A critique of the lifestyling approach to pensions

[nest egg]

I came across a paper which may help the PA answer some of those questions: "Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice" https://www.netspar.nl/assets/uploads/19.-Cederburg-ACO_Manuscript.pdf

"Our findings suggest that financial advice and pension regulations should be revised to consider all-equity strategies as viable and legal alternatives for retirement savers; we call for alternative approaches to mitigate the costs of short-term losses, such as financial education on staying the course, retirement account reporting standards that emphasize long-term performance, and regulations that assist retirement savers with maintaining a long-term focus."

 

[Brendan Burgess]

@nest egg

Wow, that paper should be required reading for the Pensions Council and the guys in the Civil Service responsible for pensions planning.

Abstract
We challenge two central tenets of lifecycle investing: (i) investors should diversify across stocks and bonds and (ii) the young should hold more stocks than the old. An even mix of 50% domestic [i.e. American] stocks and 50% international stocks held throughout one’s lifetime vastly outperforms age-based, stock-bond strategies in building wealth, supporting retirement consumption, preserving capital, and generating bequests. These findings are based on a lifecycle model that features dynamic processes for labor earnings, Social Security benefits, and mortality and captures the salient time-series and cross-sectional properties of long-horizon asset class returns.

Given the sheer magnitude of US retirement savings, we estimate that Americans could realize trillions of dollars in welfare gains by adopting the all-equity strategy.

 

[Dr Strangelove]

Wow, that paper should be required reading for the Pensions Council and the guys in the Civil Service responsible for pensions planning.

I think they know the truth deep down themselves Brendan!

They are just afraid of what would happen after an equity market crash and pensioners calling Liveline and saying my all-equity ARF was worth €600k two years ago and €400k today. Trying to convince Joe that it would be worth only €300k today if the pensioner had shifted bonds in the run-up to retirement is a fool’s errand.

 

[Gordon Gekko]

Whilst personally I stick to an all equities strategy and will do in perpetuity, I’m not sure I would do if I was entirely reliant on my portfolio and I no longer had the capacity to work. Our old friend ‘sequencing of returns risk’ is an issue whether we like it or not. Basically the scenario where markets are rubbish in the early years of retirement but you’re sucking out cash at the bottom which then never has a chance to recover so you run out of money at the end.

 

[Dr Strangelove]

You have to take a view from the totality of expected income and total wealth.

Most people will have a full state pension and a mortgage-free roof over heads.

Personally I have some DB pensions so I’ll only have about 25% of household wealth in a DC fund by retirement and I’d be mad to keep it in fixed income.

 

[Fortune]

Whilst personally I stick to an all equities strategy and will do in perpetuity, I’m not sure I would do if I was entirely reliant on my portfolio and I no longer had the capacity to work. Our old friend ‘sequencing of returns risk’ is an issue whether we like it or not. Basically the scenario where markets are rubbish in the early years of retirement but you’re sucking out cash at the bottom which then never has a chance to recover so you run out of money at the end.

No-one ever seems to consider sequence of returns risk for "safe" bonds...

 

[Dr Strangelove]

No-one ever seems to consider sequence of returns risk for "safe" bonds...

In the last two years German ten year bonds have fallen in value by about 30% and inflation has been 14%. That’s the safest asset denominated in € down 45% in real terms!

That’s not far off a worst-case scenario for equities over same horizon.

Maybe I’m cherry picking, but there was no possibility of the same return with the opposite sign with bonds. There are lower bounds to inflation and interest rates that makes it impossible.

 

[time to plan]

Whilst personally I stick to an all equities strategy and will do in perpetuity, I’m not sure I would do if I was entirely reliant on my portfolio and I no longer had the capacity to work. Our old friend ‘sequencing of returns risk’ is an issue whether we like it or not. Basically the scenario where markets are rubbish in the early years of retirement but you’re sucking out cash at the bottom which then never has a chance to recover so you run out of money at the end.

Reliance on portfolio is an important point. I was a late starter to my pension and am piling cash in monthly to 100% equities. But I have a small but not trivial NHS pension kicking in when I am 60 and then Irish and UK state pensions kicking in at the respective retirement ages.

 

[Gordon Gekko]

Agreed, it’s important to look at the overall pot rather than thinking about things in silos. Any defined benefit type income is like owning a bond, often an inflation linked bond. What’s the capital value of the State Pension for example? €300-350k?

 

[Dr Strangelove]

It’s an interesting academic exercise to calculate capital value of contributory state pension value but not all that relevant.

I think of it (and so does government) as the bare minimum to avoid poverty.

 

[time to plan]

It’s an interesting academic exercise to calculate capital value of contributory state pension value but not all that relevant.

I think of it (and so does government) as the bare minimum to avoid poverty.

I agree. I would look at it the other way around. My 2 state pensions and NHS pension will pay about €550 per week in today's money. So I am insulated against stock market swings for my private pension which is 100% equities.

 

[Gordon Gekko]

So it is relevant then…

It doesn’t matter how you look at it, either the return the different pots can generate or the capital value of those pots.

The key point is not to consider silos in isolation. It’s all about the overall pot.

 

[time to plan]

So it is relevant then…

It doesn’t matter how you look at it, either the return the different pots can generate or the capital value of those pots.

The key point is not to consider silos in isolation. It’s all about the overall pot.

Certainly not irrelevant enough to have am Xmas Eve fight over!

The other thing to add (using my case) is spouse's pension. She also has Irish and UK state pensions and a small UK university pension and is starting on the Irish university (Public sector) pension scheme. Maybe I should be going higher risk!

 

[Gordon Gekko]

Certainly not irrelevant enough to have am Xmas Eve fight over!

The other thing to add (using my case) is spouse's pension. She also has Irish and UK state pensions and a small UK university pension and is starting on the Irish university (Public sector) pension scheme. Maybe I should be going higher risk!

I think for people in retirement, an overall 60:40 allocation is pretty sensible. For that I’d exclude my home, but include investment property, cash, bonds, and DB pension income (including the State pension) as part of the ‘40%’, and then have the 60% equity allocation inside a pension vehicle.