Pension investment strategy

Discussion in 'Pensions' started by moneymakeover, Feb 13, 2018.

  1. moneymakeover

    moneymakeover Frequent Poster

    My Irish Life scheme has number of choices

    Cash fund
    Corporate bond fund
    Cautious fund
    Growth fund
    Pension for Life fund
    High growth fund
    Ethical fund
    World equities
    Emerging markets

    From what I can see with the exception of Cash Fund they all lost a few percent over past 10 days

    There is also something called personal lifestyle strategy

    In current climate and with stocks maybe overvalued what would folks recommend if say
    10 years to retirement
    15 years to retirement
    lledlledlled likes this.
  2. SBarrett

    SBarrett Frequent Poster

    It's not as simple as that.
    1. What is your investment term?
    2. What is your investment goal?
    3. What is your expected income in retirement?
    4. What do you need to earn to reach that goal?
    5. How far do markets have to fall for you to get nervous?
    Stocks may be more expensive today than they were a year ago. Do you expect them to be worth the same or more in 10 years time?

    Apple were trading at $12 in 2006 when markets were surging ahead, some would say overpriced. They are now trading at $164!!

  3. Sarenco

    Sarenco Frequent Poster

    Last edited: Feb 15, 2018
    It's a great question and one that investment professionals debate endlessly.

    "Life-styling" is industry jargon for dialling down the risk of a portfolio as an investor nears retirement. So, the manager gradually reduces the portfolio's exposure to volatile assets (equities and real estate) and increases the exposure to less volatile assets (cash and bonds).

    The idea is to mitigate the investor's "sequence of returns" risk - the risk that the investor will suffer a significant drawdown in the value of their portfolio in the run up to retirement or within the early years of retirement. These years are critical to the success of any retirement plan.

    But there's a problem - life-styling, by definition, is a default option. The pension provider does not, and cannot, know your individual circumstances.

    Will you have any other income in retirement? Do you have a younger spouse that will continue to work after you have retired? Will you be carrying mortgage debt into retirement? Will you have dependants? Is there a history of longevity in your family (or the opposite:()? Do you want to leave behind a legacy - to family members or your favourite charity?

    No pension provider could possibly know your individual circumstances so they work off certain assumptions that may or may not be appropriate to your circumstances.

    So what to do?

    Well, I can tell you one approach but it comes with significant health warnings. Firstly, it's unorthodox - this is very much my own home-grown formula. Secondly, it's pretty conservative - my philosophy is to try and meet my financial goals while taking the least amount of risk possible. Finally, it might not work! There are no guarantees in investing.

    First off, I work out an idea of what I want to draw down from my pension pot every year to meet my anticipated expenses in retirement. The numbers are not particularly important but let's say I want to draw down €30k a year (in 2018 terms), I expect to retire at 65 and to live 90 (ever the optimist!). I want my pension pot to keep up with inflation after I retire (to preserve the purchasing power of my money) but I don't want to take any unnecessary risks.

    So, that gives me a target "pot" of €750k (€30k multiplied by 25), in 2018 value terms, to try and reach by the time I hit 65.

    As I work towards this target, I would switch my allocation to global equities and eurozone government bonds roughly as follows:-
    • €0 - €250k : 100% equities;
    • €250k - €500k : 75% equities/25% bonds; and
    • €500k - €750k : 50% equities/50% bonds.
    This assumes I will own my home, mortgage free, by the time I retire @65 and I will have a decent slug of cash (roughly six months' worth of expenses) on deposit.

    Importantly, I don't pretend to know any more that the market about the correct value to assign to any asset class at any point in time.

    Hope that helps.
    Last edited: Feb 15, 2018
  4. moneymakeover

    moneymakeover Frequent Poster

    Very interesting.

    I presume at retirement...d day...a person liquidates his portfolio?

    And next couple of weeks purchases an arf?

    Is it possible to have more continuity ie keep the equities and avoid the exit/entry fees?
  5. Gordon Gekko

    Gordon Gekko Frequent Poster

    Absolutely. It’s more typical for the assets to move intact (“in specie”) for that very reason. There just needs to be enough cash generated to cover the pension lump sum.

    For what it’s worth, my approach is far more crude than Sarenco’s; I put away as much as I can and will always load it 100% into equities. That ignores the very real “sequence of returns” issue rightly highlighted by Sarenco, but I’m okay with that as I don’t envisage having to draw on the fund and will look to undertake tax planning with it.
  6. SBarrett

    SBarrett Frequent Poster

    Abraham Okusanya of Finaltiq wrote a very good article on sequencing risk that can be found here . How you withdraw the money can be just as important a factor.

    The conflicting issues for those approaching retirement is protecting the tax free lump sum and going with the market. Lots of people in "the industry" say that if you intend on investing in an ARF in retirement, stay invested as you will sell out of the pension and buy into the ARF at the same price, so it doesn't really matter what the price is. If markets are high, you are going to sell with lots of gains but buy at a high price so get less units. If markets are falling, you sell with lower gains but get more units the ARF.

    The issue is the lump sum, which is a percentage of the fund. There's no point in me telling a client not to worry if his €1m pension pot falls to €800,000 because he's going to get lots of units at a lower price in his ARF. He's after losing 25% in tax free cash. I could also tell him that because he stayed invested, that €800,000 is more than if he had been in low risk strategy from 5 years out.

    Emotional behaviours are the biggest factors in people making mistakes with their money that will cost them. Dealing with it is a big part of being an advisor these days, helping people understand the risks and talking them off the ledge in some cases. Having someone to question decisions they are making can save them a lot of money.

    ant dee likes this.
  7. Gordon Gekko

    Gordon Gekko Frequent Poster

    He hasn’t though; he’s lost 20% of what’s taxable cash.

    Meaning he’s only down €40k/€250k, or 16%.
  8. ant dee

    ant dee Frequent Poster

    If his pension pot is €1m at the time of retirement he gets 25% tax free lump sum, so €250k right?
    While if it 'crashes' to €800k just before retirement, his lump sum is only €200k?
    I think that's what Steven meant is that the average investor approaching retirement focuses on that rather than the bigger picture you are seeing.

    Can you explain your numbers a bit more please?
  9. rob oyle

    rob oyle Frequent Poster

    I hadn't thought about it before but in this scenario, if you're planning to take a lump sum from your pension fund at the date of retirement and put the rest into an ARF, there is reason for a certain level of lifestyling to remove the volatility from the lump sum element of the fund? If there was a drop in the equity markets in the months/years leading up to retirement date, the amount put side for income in retirement (through the ARF) would be hit by withdrawing a lump sum at the low end of the volatility range. Since the lump sum is being taken out of the fund at a specific point, it's not availing of low purchase costs at that point for future investment growth.

    Of course, if the majority of the lump sum was to be reinvested in equities afterwards then lifestlying wouldn't make sense. This is also not so much about holding cash in retirement as part of the retirement income but acknowledging that a material amount will be taken out of the mix at a certain point in the future.
  10. SBarrett

    SBarrett Frequent Poster

    Correct. I just threw up those amounts for simplicity purposes and didn't include the taxable element. :oops:
  11. Gordon Gekko

    Gordon Gekko Frequent Poster

    At €1m, my lump sum is €250k (25%). €200k of that is tax-free and €50k is taxed at 20%. So net €240k.

    At €800k, my lump sum is €200k, all of which is tax-free.

    So €240k vs €200k.
    ant dee likes this.