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Equity / Bonds Ratio with DB/DC Mix

Including Financial Independence and Retiring Early (FIRE)
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Re: Equity / Bonds Ratio with DB/DC Mix

#445118

Postby scrumpyjack » September 24th, 2021, 6:07 pm

There is certainly no right answer, but one must include in one's evaluation the fact that bonds almost guarantee a loss in real terms. If inflation is high that loss can be very dramatic, so there is no risk free option. Personally, with a large portfolio well diversified, I think in the long term bonds are riskier than equities, in real terms, so I hold none, but everyone must make their own choices. IFAs tend to push the view that bonds are less risky than equities. On a long term view I do not share that judgement.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445122

Postby jonesa1 » September 24th, 2021, 6:24 pm

xxd09 wrote:
As long as equities keep going up all will be OK but is this the real world?


Possibly not, but it's also not obvious that bonds will provide much respite from falling asset prices, given their current valuations and the potential for interest rates to rise over the longer term. I've taken the bet that active management (in the form of Capital Gearing Trust and RIT Capital Partners) will successfully continue to grow value, even if the global equity market is struggling. Cash provides short-term breathing space. Time will tell which, if any, strategy works best when the wheels next come off the equity train.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445123

Postby TUK020 » September 24th, 2021, 6:28 pm

Hariseldon58 wrote:
Newroad wrote:Thanks AWOL.

Yours was arguably the first post which is on JohnnyCyclops original topic and my attempt to resurrect it in the same spirit.

Yes, using annuity rates as a proxy might be the best way to reverse engineer a nominal bond-like equivalent. I can't think of anything better at present - at least they're reasonably easy to obtain (I was thinking about some calculus using the Gilt yield curve, but I'd need to dust off my knowledge of the subject and then get the data to support it - not worth the effort IMO).

Anyone who is still banging on about 60/40 being right or wrong is missing the point of the topic - whether deliberately or not is harder to say :(

Regards, Newroad


With respect to the OP, the original question was the wrong question. A DB pension is not a bond and not Bond like, however it provides a secure part of the income needed and could be assumed to reduce the needs for bonds in other parts of the portfolio.

The right or wrongs of a 60:40 or 80:20 is as you say a different topic, but not unrelated to the OP’s position…

If one had started investing in the last 12 years then 100% equity seems a great idea and with the prospect of bonds providing very little income going forward, however if markets had a protracted down market then breaking even is relatively attractive. One takes a view and only time will tell, that ‘view’ is a very personal question with no right or wrong answer.

This is very much an appropriate perspective.
I have about 2/3 of my planned retirement income coming from DB pension, and therefore feel comfortable staying close to 100% equity for my SIPP/ISA portfolio.
Overall comfort level may change if we get rampant inflation, but this is unlikely to improve the attractiveness of bonds

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Re: Equity / Bonds Ratio with DB/DC Mix

#445152

Postby Newroad » September 24th, 2021, 8:53 pm

Hi Hariseldon58.

You might, tenuously IMO, say 60/40 and similar relates to the OP's position (in that they are trying to map DB to a bond holding, if practical) but it doesn't relate to any attempt to help them answer the question asked.

Conversely, it would have been a reasonable reply to say that one believed there was no practical way of answering the OP's question - or that it was an ill-formed question - or whatever. As it happens, I don't believe this is true - but perhaps that's because I was also interested in any potential answer!

For the above reasons, I don't disagree with your last paragraph, but continue to view it as part of a different topic to discuss, if desired.

[TUK020] In your case, if an answer were possible, it would very likely lead to what you have done anyway. On your alternate scenarios, rampant inflation would indeed be unlikely to change that determination, but other outcomes might. For example, with any sort of crash, bonds (or cash) might give one optionality that one wouldn't otherwise have with 100% equities for the non DB component.

Regards, Newroad

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Re: Equity / Bonds Ratio with DB/DC Mix

#445210

Postby JohnnyCyclops » September 25th, 2021, 10:24 am

Back to me then :-)

I'm grateful to the many inputs. Some strayed, but were still useful. I thought Newroad's three views was mostly helpful in jogging me along.

Newroad wrote:1. Ignore it, and keep the D/C 60/40
2. Look at target retirement income, and adjust the 60/40 accordingly, e.g. target a bond ladder for retirement to complement the DB piece, the rest in equities
3. Adjust the split to achieve a notional 60/40, assuming that the DB component is partially or wholly a proxy for bonds - i.e. look for allocation optimisation (assuming you had it right with 60/40) not a target retirement income

I think JohnnyCyclops was asking about (3) or something close to it - whereas most answers seem closer to (2) in nature, or perhaps (1) - though xxd09's touched a bit on it. Of course, I may have the wrong end of the stick!


I was asking from the point of view of having a certain/known minimum retirement income level already in mind. But I could have been asking with no target income and instead a desire to 'maximise the pot'. I see now the two would drive different processes. Let's stick with "I've got a certain income in mind".

I think I can now treat the DB like the state pension. Starting with my target income, say £100 at age 60. If the DB is £20 then I need find another £80. I only need to focus the pot on generating £80 (not £100) and can make my allocations choice accordingly on how over/under/close I'll be to that £80. Further, I can look ahead to age 67 and factor the state pension. Let's say that's £30. So from age 67 onwards the pot needs to generate only £50, having generated £80 a year for the seven years in better. Simply speaking.

So, as I posted in the OP. Right now the DC pension is 91% equity and 9% bonds/cash. And that's to generate the £80 in my example. I now need to work out how well the pot will do that, and my approach to risk of equity volatility in the next 5-10 years of remaining working life (I hope!).

Conversely, if I was looking to "max the pot" right now, with no particular income in mind, then yes, we'd need to ascribe some value to the DB. Taking the typical 20x valuation is one way. Or, convert to an annuity equivalent (approx £100k for £2k income works well currently; L&G indicate £54k per £1k).

AWOL wrote:So for example assuming a final salary pension of £8k is available at 55 with indexation and assuming the tables show that £100k buys £2k of index linked income then it is reasonable to consider this as equivalent as having £8k/2k x £100k = £400k of bond-like allocation from an income point of view. It's not the same as you cannot sell some of it and rebalance although you could choose to reinvest some income to rebalance but in reality few people do this and the rebalancing would either be done from the remainder of your bond holdings or a glide path taken and bond holdings eroded as sequence of returns risk reduces.


I'm grateful to AWOL also for insights and I'll check out that Excel pension/retirement modeller (I'm a sucker for a good spreadsheet!).

Slightly OT (my thread, hey!), IAAG's approach to assessing income needs in retirement is similar to ours. We've tracked regular household outgoings for years (to help budget) - so food, bills, car running, household items, etc. Also mortgage. So I know pretty well what the non-mortgage costs are (mortgage to be paid before or cleared upon retirement - currently runs to age 68 gulp!), plus I can factor in other personal costs like holidays, new car purchase, clothes, hair cuts, dentists, eating out, trips, etc. So I've got a number (in current real terms) in mind. I've been mutliplying it by 33.3 (actually, looking at the pot that we'll need and factor 3% of it per year to cover our non-mortgage outgoings).

That's useful to know whether achieveing the target income (in our case now the £80 or £50 net of DB and SP, not the gross £100) is well over-provided for, or is more knife-edge, and in turn influence continued pot building, asset allocation and even when we can stop working and taking salaries. On some measures I think we're 'there' (good peace of mind) but I'm currently enjoying work, keeps me busy, doing well at it, earning reasonable bucks, so will keep adding/padding the pension pot and other investments, for a comfier life later. Once I retire, that will be it.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445212

Postby JohnnyCyclops » September 25th, 2021, 10:29 am

Hariseldon58 wrote:With respect to the OP, the original question was the wrong question. A DB pension is not a bond and not Bond like, however it provides a secure part of the income needed and could be assumed to reduce the needs for bonds in other parts of the portfolio.

The right or wrongs of a 60:40 or 80:20 is as you say a different topic, but not unrelated to the OP’s position…

If one had started investing in the last 12 years then 100% equity seems a great idea and with the prospect of bonds providing very little income going forward, however if markets had a protracted down market then breaking even is relatively attractive. One takes a view and only time will tell, that ‘view’ is a very personal question with no right or wrong answer.


Hi Hari, I think you're right, in that I've now realised we've been operating with a known target minimum retirement income in mind. I'd not realised there is another option I call "maximise the pot" with no particular income in mind, which then probably would need to consider the DB portion more. I'm not sure I asked the wrong question, rather there was some underlying information/assumption that made perfect sense to me but that I subconsciously didn't feel I needed to explain or add to the OP.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445220

Postby Itsallaguess » September 25th, 2021, 10:48 am

JohnnyCyclops wrote:
I think I can now treat the DB like the state pension. Starting with my target income, say £100 at age 60. If the DB is £20 then I need find another £80.

I only need to focus the pot on generating £80 (not £100) and can make my allocations choice accordingly on how over/under/close I'll be to that £80.

Further, I can look ahead to age 67 and factor the state pension. Let's say that's £30. So from age 67 onwards the pot needs to generate only £50, having generated £80 a year for the seven years in better.

Simply speaking.


I think that approach makes a lot of sense - so rather than worrying what 'overall value' or flavour of 'asset-type' you might apply to a given defined-benefit pension or state pension, and then viewing your position taking overall asset-allocation into account including those benefits, it does seem simpler to just deduct-away those defined-benefit pension and/or state pension benefits from your expected annual income-requirements, and then ensure that the rest of your investment capital has an appropriate asset-allocation to help provide for the remaining income-requirements...

Cheers,

Itsallaguess

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Re: Equity / Bonds Ratio with DB/DC Mix

#445265

Postby DrFfybes » September 25th, 2021, 2:06 pm

MrsF and I have a number of DB schemes (well, I do, MrsF just has one large one).

When calculating our retirement needs, we simply ignored them, or at least I thought so until this thread.

What we did was looked at our anticipated expenditure, knocked off the DB income, and worked it from there...

We have 3 years spend in cash/premium bonds, are comfortable with an 80/20 split (moving towards VWRL VAGP with Dividends reinvested). Want a top up income of £yyy so need 25X that for a 4% takedown. 'Income' is taken from periodic selling of units which also serves to rebalance the 80/20.


However on reflection the DB scheme does affect the allocation, because without that security blanket then we would probably not be comfortable with such a high equity split. So whilst the DB schemes didn't play any part in calculating our allocation, they do influence the 60/40 (or whatever) asset split as the impact of a market crash or sustained bear market has less of an impact on our income.

As it happens our DBs cover over half of our requirements, so in fact we are probably mainly in bonds if you consider a DB as a bond. Which is far more conservative than I thought we were :)

Paul

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Re: Equity / Bonds Ratio with DB/DC Mix

#445298

Postby Newroad » September 25th, 2021, 4:50 pm

Indeed, Paul.

That's what I understood JohnnyCyclops was getting at earlier (and it affects me too - not so Mrs N who only has DC).

I think it is an important question - not for the 100% or near 100% equity folks who presumably know what they're doing - but for those who wish to hold non-trivial amounts of non-equities, for whatever perceived reason (me included).

Of course, as has been observed, you can't convert a DB income stream into something else, so, unlike (say) bonds, it doesn't give you optionality in the event of an equity downturn. But more generally and including perhaps those with a target retirement income, the question does have some merit.

I remain interested in an even better "calculation" than the best one I think we currently have (as proposed by AWOL).

Regards, Newroad

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Re: Equity / Bonds Ratio with DB/DC Mix

#445306

Postby GeoffF100 » September 25th, 2021, 5:49 pm

DB pensions are usually invested in a combination of equities and bonds. They guarantee to pay an income that usually increases with the cost of living. If they go bust, they end up in the PPF, and pay a pension with reduced benefits. If too many DB pensions go bust, the PPF benefits will be watered down.

Vanguard Target Retirement has 80/20 equities/bonds for youngsters. That reduces gradually. In retirement, it reduces to 33/67. (It is interesting that these funds are very popular in the US, but do not have many takers in the UK, judging from their market caps. No income stream for advisers perhaps?)

When equities crash, top quality bonds with a reasonably long duration usually increase in value (flight to quality). If a DC pension has plenty of bonds it can continue to pay out. DB pensions do not pay out more when that happens. Some of them go bust.

If you do not need to draw an income from your DC pension, you can draw nothing until the equities recover. That could take decades, but no matter. If you do need to draw income from your DC pension, it is best to have plenty of bonds. If you are scared that your DB pension might be watered down in a crash, it is also best to have plenty of bonds in your DC pension.

Perhaps the OP should ignore his other income when deciding the asset allocation within his pension. (Of course, I do not know his circumstances in any detail... I have got a SIPP, which is 100% equities, but it is very unlikely that I will ever draw an income from it.)

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Re: Equity / Bonds Ratio with DB/DC Mix

#445314

Postby Hariseldon58 » September 25th, 2021, 6:28 pm

JohnnyCyclops wrote:
Hi Hari, I think you're right, in that I've now realised we've been operating with a known target minimum retirement income in mind. I'd not realised there is another option I call "maximise the pot" with no particular income in mind, which then probably would need to consider the DB portion more. I'm not sure I asked the wrong question, rather there was some underlying information/assumption that made perfect sense to me but that I subconsciously didn't feel I needed to explain or add to the OP.


Hi JohnnyCyclops

I was rather rude saying you asked the wrong question !

Perhaps I should have said a better question would have been....

I think you are thinking along the right lines, you will be always be right for YOUR retirement, the DB provides a floor of income and low yielding, quality bonds provide a backstop of money that could provide income for a period of years if markets experience difficult conditions. After that is a pot that is investing in a diverse, low cost manner with an equity bias to maximise the pot.

It's like treating an investment pot as a giant "accumulation" fund, you just need to manage the cashflow. Equities do well then sell a few, equities doing badly, sell a few bonds.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445338

Postby JohnnyCyclops » September 25th, 2021, 10:57 pm

DrFfybes wrote:However on reflection the DB scheme does affect the allocation, because without that security blanket then we would probably not be comfortable with such a high equity split. So whilst the DB schemes didn't play any part in calculating our allocation, they do influence the 60/40 (or whatever) asset split as the impact of a market crash or sustained bear market has less of an impact on our income.

Paul


Hi Paul, yes, this was the crux of my thinking in the OP. If I just consider my DC pensions then I'm current 91/09 split equity/bonds. If I make some rough assumptions on the DB, treat it all as equivalent to bonds and assume a 20x multiplier on the projected pension, then I'm 72/28.

Having thought further, and as I posted out earlier today, I think I'll start to work backwards from a target retirement income, net off the DB and later the state pension, and then the remainder needs to come from DC or other investments (say ISAs).

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Re: Equity / Bonds Ratio with DB/DC Mix

#445339

Postby JohnnyCyclops » September 25th, 2021, 11:02 pm

GeoffF100 wrote:When equities crash, top quality bonds with a reasonably long duration usually increase in value (flight to quality). If a DC pension has plenty of bonds it can continue to pay out. DB pensions do not pay out more when that happens. Some of them go bust.

If you do not need to draw an income from your DC pension, you can draw nothing until the equities recover. That could take decades, but no matter. If you do need to draw income from your DC pension, it is best to have plenty of bonds. If you are scared that your DB pension might be watered down in a crash, it is also best to have plenty of bonds in your DC pension.


The two DBs are in the Local Govt Pension Scheme and in the PPF already at 90% (although that employment is so long ago I couldn't readily tell you what 100% should be - probably 7/80ths (seven years worked) of whatever my leaving salary was two decades ago (index linked). I hadn't realised though that the PPF could be further diluted. I don't see either LGPS or PPF at risk of going bust, but who knows!

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Re: Equity / Bonds Ratio with DB/DC Mix

#445360

Postby GeoffF100 » September 26th, 2021, 7:13 am

JohnnyCyclops wrote:The two DBs are in the Local Govt Pension Scheme and in the PPF already at 90% (although that employment is so long ago I couldn't readily tell you what 100% should be - probably 7/80ths (seven years worked) of whatever my leaving salary was two decades ago (index linked). I hadn't realised though that the PPF could be further diluted. I don't see either LGPS or PPF at risk of going bust, but who knows!

The PPF is industry funded. Governments have repeatedly refused to stand behind it with tax payers' money.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445465

Postby JohnnyCyclops » September 26th, 2021, 7:43 pm

Good News! (at least for me and Mrs C)

Going the target income route, at present values, it seems "we're there"!!

I kind of thought we were, with a recent review of current DC pension valuations, catching up on S&S ISAs after a few years of inattention, and a look at some property gains (non main home).

We set a reasonable annual target income based on known current outgoings. We netted off the DB pensions from age 60, and state pensions from age 67, and projected out until we're both 100, and totted up the total we'll need. And it's about the total wealth we have right now, across DC pensions, ISAs, and cash (after allowing to pay of residual mortgages). Yes, I realise there'll be effects on DB and SP if/when one of us dies before the other. Conversely, building in annual holiday costs or periodic replacement car costs, probably don't matter as much beyond age 90!

It's a nice feeling to know we've made it. That said a year ago equity valuations were ~20% lower dragging down DC and ISA investments, and we would have undershot our target, and might do again if the market and prices sour. I'm still happy to keep working the next few years into my mid 50s, to further improve our position and build more of a cushion or margin for error.

Overall, a happy end to a weekend.

JC

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Re: Equity / Bonds Ratio with DB/DC Mix

#445950

Postby DrFfybes » September 28th, 2021, 2:35 pm

Good to see you think you are there, a couple of points to consider.... it looks like you are still under 55 so can't touch things quite yet anyway?

LGPS revised their reductions for early retirement a few years ago, from circa 3% to nearly 5% reduction for each year taken early. It was hidden in an AGM proposal, not well trumpeted, and other schemes may do similar. I remember one colleague who was 61 realising he would have had more prension if he'd gone a year earlier, even after the extra contributions. Also some long standing LGPS employees still get "rule of 85" protection to pre 2008 (I think) constributions, and there was some rumour that women who left LGPS when SPA was still 60 can claim their pension from 60 with no reduction. Either way get a proper illlustration rather than relying on the online calculator.

It sounds obvious, but you don't need to take your DB when you retire. You might have the option of going part time (and still accrueing pension) or taking pension and working part time (as MrsF did), or just living off the other savings for a while. Delaying taking a DB reduces the reduction, so depending on the size of the payment(s) it may be beneficial to leave them ad spend savings.

Something often overlooked when stopping work is when in the tax year to do it...... if you retire before the end of the tax year you could use the DB lump sum to put into a SIPP up to your annual limit the last year you are in work, or if you decide not to take the pension straight away then retire once you've earnt £12k in the new tax year to use all your allowance. The disadvantage with the latter is with the tax year in April you have to decide whether to enjoy the sunshine or work tax free :)

Paul

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Re: Equity / Bonds Ratio with DB/DC Mix

#445974

Postby hiriskpaul » September 28th, 2021, 3:24 pm

DrFfybes wrote:MrsF and I have a number of DB schemes (well, I do, MrsF just has one large one).

When calculating our retirement needs, we simply ignored them, or at least I thought so until this thread.

What we did was looked at our anticipated expenditure, knocked off the DB income, and worked it from there...

We have 3 years spend in cash/premium bonds, are comfortable with an 80/20 split (moving towards VWRL VAGP with Dividends reinvested). Want a top up income of £yyy so need 25X that for a 4% takedown. 'Income' is taken from periodic selling of units which also serves to rebalance the 80/20.


However on reflection the DB scheme does affect the allocation, because without that security blanket then we would probably not be comfortable with such a high equity split. So whilst the DB schemes didn't play any part in calculating our allocation, they do influence the 60/40 (or whatever) asset split as the impact of a market crash or sustained bear market has less of an impact on our income.

As it happens our DBs cover over half of our requirements, so in fact we are probably mainly in bonds if you consider a DB as a bond. Which is far more conservative than I thought we were :)

Paul

IMHO this is the most sensible way to consider the situation. After the income from the DB pension, how much do you need from the DC pensions and/or investments. Once you have a "need" percentage, you can then consider the desirable asset allocation. The higher the needed amount, the less scope there is for risk taking, but very low risk (high cash/bonds) portfolios run the risk of not lasting for a typical 30+ year retirement due to inflation.

A good historical case of interest is retirement at the end of 1968 due to the high inflation and poor sequence of stock market returns that followed. For a 100% equities portfolio the maximum SWR to last 30 years was 3.6%. For 100% cash (short dated bonds/T bills), the maximum SWR would have been only 3.4%. However, 100% equities* drawn down at 3.4% would have given a much more stomach churning ride than just drawing from cash. After 7 years of drawdown at a SWR of 3.4% there would only have been 7 years worth of money left in the equities portfolio compared to 22 years in the cash portfolio. In other words, after 7 years retirement drawing down at a prudent 3.4% SWR, more than 75% of the equities portfolio would have gone. The following year the portfolio would have recovered and thanks to the high growth in the 80s and 90s would have lasted another 37 years (drawing at 3.4%), but that recovery could not have been forseen in 1975.

Anyone choosing to go with 100% equities and needing a highish SWR should consider how they would feel if a few years into retirement they were faced with the loss of 75% or more of their portfolio, with potentially more losses to come. Do you have a plan B? It may be possible to cut back on spending, but if so, the SWR is not really the "needed" amount.

For 1968, a more comfortable ride would have been available with a portfolio in between the 2 extremes of 100% equities and 100% cash. Annually rebalanced 60/40 equities/cash, 50/50 and 40/60 would have had maximum SWRs of 4.3%, 4.3% and 4.2% respectively. Drawing down at an SWR of 3.4% would have left 11.2 years, 12.7 years and 14.3 years spending in the portfolios after 7 years. Still uncomfortable, but nowhere near as bad as with 100% equities.

If the needed SWR is 3% or lower, which may well be the case for those with reasonable DB pensions, most asset allocations would work out in all but the most extreme circumstances, so it is then a matter of trading off reward against being able to sleep at night. The higher the equity allocation, the higher the expected reward, but that comes with the risk of higher expected drawdowns.

I think the Warren Buffet quote "Never risk what you have and need for what you don’t have and don’t need" is particularly appropriate when it comes to retirement planning.

*FTSE all-share

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Re: Equity / Bonds Ratio with DB/DC Mix

#446093

Postby JohnnyCyclops » September 28th, 2021, 8:23 pm

DrFfybes wrote:Good to see you think you are there, a couple of points to consider.... it looks like you are still under 55 so can't touch things quite yet anyway?

LGPS revised their reductions for early retirement a few years ago, from circa 3% to nearly 5% reduction for each year taken early. It was hidden in an AGM proposal, not well trumpeted, and other schemes may do similar. I remember one colleague who was 61 realising he would have had more prension if he'd gone a year earlier, even after the extra contributions. Also some long standing LGPS employees still get "rule of 85" protection to pre 2008 (I think) constributions, and there was some rumour that women who left LGPS when SPA was still 60 can claim their pension from 60 with no reduction. Either way get a proper illlustration rather than relying on the online calculator.

It sounds obvious, but you don't need to take your DB when you retire. You might have the option of going part time (and still accrueing pension) or taking pension and working part time (as MrsF did), or just living off the other savings for a while. Delaying taking a DB reduces the reduction, so depending on the size of the payment(s) it may be beneficial to leave them ad spend savings.

Something often overlooked when stopping work is when in the tax year to do it...... if you retire before the end of the tax year you could use the DB lump sum to put into a SIPP up to your annual limit the last year you are in work, or if you decide not to take the pension straight away then retire once you've earnt £12k in the new tax year to use all your allowance. The disadvantage with the latter is with the tax year in April you have to decide whether to enjoy the sunshine or work tax free :)

Paul


Hi Paul

Yes, totally agree about not HAVING to take the DBs at age 60, or the SP at 67. A lot of juggling to do. And yes, still the right (wrong?) side of 55.

We probaibly going to see an IFA at some point. Although I feel mostly on top of things, there are a bunch of 'details' like the LGPS and the overall tax position. We've got a few other financial complications that need a 'cool head' to help us work through.

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Re: Equity / Bonds Ratio with DB/DC Mix

#446096

Postby JohnnyCyclops » September 28th, 2021, 8:32 pm

hiriskpaul wrote:IMHO this is the most sensible way to consider the situation. After the income from the DB pension, how much do you need from the DC pensions and/or investments. Once you have a "need" percentage, you can then consider the desirable asset allocation. The higher the needed amount, the less scope there is for risk taking, but very low risk (high cash/bonds) portfolios run the risk of not lasting for a typical 30+ year retirement due to inflation.

A good historical case of interest is retirement at the end of 1968 due to the high inflation and poor sequence of stock market returns that followed. For a 100% equities portfolio the maximum SWR to last 30 years was 3.6%. For 100% cash (short dated bonds/T bills), the maximum SWR would have been only 3.4%. However, 100% equities* drawn down at 3.4% would have given a much more stomach churning ride than just drawing from cash. After 7 years of drawdown at a SWR of 3.4% there would only have been 7 years worth of money left in the equities portfolio compared to 22 years in the cash portfolio. In other words, after 7 years retirement drawing down at a prudent 3.4% SWR, more than 75% of the equities portfolio would have gone. The following year the portfolio would have recovered and thanks to the high growth in the 80s and 90s would have lasted another 37 years (drawing at 3.4%), but that recovery could not have been forseen in 1975.

Anyone choosing to go with 100% equities and needing a highish SWR should consider how they would feel if a few years into retirement they were faced with the loss of 75% or more of their portfolio, with potentially more losses to come. Do you have a plan B? It may be possible to cut back on spending, but if so, the SWR is not really the "needed" amount.

For 1968, a more comfortable ride would have been available with a portfolio in between the 2 extremes of 100% equities and 100% cash. Annually rebalanced 60/40 equities/cash, 50/50 and 40/60 would have had maximum SWRs of 4.3%, 4.3% and 4.2% respectively. Drawing down at an SWR of 3.4% would have left 11.2 years, 12.7 years and 14.3 years spending in the portfolios after 7 years. Still uncomfortable, but nowhere near as bad as with 100% equities.

If the needed SWR is 3% or lower, which may well be the case for those with reasonable DB pensions, most asset allocations would work out in all but the most extreme circumstances, so it is then a matter of trading off reward against being able to sleep at night. The higher the equity allocation, the higher the expected reward, but that comes with the risk of higher expected drawdowns.

I think the Warren Buffet quote "Never risk what you have and need for what you don’t have and don’t need" is particularly appropriate when it comes to retirement planning.

*FTSE all-share


Hi Paul

Some excellent points about the income NEED. I was musing, IF we had £1bn in capital then we'd accept a 0.1% return (cash or bonds, probably) to drive £1m p.a. income (probably more than our needs!). Whereas, if we had £1m in capital a 0.1% return would be £1000 income, and possibly a tad short of our needs, hence perhaps needing say 3% (mix of assets incl equities) to drive £30,000 income p.a. A lot more risk to drive 3.0% return than an 0.1%.

So far I've gone a bit "brute force", totting up 40 years of income needs (60 to 100), in present value, and netting out DB and SP, and comparing that remaining total income against total capital today - ignoring any growth and dividends (but also ignoring inflation). The net income need is now covered by the total capital (a good place to be!). I think I've probably created some buffer already in doing so.

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Re: Equity / Bonds Ratio with DB/DC Mix

#446639

Postby 1nvest » September 30th, 2021, 3:36 pm

tjh290633 wrote:
Newroad wrote:The idea is to optimise, with a risk weighted approach, the likely retirement income outcome. The person following the approach in the hypothetic example believes a 60/40 equity/bond split is most likely to achieve this.

You might like to have a look at viewtopic.php?p=444867#p444867 where the topic of inflation and retirement income is discussed. Fixed interest securities are a danger in retirement.

Being 'fixed' and assuming treasury bonds/notes/bills (Index Linked Gilts) then that can be the safest in retirement. Yes it may presently cost £12,000 of present day money to buy £10,000 of inflation adjusted capital in 10 years time, but that is 'fixed' from the offset (at other times it may have cost just £8200 to buy £10,000 of inflation adjusted income in ten years time).

Once you have enough near guaranteed income (from pensions/fixed income), then it doesn't really matter how any surplus is invested. Someone with £50,000 of pension/fixed-income yearly income who spends £25,000/year will still be accumulating £25,000/year more in bonds, so even with £1.25M in bonds paying -2% real yields they still average 0% real.

Or you can go into the Stock casino and bet it all on maybe doubling or more, or halving or worse. Therein lies the danger in retirement if heavily reliant upon such actual outcomes.


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