The fallacy of "lifestyling"

[jasdpace@gmail.]

It would be nice if someone from AON or Mercer (i.e. who really know their stuff) explained modern best practice in relation to lifestyling. For DC plans, I suspect it will involve

- having different lifestyle strategies depending on the intended post-retirement use of the funds; and
- selecting a default lifestyle where the member has not chosen one.

I wouldn't want the impression to be gleaned from this thread that "I came across a silly lifestyle basis, ergo all lifestyling is bad."

 

[Duke of Marmalade]

- selecting a default lifestyle where the member has not chosen one.

This is the key issue and one that is very relevant for the proposed AE system where NEST experience in the UK is that 95% select the default fund which consists of 46 target retirement age lifestyle funds is allocated to you. People choose this default route not because they have satisfied themselves that they like the strategy but because they believe that Nanny Knows Best not realizing that a different Nanny would have a very different view. I wonder if a typical selection of such folk were put in a focus group and had the thing explained properly to them how many would chose to lock into annuity rates which everybody from JP Morgan down did not believe to be "fair value" never mind that the majority wouldn't want an annuity in the first place .

I wouldn't want the impression to be gleaned from this thread that "I came across a silly lifestyle basis, ergo all lifestyling is bad."

If you mean adjusting your investment risk profile as you approach retirement, that is common sense. But it is the Department of Social Protection's use of the term in the context of AE suggesting that this is some scientifically honed solution that they will get round to in due course, which sticks in the craw. Tell us which form of lifestyling they mean from the very wide spectrum in vogue and don't ask people to auto enrol on the basis that it will be alright on the night by the use of jargon terms suggesting everything is perfectly under control.

The "fallacy" I am referring to is this hubris that "lifestyling" clearly dictates the appropriate default route when it in fact encompasses a very wide range of interpretations.

 

[Sarenco]

Please explain why not if you are right now a year from retirement and wish to purchase an annuity.

Well, look what happened last year.

Yields spiked and long-dated bonds got crushed.

Sure, the opposite could have happened (at least in theory) but why take that risk a year out from retirement?

Don’t get me wrong; duration does have a role in a well constructed portfolio.

But 75% of s portfolio in long-dated bonds?

Nah, that never makes sense.

 

[jasdpace@gmail.]

What you said was "75% long-dated bonds makes zero sense in any circumstances".

To justify this, what I believe to be pure nonsense, you avoid my specific question and select a particularly bad time to buy long-dated bonds. Not impressive.

I don't wish to waste any more time on this. The comments from Marc and Conan in this specific regard are completely reasonable.

 

[Duke of Marmalade]

75% in long dated bonds makes zero sense as a default position for a whole cohort in any circumstances. Sure in the circumstance of a particular individual they may want that as an option which of course is available just as is a risk rated 7 option, which is also totally unacceptable as a default strategy for a whole cohort. Arguing that some individuals may precisely want to lock into ridiculously low annuity rates doesn't wash for a cohort default.

 

[Sarenco]

What you said was "75% long-dated bonds makes zero sense in any circumstances".

To justify this, what I believe to be pure nonsense, you avoid my specific question and select a particularly bad time to buy long-dated bonds. Not impressive.

Yes, I’m of the view that any portfolio that consists of 75% in long-dated bonds makes no sense in any circumstances.

I answered your question as to why it makes no sense by way of specific, real world example.

In short, it’s too risky!

Now, if you want to explain the circumstances where it makes sense to hold a portfolio consisting of 25% in cash and 75% in long bonds, I’m all ears.

 

[Gordon Gekko]

What you said was "75% long-dated bonds makes zero sense in any circumstances".

To justify this, what I believe to be pure nonsense, you avoid my specific question and select a particularly bad time to buy long-dated bonds. Not impressive.

I don't wish to waste any more time on this. The comments from Marc and Conan in this specific regard are completely reasonable.

But “never makes sense” and “makes zero sense in any circumstances” are the same things…

Why hold 75% LONG-DATED bonds?

 

[Steven Barrett]

The 25% cash thing is a dangerous marketing gimmick. We move your tax free lump sum to cash to protect it. Meanwhile, the bulk of your pension falls by 20%. So your €1m pension is now valued at €850,000. Your lump sum is no longer €250,000 but €212,500. But I thought it was protected???

The problem with lifestyling funds is they move funds automatically. Moving someone in bonds when they were being crushed was a mad thing to do, yet the computer system triggered purchases on policyholder's birthdays. You need someone to pull up the handbrake on this.

I did a review for a client recently who's work pension started the gradual process of moving to bonds 20 years from retirement! There is no need for her to reduce her equity exposure that far from retirement. In doing future projections, we reduced her growth by 2% per annum as a result and it would cost this client over €300,000. Yes, she would have more volatility but with such a long term to retirement, she can afford it.


Steven
www.bluewaterfp.ie

 

[Duke of Marmalade]

@Steven Barrett There is another illogicality about targeting that the tax free lump sum should in fact be 100% in cash at retirement. In your example the person is likely not planning on spending €250k on her retirement date. More likely a large bulk will need to be reinvested for the medium term. Lifestyling has effectively gradually liquidated investments only for the lump sum to be reinvested in same investments.

 

[Sarenco]

I did a review for a client recently who's work pension started the gradual process of moving to bonds 20 years from retirement!

There’s nothing unusual about that.

If you look at the target date funds of the major fund houses (State Street, Vanguard, etc) they all start their “glide path” around 20 years prior to the targeted retirement date.

There have been periods of 20 years and longer where bonds have outperformed equities. The first 20 years of this century is a good example.

 

[Colm Fagan]

Most of the people on this forum will know my views on this. My proposal for AE (which I'll be presenting in person for the first time in Ireland tomorrow: https://www.tasc.ie/news/2023/03/07/assessing-the-proposed-auto-enrollment-pension-scheme-tasc-e/ ) recommends 100% in equities for everyone, always, pre- and post-retirement. Returns are smoothed to eliminate the risk of a new retiree suffering a massive fall in the value of their fund just as they're about to take their tax-free lump sum.
I view AE not as agglomeration of individual accounts but as a sovereign wealth fund, which will continue to grow for decades into the future, with no need to sell investments, so the right investment strategy is to invest everything in equities.

 

[Steven Barrett]

@Steven Barrett There is another illogicality about targeting that the tax free lump sum should in fact be 100% in cash at retirement. In your example the person is likely not planning on spending €250k on her retirement date. More likely a large bulk will need to be reinvested for the medium term. Lifestyling has effectively gradually liquidated investments only for the lump sum to be reinvested in same investments.

I agree with this. I am working with a client who is retiring in the next few weeks. When I started working with him, we were watching whether he'd go over the €2m threshold. It hasn't worked out that way in the end but he's been very relaxed about things. He said to me, that the ARF has another few decades of investment and he'll be investing most of his lump sum anyway. While the lump sum is lower, he's happy to take a mainly equity based approach to investing (I do realise that the bigger the pension pot, the more relaxed you can be as he is still going to receive a lot of money).

There’s nothing unusual about that.

If you look at the target date funds of the major fund houses (State Street, Vanguard, etc) they all start their “glide path” around 20 years prior to the targeted retirement date.

There have been periods of 20 years and longer where bonds have outperformed equities. The first 20 years of this century is a good example.

I am not saying it is unusual. I am questioning the appropriateness of the whole lifestyling strategy and the automatic transfer of assets from equities to bonds regardless of the market.


Steven
www.bluewaterfp.ie

 

[MTB_FS]

Similar to what Steven mentioned a client close to retirement (65) has a rough investment time horizon of 20 years to 85 thus the 'lifestyling' strategy taken by the life companies doesn't make one bit of sense to the 90% of people who are defaulted into this strategy.

I am with Willis and had to change to self directed and change all contributions to 100% equity. I am 32.

 

[Conan]

Generally the "Lifestyle Fund" is an option for members (maybe default option). So if its not going to be suitable for you (because you intend to go the ARF route in retirement) then you can opt out of the Lifestyle Fund and adopt a different investment strategy in the run up to retirement.
The basis message us that members need to be pro-active in managing their investment strategy particularly in the run up to retirement.

 

[Robzig]

Generally the "Lifestyle Fund" is an option for members (maybe default option). So if its not going to be suitable for you (because you intend to go the ARF route in retirement) then you can opt out of the Lifestyle Fund and adopt a different investment strategy in the run up to retirement.

I don't really understand this. My pension is in lifestyle and I intend some day to go the ARF route if it's still there

 

[Conan]

I don't really understand this. My pension is in lifestyle and I intend some day to go the ARF route if it's still there

You might be invested in a Lifestyle Fund currently (perhaps by default) but you are not obliged to stay in such a fund. You should have other Fund options which you can transfer into.

 

[Robzig]

There are lots of fund options available but the company who looks after our pension scheme told me that the lifestyle approach sounds like the right one for me even though i dont want to buy an annuity. Thats the bit I dont understand.

 

[nest egg]

I've also opted to self-manage my Irish pension pot so it stays passively invested in equities. Otherwise from age 40, lifestyling kicks in where they increasingly move more and more of your pot into actively managed "growth funds" (i.e. more expensive) and bonds, cash etc. over the subsequent 25 years. The number of "warnings" you get on the portal though is hilarious, the language seems to designed to discourage people from taking control.

Interestingly though, I've done the opposite with my 401k, which I keep in a lifestyled "target retirement date" fund. The reason is simple enough, this fund includes a healthy balance of US and non-US equities, whereas their only 100% equity fund is entirely US equities (too concentrated for my liking).

The "workaround" to avoid ending up in bonds and cash by the time I retire, was to select the longest dated fund on offer! This means it stays invested in equities well past when I'm due to retire. I'll likely switch it again in a few years to whatever the longest dated fund they offer at that time, which should be far enough into the future to ensure I stay heavily invested in an equity portfolio till I'm 6 feet under!

 

[David_Dublin]

I agree with this. I am working with a client who is retiring in the next few weeks. When I started working with him, we were watching whether he'd go over the €2m threshold. It hasn't worked out that way in the end but he's been very relaxed about things. He said to me, that the ARF has another few decades of investment and he'll be investing most of his lump sum anyway. While the lump sum is lower, he's happy to take a mainly equity based approach to investing (I do realise that the bigger the pension pot, the more relaxed you can be as he is still going to receive a lot of money).



I am not saying it is unusual. I am questioning the appropriateness of the whole lifestyling strategy and the automatic transfer of assets from equities to bonds regardless of the market.


Steven
www.bluewaterfp.ie

Mind if I ask a question about someone like that?

Say it was 2M pot. From what I understand, on retirement the first 200k can be taken tax free. If the retiree has everything they need, presumably they don't take the next 300k at 20% tax, they just invest the 1.8M into an ARF?

What types of situations would you see someone dipping into the 300k? Would it generally be to pay off debt? Or do people gift to kids, or bump their current accessible cash by 300k to do more lavish lifestyle stuff?

On the one hand it seems like a no brainer to get 300k at 20% but if you don't have a need or use for it presumably it is better drawn down as needed even if it means incurring higher rate income tax As you draw it down.

 

[Conan]

Mind if I ask a question about someone like that?

Say it was 2M pot. From what I understand, on retirement the first 200k can be taken tax free. If the retiree has everything they need, presumably they don't take the next 300k at 20% tax, they just invest the 1.8M into an ARF?

What types of situations would you see someone dipping into the 300k? Would it generally be to pay off debt? Or do people gift to kids, or bump their current accessible cash by 300k to do more lavish lifestyle stuff?

On the one hand it seems like a no brainer to get 300k at 20% but if you don't have a need or use for it presumably it is better drawn down as needed even if it means incurring higher rate income tax As you draw it down.

If you don't take the additional €300k (taxable at 20%) but transfer it also into an ARF , the result -€1.8m- will simply generate a higher income drawdown each year which will possibly attract a marginal tax rate close to 50% (PAYE + USC+ PRSI). So not taking the additional €300k may not make sense.