Colm,
In terms of income drawdown in retirement, if you have any evidence to support this statement, I'd love (and be amazed
) to see it.
In the U.S., others like Wade Pfau and M.McClung have produced very detailed research to the exact contrary.
I’ve now had a chance to look at Wade Pfau’s conclusions.
First of all, we are comparing apples and oranges: my proposed approach differs in a number of key respects from the approach described by Wade Pfau so his conclusions cannot be used to draw any conclusions from the work I’ve done. I think I’ve explained my approach in some detail, and I stand by my statement, as quoted by you in post #200 on this thread. If you disagree, let me know which of my conclusions/ assumptions you don’t accept, and we can take it from there.
In this response, I would like to focus exclusively on Wade Pfau’s work and explain why I have serious reservations about his methodology and conclusions. In a nutshell, he takes a highly theoretical approach, which ignores the reality of stock market investing.
To keep things simple, I’ll just focus on the scenario where he assumes 100% investment in equities (he also looked at bonds and bills, in varying percentages for all three).
He assumes 100% of the money is invested in the index at the outset. Then 4% (or whatever) is withdrawn each year by cashing the required number of units. Taking this approach, he found that the money ran out in a significant proportion of past time periods.
Let’s look at what this means for a real-life portfolio invested in equities, not his artificial construct.
1. He assumes that every single cent is invested in equities at the start, with no cash being retained in the fund. This is wrong (but it’s only a minor mistake). Every equity fund has a small liquidity element, probably less than 5%. This cash element will in practice be used if needed to meet withdrawals in the first few months. As we shall see later, however, it may not even be needed. If the liquidity in the fund is used to fund “income” payments, it will have to be replenished to ensure the liquidity level never falls below (say) 1%.
2. He assumes that all dividends are reinvested immediately, even if the equities thus purchased are sold again within minutes to fund “income” requirements. That’s a ludicrous assumption. If someone is taking a constant “income” from the fund, they will hoard whatever dividends they’ve received until the next “income” payment is due, thus reducing the number of shares that need to be sold to fund the regular outgo.
3. Much the same is true for stock turnover within the fund. The mechanics of this depend on whether the fund is being managed actively or passively. Let’s assume it’s being managed passively (the argument is even stronger for an actively managed fund). Some people think that a passively managed fund has little or no stock turnover. That’s what’s implied by the term passive. It’s far from the case. A passive fund must track the index, so if a stock is removed from the index, the fund must sell the shares in that particular stock and buy ones in the stock that replaces it in the index. Similarly, a share buyback, which reduces the number of shares in issue, requires a passively managed fund to sell some of its holding of that share. The opposite is true for rights issues, or IPO’s. As an aside, managers of passive funds objected to Mifid II’s decision to include the costs of these purchases and sales in the costs of such funds. Here again, Mr Pfau in his wisdom assumes that, if a company is removed from the index, the fund will sell shares in that company, then buy the shares in the company that replaces it in the index and immediately sell those shares again to pay the “income” to the beneficiary. Very intelligent behaviour, I don’t think. In real life of course, when the fund sells the shares in the company that has been removed from the index or that has completed a buyback, it will not reinvest if it needs the money to pay an “income” to beneficiaries (assuming it’s already used up dividend receipts and hasn’t enough cash for the “income”). In fact, rebalancing is much easier in a fund where there is a continuing flow of new money or a regular outflow than where there is no net change in the money invested in the fund.
4. He assumes that the investment strategy for a fund devoted exclusively to paying a continuing regular income to beneficiaries is exactly the same as for a fund with no requirement to deliver a regular “income”. Once again, that is completely unrealistic and artificial. I’ve looked at my two biggest portfolios to explore the truth or otherwise of this assumption. One of the portfolios is my ARF, from which I am required by law to take an “income” of 6% every year. The other is the home for the proceeds from selling my shares in the business where I once was a major shareholder. I don’t have to take an “income” from that portfolio. Both portfolios are invested virtually 100% in equities. I decide the equities to hold in both portfolios. The average dividend yield on the portfolio from which I must take 6% per annum is
more than three times the dividend yield on the portfolio from which I don’t have to take a regular income. The average dividend yield on the two portfolios combined is probably not too far off the average dividend yield for the index. I would think my experience is not untypical of the market.
5. I’m sure there are other artificial assumptions that I haven’t considered. For example, it’s likely that Mr. Pfau assumes that “income” is taken in one lump sum at the end of each year. In real life, income is taken gradually throughout the year. This assumption probably has a significant impact on the conclusions.
What do these differences mean in practice. I don’t know. I can only relay my own experience. My ARF has been in drawdown since 2010 and I don’t recall a single instance of having to cash an investment to meet the “6% income” requirement. Note that I’m NOT saying that the fund returned more than 6% each year. No. I’m only saying that the 6% “income” requirement each year was met by a combination of dividend receipts, or temporarily allowing the level of liquidity in the fund to fall, or holding back proceeds from selling stocks that I’d gone cold on instead of reinvesting the entire proceeds in stocks that I preferred at that time. There was also an element of timing when I took the “income”, i.e. I didn’t take it on the same date each year; instead, I took it when I thought the time was opportune. That safety valve wouldn’t be available to a professional manager who promised to deliver €X per month to a beneficiary, but it hasn’t played a significant role in the end result of not being forced to sell investments to meet the income requirement. The consequences for Mr Pfau’s conclusions don’t need to be spelt out.
Let me know if you still believe Mr Pfau.
I will reiterate what I said at the start, that my proposed approach is quite different.