest your accumulated pension pot at retirement in a ARF and for the first 3/4 years live off your cash reserves and then use your ARF as your only source of income ??
Click to expand...

Close enough yes, my thinking currently would be to reinvest the 75% into the same MSCI Index as I am planning to have for my pension investments and use the profits from this to fund the mandatory 4% withdrawal and also take the 25% and hold as a reserve to ride out any downturn in the equity market to avoid selling shares when they are down in value.
Thats the gist of my plan currently but am open to suggestions and for people to point out any flaws as they see them.
 

Thanks Colm, I’ve read through your diary entries and the conversations around it with great interest, I don’t like the idea of moving from a high volatility fund myself either now or in retirement but it just strikes me as a sensible move for that 5 year or so period leading into your planned retirement date to ensure the 25% tax free portion of your fund doesn’t take a hit right at your retirement date.
That is with the caveat that I’m basing this view on the current outcome I see most likely in my situation that my wife and I will retire with no other income streams other than the state pension (big doubt) and our private pension funds. So as I said above I would use the 25% as an emergency fund to draw down from should the equity market drop severely but in general I would plan to follow a similar plan as yourself of maintaining an ARF of 100% equities to fund the 4% yearly withdrawal.
 
I can't advise, offer suggestions or even point out flaws as it's kind of similar to what we have done but I can give you the returns for our first 3 years
Early in 2015 we found ourselves with over a million mainly in cash so we invested most of it in three areas

€500,000 in a balanced portfolio of 5 ETFs (ARF)
€180,000 in an aggressive portfolio with the same 5 ETFs (Self managed PRSA)
€240,000 in Prize Bonds

The balanced portfolio which is an ARF was to give us an "easy" 4% net growth per year and in year 4 we could if we wanted start taking €20,000 a year to supplement our lifestyle

at the end of three years the value of our investments are

€520,000 ARF
€196,000 PRSA
€246,250 PBs

Not sure if this is of any help to you but sometimes the reality of investing is different to the projected returns.
 

Is that something that is only disclosed when you qualify as an actuary, that 100% isn't the highest percentage you can get to?
 
SBarrett said:
Is that something that is only disclosed when you qualify as an actuary, that 100% isn't the highest percentage you can get to?
Click to expand...
It was almost 40 years after I qualified that I made that discovery!! Trying to make a profit out of the discovery proved extremely painful initially, for reasons I'll probably explain in a future "diary" entry, but I think - and hope - that I've finally worked out how to tame the power of those extra percentages. I recognise full well though that a long bull run is not the ideal environment for testing the durability of my discovery. Come back to me when the market tanks.
 
Thanks for that Steven - very interesting.

Like @elacsaplau, I would be very interested to see what the results would look like if a bond allocation (say, 25% in 10-year bunds) was added to the mix. I suspect the 70% success rate would be improved marginally.
 
SBarrett said:
Example of what the software produces is attached.
Click to expand...
Steven. Thanks for sharing. The software looks impressive, but I'm not convinced. It makes some very unrealistic assumptions, which don't reflect what happens in the real world. I hinted at some of the deficiencies in my column in last Sunday's Sunday Times. For example, for the 100% equities scenario, it assumes that all withdrawals have to be funded by cashing units, possibly when markets are down. In almost 8 years of running an ARF that is generally over 95% in equities, I don't recall ever having to cash shares to meet the mandatory income requirement, even when markets were down. Invariably, there was enough cash in the ARF, either from dividend receipts, from the small cash balance (generally around 5%) that's always in the fund, or from natural turnover of the portfolio (i.e. selling shares I no longer liked to invest in ones I now preferred). The software makes no allowance for those sources of cash. Also, in the real world we don't look for a constant income irrespective of external conditions. When we're in business, we have to economise occasionally when times are tough. The same is true when we're retired. I reckon the software would produce very different results if the income was flexed, even just a little (say up 5% in the good times, down 5% in the bad times). It might be worth asking the vendor if they could make that little adjustment to the program, even if they couldn't adjust for dividends and for allowing the cash balance in the fund to vary.
 
Colm Fagan said:
The software makes no allowance for those sources of cash.
Click to expand...
I don't think that's right Colm.

According to the notes at the end of Steven's presentation, the returns are based on the DMS dataset used in the Credit Suisse Annual Investment Returns Yearbook. That dataset refers of the historical total return of various securities and assumes that all dividends/interest were instantly reinvested in the relevant securities.

As previously discussed, it doesn't make a whit of difference whether you draw from capital gains or income generated within an ARF.

The projection gives the success rate of a fixed withdrawal. I don't think it's really possible to model a variable withdrawal strategy - there are too many idiosyncratic variables.
 
Last edited:
Steven,
Interesting software. I will make a few comments but first can you explain what the Longevity-adjusted-success is?
 
Last edited:
Sarenco said:
As previously discussed, it doesn't make a whit of difference whether you draw from capital gains or income generated within an ARF.
Click to expand...
I'd better revisit that discussion. I can see the logic in your argument, but it doesn't feel right and doesn't accord with my own experience.

Sarenco said:
I don't think it's really possible to model a variable withdrawal strategy
Click to expand...
It should be very straightforward. The rule for the program could simply be that the normal annual withdrawal is X (nominal or real) but it 105% of X if prices rose in the year and 95% of X if they fell.
 
Duke,

It's defined in the output as:

Longevity-Adjusted Success Rate: This shows the chances of the portfolio lasting until a given age, given your chances
of living that long.

I think it's saying you'll have no mullah left but nay worry coz you'll probably be dead - look forward to your analysis.


Colm Fagan said:
I reckon the software would produce very different results if the income was flexed, even just a little (say up 5% in the good times, down 5% in the bad times).
Click to expand...
and
Colm Fagan said:
It should be very straightforward. The rule for the program could simply be that the normal annual withdrawal is X (nominal or real) but it 105% of X if prices rose in the year and 95% of X if they fell.
Click to expand...

Colm -

Surely all this would do is reduce the observed success rate given the ratio of good to bad years on equity markets? (I've just verified this with the S&P over the last 90 years where the ratio good to bad exceeds 2:1).
 
elacsaplau said:
Surely all this would do is reduce the observed success rate given the ratio of good to bad years on equity markets? (I've just verified this with the S&P over the last 90 years where the ratio good to bad exceeds 2:1).
Click to expand...
I haven't thought that much about it, but my 95%/105% suggestion is to recognise what I think is a real life scenario. If you have to sell units when prices are down, you'll economise and try to reduce the number of units you have to sell (i.e. you'll opt for 95% of X) while if they've done well you might give yourself a bonus. I think it will help Steven's results in that you are actually cashing fewer units when unit prices are depressed. I take your point on good years outnumbering bad years by 2:1. That can be allowed for (to get the average X per annum over the entire period), either by assuming that you only take (say) 103% of X in the good years and 95% in the bad years, or you only take a bonus when the price rises by more than (say) 2% in the year.
 
It seems to be saying that but I need the formula to know what it really is. It is clear that the portfolio has more chance of lasting to 100 than the punter (indeed the portfolio could last 1000 years). A straight ratio would come out at greater than 100% but instead it appears to be asymtotically approaching 1 which suggests it is a probability in its own right but I can't figure out what that could be.
 
Okay so this is some sort of conditional random variable. I can make sense of the concept of what are the chances of the portfolio lasting N years (a) assuming the punter survives and continues to take an income and (b) allowing for the probability that the punter doesn't survive

(a) is what is termed the Portfolio Success Rate and one might have thought that (b) was the Longevity-Adjusted Success Rate.

(b) is higher than (a) which one would certainly expect, also the gap only opens up after a few years and then increases progressively, which is also fully to be expected.

But what really puzzles is that (b) whilst initially a decreasing function of N, it bottoms out an d then seems to increase inexorable toward 1 at infinity. That does not make sense as clearly both (a) and (b) should be non increasing functions of N.

So I am missing something, scream
 

Further Google yields the following explanation from Kitces.
Okay so the formula is:
LAS = p + (1 - p) x (1 - s)
where p is the probability of portfolio success given the punter survives and s is the probability of survival. Thus when s becomes 0 the LAS becomes 1, even if you had opted for an enormous withdrawal which blew the fund in the first month. Not sure how useful a statistic this is.

The correct statistic is what is the probability of portfolio success allowing for longevity. This is the sum over n of d(n) x p(n) where:
n is the number of years till death
p(n) is the probability of portfolio success given survival for n years
d(n) is the probability of death at exactly n years
 
Last edited:
Now that I think I understand the methodology, these are my comments.

Overall, this an excellent tool. It gives very meaningful illustrations of the possibilities. It is not unlike (albeit much more sophisticated) the one I cobbled together myself and shared with AAM.

But I do have some critique. It uses historical data directly rather than a stochastic model. Professionals would always use a stochastic model to value, say, Options. Admittedly these models are calibrated to the (recent) past, so they do use historical data. Still, I wonder how relevant the conditions of the equity market in 1900 are to those of today. The fact that the demonstrations are inflation adjusted helps to level out what have been vastly different economic scenarios over the last century or so. For example, 1% bond yields whilst totally unprecedented look more normal when inflation adjusted.

My second point is that I think it might be more meaningful to condition the historical scenarios to more resemble where we currently are. Thus P/E ratios are very high, it might be more appropriate only to use those historical scenarios which belong in the upper quartile of P/E ratios. An ARF is a one off purchase in the second hand financial markets and so timing is important and I am not the only one thinking that the current QE adrenalin surge could be due a correction. In my own humble ARF tool I allowed the facility to build in a one off correction.
 
Last edited:
@Duke of Marmalade. Good work, Duke, in replicating the software product.
I wonder if you could use it to explore my conjecture that the durability of the income is improved considerably by introducing a conditionality into the regular income amount from the ARF.
For example, if the contributor withdraws X every year, then there is enough in the fund to pay a lifetime income (for however long you define "lifetime") y% of the time, but if they withdraw 103% of X in years when the price has increased, but 95% of X in years when the price has decreased (the different percentages being suggested in response to @elacsaplau 's observation that "up" years exceed "down" years by 2:1, so we need to have a rule as suggested to ensure that the average over a full lifetime is still X) then there is enough in the fund to pay a lifetime income z% of the time. I reckon that z will exceed y, by how much I'm not sure, but I think it could be significant. We could obviously flex it further, by varying the 95% and 103%, and by having it dependent on the size of the rise/fall in the price from one year to the next. Another practical issue, of course, is that withdrawals will be made more frequently than yearly, but that's a bridge too far.
 
Sorry I haven't been able to reply sooner...work and all that

I have uploaded the scenario of 70% World Equity and 30% European Bonds. I've also uploaded the user guide but I see Duke has done a lot of homework himself.

The software is only a few months old and is being worked on all of the time. An obvious flaw that I saw and pointed out to the owner is that the withdrawal rate is an actual amount with no adjustment in down years. I suggested having a % withdrawal (which works better with our own imputed distribution method) and it is something that will be added.

I agree that having data from 1900 doesn't seem relevant today and in fact skews the data as we had 2 World Wars and the Great Depression during that period. But overall, it is an illustration to give clients an idea of how certain withdrawal rates would have fared in the past. It is certainly not a crystal ball.


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

Attachments

  • Income_Withdrawal_Policy_Statement_John_Doe_Example (2).pdf
    394.2 KB · Views: 21
  • timeline_app_user_guide.pdf
    608.8 KB · Views: 11
You must log in or register to reply here.
Menu
Log in
Register