The fallacy of "lifestyling"

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Duke of Marmalade

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I was recently made aware of a situation which highlights the total fallacy of "lifestyling".
The basic premise behind lifestyling is that one should invest in growth assets up to, say, 10 years before retirement and then ease into bonds/cash or "safer" investments as you approach retirement. But it transpires there are considerable variations on the theme. Irish Life target 25% lump sum cash with the remaining 75% in their MAPS4 fund which has less than 20% in bonds. This is probably the most appropriate mix of caution and continuing exposure to growth assets for a typical retiree.
But I was recently made aware by someone that their fund had fallen around 20% in the last year coming up to their retirement. They said it was something to do with lifestyling. I corrected them - "no, no, 20% fall would be a very bad year for equities, lifestyling protects you from that sort of shock at retirement". So they sought clarification from their life company. I could hardly believe my eyes at the response - they had been directed 25% into cash (fair enough) and the remaining 75% into the "annuity fund". The annuity fund consists entirely of long bonds and had fallen 24% over the previous 12 months.
I know the so called rationale - steer folk towards 25% lump sum and the rest to buy an annuity; lock in the annuity rate. But this default assumption that everybody will use their 75% to buy an annuity is completely at variance with actual experience.
But did the life company not even pause to ask "should we really be putting people in long bonds at these ridiculously and artificially low yields?". The following comment from JP Morgan in the context of the SVB debacle comes to mind.
JP Morgan said:
" I wonder whether Fed models on systemic risk incorporate the possibility that some banks would be duped into thinking that QE-induced rates prevailing in 2020 represented fair value, and would load up on them "
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It seems that the life company behind the above lifestyling example was so "duped".
 
Hi Duke,

To be fair, last year does seem to be an outlier, in that many lower risk strategies did worse than higher risk equity strategies.

Gordon
 
Hi @Gordon Gekko The fact that last year was an outlier is not much consolation for someone in that position.
I know it's easy to be wise after the event, but who in their right mind could ever have thought it sensible to lock in long-term interest rates of almost zero as part of a sensible retirement planning strategy?
 
Duke of Marmalade said:
I was recently made aware of a situation which highlights the total fallacy of "lifestyling".
The basic premise behind lifestyling is that one should invest in growth assets up to, say, 10 years before retirement and then ease into bonds/cash or "safer" investments as you approach retirement. But it transpires there are considerable variations on the theme. Irish Life target 25% lump sum cash with the remaining 75% in their MAPS4 fund which has less than 20% in bonds. This is probably the most appropriate mix of caution and continuing exposure to growth assets for a typical retiree.
Click to expand...
This is a wise comment.

Duke of Marmalade said:
But I was recently made aware by someone that their fund had fallen around 20% in the last year coming up to their retirement. They said it was something to do with lifestyling. I corrected them - "no, no, 20% fall would be a very bad year for equities, lifestyling protects you from that sort of shock at retirement". So they sought clarification from their life company. I could hardly believe my eyes at the response - they had been directed 25% into cash (fair enough) and the remaining 75% into the "annuity fund". The annuity fund consists entirely of long bonds and had fallen 24% over the previous 12 months.
I know the so called rationale - steer folk towards 25% lump sum and the rest to buy an annuity; lock in the annuity rate. But this default assumption that everybody will use their 75% to buy an annuity is completely at variance with actual experience.
But did the life company not even pause to ask "should we really be putting people in long bonds at these ridiculously and artificially low yields?". The following comment from JP Morgan in the context of the SVB debacle comes to mind.

It seems that the life company behind the above lifestyling example was so "duped".
Click to expand...
It is doubtful if switching from equities into bonds is an appropriate strategy for those nearing retirement unless the provider has analysed the sensitivity of the price of the bonds to changes in the interest rate and selected bonds accordingly. This article in the Guardian covers the issue in some detail. Pensions: why do those retiring face ‘massive’ losses despite FTSE highs? | Pensions | The Guardian
 
A portfolio consisting of 25% cash and 75% long-dated bonds makes zero sense in any circumstances.

However, that doesn’t demonstrate that life styling is a fallacy.

It’s perfectly rational to gradually reduce exposure to risk assets in the run up to retirement to manage sequence of return risk.
 
Duke of Marmalade said:
I was recently made aware of a situation which highlights the total fallacy of "lifestyling".
The basic premise behind lifestyling is that one should invest in growth assets up to, say, 10 years before retirement and then ease into bonds/cash or "safer" investments as you approach retirement. But it transpires there are considerable variations on the theme. Irish Life target 25% lump sum cash with the remaining 75% in their MAPS4 fund which has less than 20% in bonds. This is probably the most appropriate mix of caution and continuing exposure to growth assets for a typical retiree.
But I was recently made aware by someone that their fund had fallen around 20% in the last year coming up to their retirement. They said it was something to do with lifestyling. I corrected them - "no, no, 20% fall would be a very bad year for equities, lifestyling protects you from that sort of shock at retirement". So they sought clarification from their life company. I could hardly believe my eyes at the response - they had been directed 25% into cash (fair enough) and the remaining 75% into the "annuity fund". The annuity fund consists entirely of long bonds and had fallen 24% over the previous 12 months.
I know the so called rationale - steer folk towards 25% lump sum and the rest to buy an annuity; lock in the annuity rate. But this default assumption that everybody will use their 75% to buy an annuity is completely at variance with actual experience.
But did the life company not even pause to ask "should we really be putting people in long bonds at these ridiculously and artificially low yields?". The following comment from JP Morgan in the context of the SVB debacle comes to mind.

It seems that the life company behind the above lifestyling example was so "duped".
Click to expand...
Annuity rates have increased dramatically in the last year to the extent that for many people they are now the default against which any other option needs to be compared.

Under those conditions a long bond fund is a reasonable hedge as bond prices drop yields rise and annuity rates improve.
 
Marc said:
Annuity rates have increased dramatically in the last year to the extent that for many people they are now the default against which any other option needs to be compared.

Under those conditions a long bond fund is a reasonable hedge as bond prices drop yields rise and annuity rates improve.
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Yes, and I have explained to the person that if they are purchasing an annuity then the fall in the annuity fund will to some extent be cancelled out by the rise in annuity rates.
You state that current more "normal" annuity rates are now the benchmark. Fair enough, but at zero interest rates I think everyone in this parish said don't touch annuities with a barge pole - and they have been proven right in spades. The example I quoted effectively locked in the zero interest annuity rates. To paraphrase JP Morgan how were the providers "duped" into thinking these rates were fair value to lock into?
 
Sarenco said:
A portfolio consisting of 25% cash and 75% long-dated bonds makes zero sense in any circumstances.

However, that doesn’t demonstrate that life styling is a fallacy.

It’s perfectly rational to gradually reduce exposure to risk assets in the run up to retirement to manage sequence of return risk.
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The title was more in the nature of click bait;)
I think you are closer to the current zeitgeist than me so it is good that you agree that the approach adopted in OP "makes zero sense in any circumstance".
I agree that, in the absence of some collective pooling of equity volatility risk, the average employee should follow some lifestyling approach. I suppose the "fallacy" that I am highlighting is any idea that lifestyling is a universal standard. In OP I illustrated the huge difference between the Irish Life approach, which I broadly agree with, and the extremely purist approach of locking into zero interest rate annuities in the example.
My interest really derives from my involvement with the proposed AE scheme. As pointed out elsewhere the Heads of Bill don't even tell us what the approach to lifestyling will be other than it will be required for the default fund. If the strawman is followed the default fund will depend on which of the four providers' schemes is allocated to the employee, possibly by carousel. As OP shows this will indeed point to how much of a lotto this allocation will be.
 
Duke of Marmalade said:
know the so called rationale - steer folk towards 25% lump sum and the rest to buy an annuity; lock in the annuity rate. But this default assumption that everybody will use their 75% to buy an annuity is completely at variance with actual experience.
But did the life company not even pause to ask "should we really be putting people in long bonds at these ridiculously and artificially low yields?". The following comment from JP Morgan in the context of the SVB debacle comes to mind.
It seems that the life company behind the above lifestyling example was so "duped".
Click to expand...

The financial industry loves silly words and jargon  lifestyling , who makes this stuff up? The JP Morgan quote about banks getting duped by the central banks into buying these low interest rate bonds is correct. The central banks had skin in the game themselves because they needed to make sure that there was a demand for these ultra low interest bonds especially during covid because this is where all the funding for governments was coming from . Now we are finding out who was really paying for these lockdowns. It looks like these lifestyle pensioners are one group that have paid for it. Of course everyone is now paying for it through inflation and this was sparked during covid not the Ukraine war, the popular misconception, that just poured fuel on the flames but covid lockdowns started the inflation fire
 
Perhaps interestingly Mercer (at least in regards the IBM pension plan) now defaults the lifestyling to assume the beneficiary will take out an ARF rather than an annuity. They advised of this change last year IIRC. Anyone who was on the default lifestyle plan was automatically migrated to the new one. You had to opt back in to the "heading towards annuity" lifestyling.
 
Excuse my ignorance here, but how do people get "lifestyled". Is this where they're some sort of actively managed thing that gets adjusted per the investors age? I thought what happens when people invest in funds is that you pick your risk appetite/level and then you choose from the fund options your advisor has access to. So I'm wondering how people find themselves with their investment profiles being changed on their behalf, what sorts of instruments does this happen with?
 
David_Dublin said:
Excuse my ignorance here, but how do people get "lifestyled". Is this where they're some sort of actively managed thing that gets adjusted per the investors age? I thought what happens when people invest in funds is that you pick your risk appetite/level and then you choose from the fund options your advisor has access to. So I'm wondering how people find themselves with their investment profiles being changed on their behalf, what sorts of instruments does this happen with?
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It is an optional choice but it really came into its own with the introduction of PRSAs which required a "default" option for those (over 90%) who haven't a clue what to select and the conventional wisdom was that the default should involve lifestyling.
Auto Enrolment as currently drafted will require the default option to include lifestyling - but crucially it does not specify which form of lifestyling from the very wide spectrum of providers' views on the matter. As I asked earlier - how will AE actually apply lifestyling given that this wide spectrum is likely to be reflected in the 4 providers that are selected.
Of course if Colm Fagan's smoothing approach is adopted this conundrum becomes irrelevant as people will be protected from the equity volatility risk or what @Sarenco refers to as the "sequence of return" risk, with the enormous benefit that people will continue to enjoy the (4%) Equity Risk Premium not just during the lifestyling phase but also in retirement.
 
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Irish Life's, Lifestyle strategy (Targeting 25% cash and 75% long-dated bonds) makes zero sense because the majority of people do not choose to buy annuities, they choose to go into the ARF.
It's the equivalent of forcing everyone to change into their swimming trunks, and only then asking them to choose between swimming and bowling when you know >75% of them are going to choose bowling.
 
Even if you are planning on buying an annuity, it still makes no sense to have 75% of a portfolio in long-dated bonds.

The duration of a fixed-income portfolio should match your investment horizon.
 
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AJAM said:
Irish Life's, Lifestyle strategy (Targeting 25% cash and 75% long-dated bonds) makes zero sense because the majority of people do not choose to buy annuities, they choose to go into the ARF.
It's the equivalent of forcing everyone to change into their swimming trunks, and only then asking them to choose between swimming and bowling when you know >75% of them are going to choose bowling.
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That’s been the case for the last decade or so with zero interest rates. Annuities were poor value and therefore ARFs looked more attractive. But with interest rates rising, so are Annuity rates and this makes the decision of ARF V Annuity more complicated.
Annuities offer certainty of income for life whereas an ARF requires the client to “invest” the fund, thus involving some level of investment risk.
So the Irish Life Lifestyle fund might be attractive to those close to retirement who intend to buy an Annuity and who want to reduce the risk of their lump sum falling close to retirement. But for those intending to go the ARF route, this fund would not be appropriate.
 
AJAM said:
Irish Life's, Lifestyle strategy (Targeting 25% cash and 75% long-dated bonds) makes zero sense because the majority of people do not choose to buy annuities, they choose to go into the ARF.
Click to expand...
My understanding is that the Irish Life default Lifestyle strategy is 25% cash and 75% MAP 4. MAP 4 has a risk rating of 4 and has less than 20% in bonds and even then much less in long dated govies.
But the example I quoted from another provider is as you say. Wrong for two reasons, only a minority will actually buy annuities and secondly only those with highly technical reasons for doing so or who had been "duped" as JP Morgan suggests would have invested in long bonds at near to zero yields.
 
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