How much of an ARF should be in equities?

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elacsaplau

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Marc said:
The “traditional” rule for age based bond allocations is 100% stock less current age but as an asset allocation model it’s not great, especially if you intend to ARF in retirement you’ll end up being too light in equities.
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Marc - how high an allocation to equities would you advocate for the "normal" individual with just an ARF - by "normal" I mean someone without extreme wealth, health concerns or other factors, etc. and by "just an ARF" I mean without a DB promise/annuity in addition?
 
If they have "just an ARF" , then they should cash as much as possible and buy a home. The house would be ignored for means testing purposes so they would get the Non Contributory OAP.

If they own their own home without a mortgage and if they qualify for the Contributory OAP, then it would be a different matter. As this is a very good basic income, they should invest the rest of their wealth in equities - assuming that they have at least a 20 year life expectancy.

If they are coming towards the end of their life, they should discuss it with their beneficiaries as it's their investment horizon which is most relevant.

Brendan
 
elacsaplau said:
Marc - how high an allocation to equities would you advocate for the "normal" individual with just an ARF
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Good question.

I'm some way off having to make any decisions in this regard (and I may well adapt my position over time) but my current plan on retirement is to have roughly 15 years' worth of residual expenses in cash and fixed-income investments, with the balance (if there is a balance!) in equities. By residual expenses, I mean the amount I think I will need to fund a comfortable lifestyle, less any State pension, etc.

I also plan to draw down the cash/fixed-income portion of the ARF first, so that I effectively increase my allocation to equities over time. That might seem counter-intuitive but I think it's a reasonable way of balancing inflation and sequence of return risk.

I certainly don't have a firm opinion on this issue and would be very interested to read the views of others.
 
Thanks Sarenco,

That's exactly the angle I've been wondering about - my question got distorted slightly as it was moved from another thread.

Rather than commenting right now on your approach, just to explain further where I'm coming from. I suppose the question was prompted by Marc's view that "age in bonds" is passé so I was seeking Marc's views on an acceptable upper range for equities (for ARFers).

Meanwhile, Brendan has chimed in that the ARF investor "should" invest 100% in equities (so long as the house has been paid off, etc. which is kinda what I meant by "normal" investor - figuring it to be a reasonable working assumption).

So, in essence, Marc is saying 35% equities (at 65) and reducing thereafter as one's age increases is too low - (which, incidentally, I agree with) and Brendan is broadly saying 100% equities (which I think is too high - certainly for most people).

What I'd like is for all posters, and particularly the financial adviser community, to address this asset allocation question. [Obviously - given the thread of the weekend, we all know where our resident tax guru stands!]

I think this is a really important question and I have asked it before but do not recall ever seeing an answer from the adviser community. The bottom line is I'd like to know how advisers deal with this asset allocation question in practice, the basis for subsequent re-balancing, etc.

I suppose if we divide assets between defensive and return-seeking, where do people invest their defensive assets in current market conditions?

Finally, what I'm really, really interested in is:

1. The data such advice is based on; and
2. What specific guidance is given by the relevant professional bodies that advisers belong?
 
Hi elacsaplau,

You probably don’t know where I stand to be fair! The position with an ARF is different, and even then it depends on the status of the ARF-holder.

I’ve come across 50 year old ARF holders with 11 years to go before the mandatory drawdown kicks in.

Then you’ve ARF holders who are subject to 4/5/6% mandatory drawdowns; that changes the analysis quite a bit. It all comes down to sequencing of returns; basically, if you’re 100% invested in equities and you start drawing down from your ARF at 4% or 6% and markets tank, you have a problem, because you’re taking money out whilst the capital value of your ARF is falling and that capital never has the chance to recover.

It’s very different to my strident view regarding someone with a 20 year time horizon and no need to access the cash.

Gordon
 
Fair enuff, Gordon!!

I agree with your points.

[In my feeble defence - and let's leave it at that please! - I was (a) kinda half joking and (b) did have a recollection of a previous post of yours to the effect that you'd personally be pretty much all-in equity when your ARF times rolls around! However...…...I accept my joke may not have been funny and my recollection may not be accurate! ;)]

Just to add: I accept that there are a whole pile of variables (like the age 50 scenario described by Gordon above.) For the purposes of this thread, probably best to maintain as typical a scenario as possible - so let's consider the ARFer has arrived at "compulsory" drawdown age. Whilst I'm at it, let's assume it's an ARF based on current legislation - this last caveat may save me a lot of grief later!
 
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It wouldn’t be a great idea to be 100% invested in equities in such circumstances because initial market weakness would have a detrimental effect longer term. I’m referring specifically to circumstances where the individual is basically reliant on the ARF for income in retirement.
 
I think the size of the pension pot is a pretty important consideration.

For discussion purposes, maybe we should assume a pension pot of €1million, with lifestyle expenses of €40k per annum.

So, my tentative formula of having 15 years' worth of residual expenses in cash/fixed-income investments at retirement (ignoring the State pension for simplicity) would result in an equity/fixed-income split of 40/60.

Coincidentally, that's "age in bonds" for somebody retiring at 60 but my suggestion is that the proportion in equities would gradually increase as the retiree ages, perhaps with an upper limit of, say, 60% in equities.

Interested to hear the thoughts of others on what I agree is a very important question.
 
Hi Sarenco,

What’s your view on someone not taking their mandatory distribution?

For a 61 year old, an ARF of €1m can have a mandatory distribution of €40k or just pay tax of circa €20k.

If someone negotiatied a very cheap QFM charge and bought a really cheap ETF for example (say 40bps all in).

Gordon
 
Marc said:
5) the annuity forgone should also be used as a hurdle for measuring how “successful” the arf strategy is. You’re not keeping up the Jones’s you are trying to do better than your own annuity rate after costs
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The only snag is you won't know whether your strategy has been successful until it's too late!

Which brings us back to the original question - what's a reasonable yardstick for determining your initial allocation in an ARF in a "normal" scenario? Age in bonds, 100/110/120 less your age in equities, a static allocation (maybe 60/40) for life, a multiple of your residual expenses in fixed-income or something else entirely?

I fully appreciate that there is no universally correct answer here but I'm interested to know how others are approaching this issue.
 
But say I’ve the potential to have an ARF of (say) €1.5m or a simple annuity of €45k a year.

Most people I’ve come across are more concerned about the succession planning aspects of the ARF (i.e. becomes a spouse’s ARF and then 70% of its value paid to the kids without impacting their CAT thresholds).
 
Marc said:
As time goes on and people get older, the pool of people who die early gets smaller until the life company is just left with those annuitants who aren’t going anywhere soon. They get a relatively worse annuity rate for their age than they would have received when they were younger.
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In practice in current conditions annuity rates become relatively better value as you get older. From the Irish Life annuity calculator the annuity rates are as follows: 65 year old 4% p.a., 75 year old 6% p.a. and 85 year old 10% p.a. So assuming we can fairly safely earn 2% p.a. we have the following alternative scenarios:
1) 65 year old buys annuity now to earn 4% p.a.
2) He postpones until age 75 dipping into his fund to provide that 4% p.a., then buys an annuity with the remaining c.78; that would give an annuity of 4.7% p.a.
3) He postpones until age 85 then buys an annuity with the remaining 51; that would give an annuity of 5.1%

Postponing taking out longevity insurance (annuity) is very much to be recommended to a 65 year old. Unlike other risks there is no danger of suddenly finding it uninsurable. Yes longevity in general might improve but expectations of longevity improvements are already well built into current annuity rates and surely the interest rate environment must improve at some stage. Also postponement provides some hedge against inflation which is totally absent the annuity route.

I presume these days nobody advises a 65 year old to take out an annuity.
 
Marc said:
This personal benchmark, the guaranteed annuity income given up to buy the ARF, is known with certainty by all ARF investors and is the real hurdle against which they should be measuring their account
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I don't agree that beating the return on an annuity should be the measure of success of an investment strategy for an ARF.

But even if you want to view this issue through that lens, you will only know for certain that your strategy has been successful with the benefit of hindsight.

That brings us right back to the original question posed – what's the optimum way of determining a reasonable allocation of assets within an ARF in a typical scenario?

At this point, I would guess that many financial advisers would turn to portfolio optimisation software that projects the return on a portfolio comprising various assets classes. While these models might appear sophisticated, I am deeply sceptical about the ability of anybody to predict portfolio returns over an indeterminate, or even an assumed, time period with anything even approaching precision.
 
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