Pension investments

[Sarenco]

Once you are drawing from a portfolio, your investment horizon is far shorter than your lifetime.

In that scenario, only a small fraction of the portfolio will remain invested for the full balance of your lifetime (assuming, obviously, that the portfolio hasn’t been exhausted prior to that point).

Personally, I think it’s bonkers to retire with an all-equity portfolio.

 

[joe sod]

@AJAM could you do the same calculation at 6.5% growth but with 1% lopped off each year to take account of AMC drag on return, that would be good to see especially with an already large starting amount?

 

[CharlieMac]

I'm wondering is it realistic to factor in 6.5% every year for the next 20 yrs.

 

[ClubMan]

I'm wondering is it realistic to factor in 6.5% every year for the next 20 yrs.

Who knows. Best to model it with worst, likely and best case scenario assumed growth rates and/or using something like a Monte Carlo simulation based on past data (I've done this via ChatGPT but even mentioning that seems to trigger some people around here these days...). Your mileage may vary. Always double check what it gives you. E&OE. Yadda yadda...

 

[ClubMan]

Personally, I think it’s bonkers to retire with an all-equity portfolio.

I guess I'm bonkers so.

 

[conor_mc]

I'm wondering is it realistic to factor in 6.5% every year for the next 20 yrs.

It’s probably not realistic, but it probably doesn’t matter all that much. You’ll be retired for long enough that a prolonged under-performance now would be offset by a subsequent over-performance at some stage thereafter. In fact, a prolonged under-performance could significantly reduce your Sequence of Returns risk at retirement.

 

[ArthurMcB]

It’s probably not realistic, but it probably doesn’t matter all that much. You’ll be retired for long enough that a prolonged under-performance now would be offset by a subsequent over-performance at some stage thereafter. In fact, a prolonged under-performance could significantly reduce your Sequence of Returns risk at retirement

So basically if youre 10 yrs + out from retirement then you want a bit of underperformance so that you buy units cheaper and in the hope that that underperformance swings into overperformance at retirement?

 

[AJAM]

This website will allow you to do your own Monte Carlo Simulations

Monte Carlo Simulation

Online Monte Carlo simulation tool to test long term expected portfolio growth and portfolio survival during retirement

www.portfoliovisualizer.com

could you do the same calculation at 6.5% growth but with 1% lopped off each year to take account of AMC drag on return

I've attached the excel so you can play around with the numbers.

I'm wondering is it realistic to factor in 6.5% every year for the next 20 yrs.

I would say yes, but does it matter? The point is that you have a better chance of retiring at 60 by investing in 100% equities. If equity returns are lower, the conservative funds return will be even lower again. The only caveat to that, is if central banks push high interest rates for most of the 16 years, and equity returns are unusually low, then possibly the gap between the 100% equity fund and the conservative fund might close, but if you pay any attention to interest rates at all (anyone with a mortgage does) then you will see this coming.

 

[AJAM]

In the 20 years from September 2003 to June 2024, the FTSE All-World index (in EUR) had a compound annual growth rate of 9.10%, a standard deviation of 13.06%, and a Sharpe ratio of 0.64.

Backtesting for the European index investor

Backtest by Curvo is the best backtesting simulator for European index investors. Discover the historical performance of your portfolio and compare it to others.

curvo.eu

 

[Setforlife]

I’ve seen yet another change to how they show the statements of reasonable projection (SORP) on my pension recently. They changed the rates previously to more realistic ones for equities, increasing the SORPs significantly. Now they have added a range from ‘favourable’ to ‘unfavorable’ and removed the early retirement estimates. The rates used now are only on a 1% spread, which seems small but still shows a significant difference at normal retirement date (NRD). Based on these rates 6.5 would be ‘very favourable’ I guess.

• For the Favourable Scenario, at Normal Retirement Date, your fund achieves a rate of investment return of 5.84% per annum compound before any allowance for the effects of charges. The effect of charges is to reduce your gross investment return by 0.23% a year compound.
• For the Unfavourable Scenario, at Normal Retirement Date, your fund achieves a rate of investment return of 4.84% per annum compound before any allowance for the effects of charges. The effect of charges is to reduce your gross investment return by 0.23% a year compound.

 

[conor_mc]

So basically if youre 10 yrs + out from retirement then you want a bit of underperformance so that you buy units cheaper and in the hope that that underperformance swings into overperformance at retirement?

Let’s stick with the OP’s scenario - at age 45, with between 15 and 20 years to retirement (ie early retire at 60 if possible, otherwise keep working until 65) you’d happily buy 10+ years of stocks at a low CAPE.

Or put another way, I’d much prefer to be retiring after a lengthy period of under-performance (think 1980) rather than before one (1968). The US 1968 cohort faced the decade of 70’s stagflation, three drawdowns over 12-14 years before the next proper bull market kicked in, depleting their investments all the time through withdrawals. Their equivalents in 1980 accumulated at low CAPE for those 12 years then watched the 1980’s bull run absolutely explode their pension values. At the extremes, the difference in a $2m pot at 4% withdrawal rate was something like running out of money after 20-odd years versus dying with $16m!

 

[ArthurMcB]

Once you are drawing from a portfolio, your investment horizon is far shorter than your lifetime

Personally, I think it’s bonkers to retire with an all-equity portfolio

Would you change your view on this retiring early at, say 50?

 

[conor_mc]

Once you are drawing from a portfolio, your investment horizon is far shorter than your lifetime.

In that scenario, only a small fraction of the portfolio will remain invested for the full balance of your lifetime (assuming, obviously, that the portfolio hasn’t been exhausted prior to that point).

Even assuming a stagnant valuation but with a 4% withdrawal rate, 80% of your portfolio will be invested for greater than 5 years.

Tbh, when you take into account the fixed income of a COAP, I think having 10 years expenses in cash is far riskier (inflation risk) than being 100% global equities.

If I was relying totally on my pension pot though and had no other fixed income then yes, 100% equities would be ill-advised.

 

[Sarenco]

@ArthurMcB

No, I think it’s prudent to have 10 years of anticipated expenses in cash at retirement regardless of age.

However, if I was retiring at 50 I would want a materially bigger portfolio then would be the case if I was retiring at 65.

As such, the percentage allocation to cash would be lower at 50 and I would seek to maintain that % allocation by rebalancing periodically throughout retirement.

@conor_mc

When drawing down a portfolio you are trying to balance a number of different risks (investment, inflation, longevity, etc).

Focusing on one single risk is a mistake IMO.

BTW when I say “cash” I’m referring to interest bearing deposits, short-term bonds, etc. I don’t mean notes stuffed under the metaphorical mattress!

 

[AJAM]

For the Favourable Scenario, at Normal Retirement Date, your fund achieves a rate of investment return of 5.84% per annum

The vast majority of pensions are invested in the default portfolio, usually some type of lifestyle fund, which firstly in not 100% equities and secondly, gradually increases the % of bonds as you get older. So this lower and more conservative assumption is correct to use for SORP, but will likely underestimate actual if you are in a global equity index.

If you compare the performances of the default funds vs the global index fund, (over 5 or 10 years please) you'll see that they underperform.
The last time I ran the numbers Dec 2023
Irish Life Empower Growth 5 year annualized performance 4.85%
UNIO Navigate Balanced (Lifestyle fund) 8.8%
Navigate World Equity Index fund 13.3%

 

[Setforlife]

The vast majority of pensions are invested in the default portfolio, usually some type of lifestyle fund, which firstly in not 100% equities and secondly, gradually increases the % of bonds as you get older. So this lower and more conservative assumption is correct to use for SORP, but will likely underestimate actual if you are in a global equity index.

For clarity the SORP takes account of exactly which funds you are invested in (definitely in my case and I presume all cases and that it’s a requirement of the SORP, which also limits the % that can be used for the growth calculation)

Thus was last updated 1/1/25:

Statutory changes have been made to the assumptions used to calculate members’ SORP. The projections will now be more conservative and the estimated retirement fund and pensions shown will therefore be lower than has been shown to date.

These changes impact on all projections included on annual benefit statements and leaving service option statements effective from 1st January 2025.

The changes primarily impact the assumed future growth rates for investments returns, salary increases and the cost of buying a guaranteed pension.

The maximum future rates of annual investment return to be used in projections for different asset types are;

Equites (Shares) increases from 5.75% to 6.65%
Property increases from 5.75% to 6.65%
Fixed Interest (Bonds) increases from 2.5% to 3.4%
Cash increases from 0.25% to 2.65%

 

[AJAM]

No, I think it’s prudent to have 10 years of anticipated expenses in cash at retirement regardless of age.

No it is not prudent. It is exceptionally Risk averse and conservative. Not that there is anything wrong with that, if that's what you're into.
But any study will show you that over the vast majority of 10 year time horizons Cash will lose out to any other type of diversified investment.
So the Prudent thing is to stay mostly invested. The Risk averse, doomsday prepper thing is to keep it all in cash under the mattress. But the % probability of being better off is much much lower.

You can Monte Carlo it out on that website above if you are interested.

 

[Sarenco]

@AJAM

Look at the first 10 years of this century - cash deposits comfortably outperformed global equities.

If I had retired at the start of 2000 with a €1m all-equity portfolio and withdrew €40k per annum, adjusted for inflation, I would have gone bust years ago. If, on the other hand, I had maintained a consistent 40% allocation to cash/bonds, I would be doing absolutely fine now.

The performance of equities over the “vast majority” of 10-years periods is irrelevant to me - I only have one lifetime and one shot at getting this right.

If you want to consider other time periods where cash/bonds outperformed equities, this thread might be of interest -

Stocks for the long run?

It's commonly stated that stocks provide superior long-term returns to bonds. But what does "long-term" mean in this context? Over the last 20 years, the S&P500 has produced an annualised 4% return, with all dividends reinvested. That's an annualised real (after-inflation) return of less than...

www.askaboutmoney.com

 

[AJAM]

I'm not saying that you can't cherry pick 2 dates and have cash or bonds outperform Stocks.
But you have to pick very specific dates, from a very very small % of possible dates. This is basically sequence of return risks and it assumes you take no countermeasures.

You can compensate for sequence of returns risk by adjusting your inflation adjusted 40K to 5% of portfolio instead. Or even better use a flexible withdrawal rate to compensate for the initial poor returns sequence.

"Sequence of Returns Risk"

References: https://zbib.org/37315fd951f3402c8baaba6f64076fe7Learn about amortization based spending from economist Ben Mathew on the Rational Reminder podca...

www.youtube.com

What you are doing, is trading a 100% chance that you won't suffer any significant downturn for a >90% chance that overall you will end up with a larger portfolio balance and a higher sustainable withdrawal rate. Again, I'm not saying there's anything wrong with that. It's just exceptionally conservative and in all but the most extreme of cases will result in you being worse off financially.

 

[Sarenco]

@AJAM

Per Jeremy Siegel, bonds have outperformed stocks in 20% of 10-year holding periods since 1801. It’s really not that unusual.

You are basically saying that I should cut my spending in real terms if I’m unlucky enough to encounter a poor sequence of returns early in my retirement. No thanks, I’ve a lifestyle to maintain.

I should point out that my priority is not to maximise my terminal wealth. On the contrary, my priority is to maximise the probability that I can fund my desired lifestyle throughout my retirement.

You may have a different objective.