FIRE - Psychology of investment once retired

[dealtn]

I had wanted to move far more into bonds but anything fixed income looked overpriced to me

What concerns me is attaining a certain level of return even in a long term bear market even if this means forgoing long term better outcomes

I was targeting not lower than 4.75% from my bonds

Those past tense verbs suggests my thinking aligns with yours. Truth is, the market has decided bond yields are low now making annuities expensive, and there's nothing we can do about it other than cut our spending, earn more personal exertion income, or take more risk (which you've indicated you won't do).
If you're too 'nervy' about your equity values declining, what about using some of your assets to build a non-rolling bond ladder with inflation linked Treasuries which will give you an almost guaranteed cost of living adjusted income for as many years as you want to buy. That'll help you sleep at night. The 'return' on those bonds won't be great, but we've already agreed we have to accept market rates whatever they are. And if bonds seem expensive because of low interest rates, hasn't this pushed up equity prices also?
As useful as cash is at this low inflation time, in the long term even modest inflation damages cash holdings.

Good luck with buying your non-rolling bond ladder in Inflation linked bonds and getting a cost of living adjusted income. That works if you can buy such bonds at par. Index Linked Gilts are trading a long way above par. You might be spending £2 to buy £1 worth of bond. There is no free lunch. Real interest rates are negative all along the curve.

[xxd09]

It may be of interest
Aged 73-retd 17 years
I use Vanguard Global Bond Index Fund hedged to the Pound for 65% of my Portfolio
Averaging 4% pa over the last 10 years .Over 6% last year
Made my pile so only 30% equities
3-3.5% Withdrawal Rate and can sleep at night
2 years living expenses in cash
xxd09

[uryjm]

Talking about the psychology of investment once retired.....I was made redundant at 50 and felt I was in a nice position to FIRE myself. I took a year out and then went back to work.
However, the thing I wanted to relay was the psychological pain of going from a wage to having to spend and live off my investments and cash. Let's say when I was working I earned £3,000 a month which covered all my bills. Suddenly the wage stops. I now have to start depleting my savings by £3,000 a month to cover said bills. Now, I know this isn't actually correct, but this really felt like a £6,000 adverse swing! No matter how much I told myself not to be daft, it really felt like I was somehow six thousand pounds a month worse off!
I have to say it was a shock going from a monthly wage for over thirty years to zero income. Although the money wasn't the main reason I went back to work, it was a big relief to get back to a steady wage. No matter how many financial spreadsheets and projections I have telling me not to worry too much, it seems my brain isn't a spreadsheet.

[JohnW]

That works if you can buy such bonds at par. Index Linked Gilts are trading a long way above par. You might be spending £2 to buy £1 worth of bond.

Thanks for that; I don't have experience buying Index Linked Gilts, but I've seen the movie, as it were, if that counts.
I'm not sure what your '£1 worth of bond' means, but if inflation has lifted the price of a bond issued at £1 to cost £2 now, then whenever it matures I'll get £2 (or more if there's been inflation since). I think.
As well, if the bond was issued at £1 but now costs £2 because interest rates have fallen, then its yield will be exactly the same as any other Index Linked Guilt with the same maturity date, including any further bonds in that series that are issued subsequently to the first issue of that bond. (I'm assuming the treasury issues 20 year bonds maturing in say, 2030, not only once in 2010 but it makes subsequent offers to raise more money as needed.) So, yes, it's not a free lunch, but we're agreed that bond yields are low presently about which we can do nothing.
If I'm nervy about a retirement income from equities, a non-rolling bond ladder gives complete certainty about the amount and payment dates of my income for as long as I've bought the bonds for, which is just what an annuity will do (and they're 'expensive' now too, for the same reason that bond yields are low); but unlike an annuity, you can bail out of a bond ladder anytime you like, and if you die early your estate gets what's left. Those sort of investment certainties don't often come with a free lunch.
So, I'm not sure one needs luck, and I don't think one needs to buy them at issue.

[staffordian]

That works if you can buy such bonds at par. Index Linked Gilts are trading a long way above par. You might be spending £2 to buy £1 worth of bond.

Thanks for that; I don't have experience buying Index Linked Gilts, but I've seen the movie, as it were, if that counts.
I'm not sure what your '£1 worth of bond' means, but if inflation has lifted the price of a bond issued at £1 to cost £2 now, then whenever it matures I'll get £2 (or more if there's been inflation since). I think.

I'm not an expert, but I understood that they mature at par (if that's the correct term) meaning you'll only get the £1 back, not the current value, or cost, of £2

[JohnW]

Me either, but if you redeemed them at maturity for the same price you bought them, and there had been a nett rise in the inflation measure, you'd be missing out on a potential benefit of an index linked bond. That's because the coupon payments you'd be getting would have risen with any inflation, but there'd be no other benefit.
But I think UK linkers, other countries' might be different, also adjust their value as the retail price index changes; and unfortunately that means down if there's deflation. But then you're also holding nominal bonds so you've got some protection from that.
Of course, the price you can buy index linkers for will also change with interest rate changes, but those changes will see the value of the bond trend towards its inflation adjusted value as the time moves closer to maturity. At that time, all interest rate changes will be irrelevant to the bond's price because there are now (almost) no more coupons to be paid, and the nett inflation effect since issue will be what determines the redemption value. I think.

[dealtn]

Me either, but if you redeemed them at maturity for the same price you bought them, and there had been a nett rise in the inflation measure, you'd be missing out on a potential benefit of an index linked bond. That's because the coupon payments you'd be getting would have risen with any inflation, but there'd be no other benefit.
But I think UK linkers, other countries' might be different, also adjust their value as the retail price index changes; and unfortunately that means down if there's deflation. But then you're also holding nominal bonds so you've got some protection from that.
Of course, the price you can buy index linkers for will also change with interest rate changes, but those changes will see the value of the bond trend towards its inflation adjusted value as the time moves closer to maturity. At that time, all interest rate changes will be irrelevant to the bond's price because there are now (almost) no more coupons to be paid, and the nett inflation effect since issue will be what determines the redemption value. I think.

Linkers redeem at inflation adjusted par, and pay coupon adjusted for inflation too. So if issued at 100 with a coupon of 1% if you invest £100 you will get £1 a year "interest" and £100 back on maturity, but adjusted for the increase in RPI. So if the inflation index moves from 100 to 105 over the year you will get £1.05 interest and £105 on maturity, assuming its a 1 year bond. (It's slightly more complicated than this, but that's the broad idea).

Now since the inflation element is unknown, but the calculation works for every level of inflation, the convention is to quote bond prices in "real" and strip out the inflation. The bonds now look like conventional Gilts. (Only true for "new style" 3 month lag linkers, not "old style" 8 month lag linkers a few of which still exist.)

So if say a 20 year linker with a 1% coupon is trading at say £200 it will cost you £200 to buy the inflation linked £1 income stream, and in 20 years time you will receive back £100 (inflation adjusted). In the mean time the price of that linker will be determined by market prices, mainly what interest rate expectations are, just like other gilts. £200 might well rise to £300, but might also fall to £50, but on the maturity date it will "redeem" at £100.

So if you need to sell during the bond's life time you can make a capital gain, and you could also make a capital loss. If you die before the bond does you could lose "real" capital, which isn't a recommended strategy for reducing Inheritance Tax I would have thought!

So like all Gilts, the cashflows, and hence Yield to Maturity are all known at the outset (with the exception of the unknown inflation adjusting) but crucially that doesn't mean you can't face a capital loss, whether on paper or for real, during ownership. Specifically for linkers if you are buying at a price different to the par redemption, you are not preserving the inflation adjusted capital invested. In the example of a world where there is 0% inflation every year the maths is very easy and should demonstrate that.

[Wuffle]

There is a reciprocal effect here.
A nominal couple of percent delta for certainty against the 100% certainty of getting paid if you stay makes work 50 times more effective.
That is where the powerful psychological forces are acting.

W.

[JohnW]

Thanks. Clearly you're all over this. A couple of issues arise for me, perhaps you can help with the second:
Firstly,

£200 might well rise to £300, but might also fall to £50, but on the maturity date it will "redeem" at £100

I think it would have been right to have followed that with '(inflation adjusted)', as you did on the previous line. I'd only get the £100 you state, at maturity, if there'd been no nett inflation during the bond's full life.
Secondly,

Specifically for linkers if you are buying at a price different to the par redemption, you are not preserving the inflation adjusted capital invested.

I don't get that. Can you give a simple concrete example, perhaps assuming the are no interest rate changes to complicate the matter?
I do understand, at least I think I do, that using a non-rolling bond ladder to fund retirement spending can result in you getting back less money than you invested despite holding them all to maturity, because interest rate changes (or anticipated changes) have been unfavourable; but when you buy the ladder the you know exactly what it's costing and you know exactly what you'll get back if it runs to completion. That's a level of certainty some people like in retirement.

[dealtn]

Secondly,

Specifically for linkers if you are buying at a price different to the par redemption, you are not preserving the inflation adjusted capital invested.

I don't get that. Can you give a simple concrete example, perhaps assuming the are no interest rate changes to complicate the matter?
I do understand, at least I think I do, that using a non-rolling bond ladder to fund retirement spending can result in you getting back less money than you invested despite holding them all to maturity, because interest rate changes (or anticipated changes) have been unfavourable; but when you buy the ladder the you know exactly what it's costing and you know exactly what you'll get back if it runs to completion. That's a level of certainty some people like in retirement.

You buy a 20 year linker with 1% coupon 10 years after it's been issued, so 10 year life left. There has been no inflation at all to date. You pay £200 for this.

You hold until maturity during which time there is also no inflation (or interest rate changes). The current RPI Index is 100. Because there is no inflation the RPI Index remains at 100 throughout the 10 years.

Your cashflows are -£200 on purchase, £1 in 1 years time, £1 in 2 years time .... £101 in 10 years time.

The purchasing power of your initial £200 remains the same as there has been no inflation, but you have received only £110 back. You have lost £90.

The maths is more complicated (but cancels) if there is inflation. The maths is even more complicated if you don't hold to maturity and "value" at market price during it's life. You might be "up" or "down".

But if you are buying something valued in "real terms" at £200 and it redeems in "real terms" at £100 you are buying 50p pieces for a £. This is the same for any bond (but not in real terms) but ordinarily the coupons you receive normally are sufficient to outweigh the drop in price to par. With negative real rates across the entire curve you can only make (real) money, and then far from guaranteed, from trading, not from holding to maturity.

(When I use the term "real" this means in inflation adjusted, not nominal. So if prices go up 5%, say, but you turn £100 into £102, you are in profit to the tune of £2 but are still at a loss as this £102 doesn't buy the £105 any goods that were originally at £100 cost)

[Gan020]

It is interesting to see that following the general fall last week, ‘quality’ shares and IT’s are recovering and some such as Personal Assets Trust are back to where they were. I would suggest it you want a ‘sleep well at night fund’ this is worth considering. Otherwise it is worth looking at the criteria you set for an investment- personally one of mine is that the managers/directors have “skin in the game” being shares bought with their own money, not free or subsidised by shareholders....

I can also see the recovery in these IT's and it worries me. Because whether we have containment or not with Covid19 company profits are going to be depressed for a period and therefore both equity and bond prices should be under pressure. (bond prices due to the credit risk). Yet none of that credit risk seems to be feeding through to the markets. Or worse, it did to start with, has been rejected and we are back to where we started as if nothing has happenned.

I understand there is a view the BOE are now certain to cut rates andt that looks priced in. Well I'll not argue with that but I'd also point out that cutting rates isn't going to help much if part of your supply chain in China or India or even Italy can't supply your goods. I don't think it's as clear cut as the market thinks it is. And whether the base rate is 0.75% or 0.5% or 0.25% I'm not sure will make much difference because again it's not going to change your decision about spending on cinemas, eating out or travel or indeed many other things.

What I see is at the margin companies defaulting on their debts or banks now wanting a greater interest margin to cover their risk.

And then there's governent tax receipts. They aren't going to be as high as they were either. How long before Italy's debt starts to look more expensive and then it will slowly fan out from there?

Yes, I can see the Covid19 situation is a little different because there is an end to it in and therefore the downturn will be temporarty. But, at the margin a few companies are going to go to the wall.

I can clearly feel I am out of alignment with the market view on credit risk. Ineteresting times.

[JohnW]

You buy a 20 year linker with 1% coupon 10 years after it's been issued, so 10 year life left. There has been no inflation at all to date. You pay £200 for this.

Thank you again. It’s coming together for me.
Your example helps and is clear showing how you can lose capital, but leaves me uneasy - perhaps it’s just bonds that are bad. But I don’t think we ever disagreed you can lose money with a bond ladder, I just didn’t make it clear initially. But in my own defence, describing a non-rolling bond ladder is not real simple in a short post, especially when your grasp on it is tenuous.
Your twenty year, 1% bond issued for £100 would struggle to cost £200 a decade later from interest rate falls. That bond when new has a duration of about 18 years. Interest rates have to fall immediately after issue by 100/18 ie 5.5% to force the price of the bond up by 100%, surely, or even more if rates don’t fall until a longer time after issue. I’ve used Investopedia’s duration calculator ('As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration.'). Fall from 1% to minus 4.5%; possible, of course.
So assume it happens; my friend arrives the day I pay £200 for my bond, and she spends £200 on two new 10 year bonds which are now paying minus 4.5%/yr. So for 10 years she loses £9 each year, and gets her principal back intact. She and I are similarly disadvantaged, both down £90.
If my example is valid, the problem is not buying bonds other than at issue or at par prices, it’s buying bonds at times of low interest rates.

[SoBo65]

It is interesting to see that following the general fall last week, ‘quality’ shares and IT’s are recovering and some such as Personal Assets Trust are back to where they were. I would suggest it you want a ‘sleep well at night fund’ this is worth considering. Otherwise it is worth looking at the criteria you set for an investment- personally one of mine is that the managers/directors have “skin in the game” being shares bought with their own money, not free or subsidised by shareholders....

I can also see the recovery in these IT's and it worries me. Because whether we have containment or not with Covid19 company profits are going to be depressed for a period and therefore both equity and bond prices should be under pressure. (bond prices due to the credit risk). Yet none of that credit risk seems to be feeding through to the markets. Or worse, it did to start with, has been rejected and we are back to where we started as if nothing has happenned.

I understand there is a view the BOE are now certain to cut rates andt that looks priced in. Well I'll not argue with that but I'd also point out that cutting rates isn't going to help much if part of your supply chain in China or India or even Italy can't supply your goods. I don't think it's as clear cut as the market thinks it is. And whether the base rate is 0.75% or 0.5% or 0.25% I'm not sure will make much difference because again it's not going to change your decision about spending on cinemas, eating out or travel or indeed many other things.

What I see is at the margin companies defaulting on their debts or banks now wanting a greater interest margin to cover their risk.

And then there's governent tax receipts. They aren't going to be as high as they were either. How long before Italy's debt starts to look more expensive and then it will slowly fan out from there?

Yes, I can see the Covid19 situation is a little different because there is an end to it in and therefore the downturn will be temporarty. But, at the margin a few companies are going to go to the wall.

I can clearly feel I am out of alignment with the market view on credit risk. Ineteresting times.

Thanks, for me the market has been in la la land for sometime regards the credit risk on corporate bonds, do not bother with them myself, prefer low risk shares such as utilities, low geared REITs or infrastructure funds with decent dividend yields. I have 30 years experience in credit risk and believe it is often underpriced in corporate debt.

[dealtn]

You buy a 20 year linker with 1% coupon 10 years after it's been issued, so 10 year life left. There has been no inflation at all to date. You pay £200 for this.

Thank you again. It’s coming together for me.
Your example helps and is clear showing how you can lose capital, but leaves me uneasy - perhaps it’s just bonds that are bad.

Your twenty year, 1% bond issued for £100 would struggle to cost £200 a decade later from interest rate falls.

You asked for a simple example so that's what I provided.

If you want something that is real (no pun intended) look at the first issuance of the Index-Linked 2041 Gilt in July 2018. This has a coupon of just 1/8% (it isn't impossible but impractical to issue a gilt with a zero, or indeed, lower coupon). Real interests rates then, and indeed now, were negative. So instead of being issued at par, or a price of 100, the bonds were syndicated and began trading at a price of 148.97.

So buyers would accept a redemption "real" loss of 1/3 of their capital for the privilege of receiving just 1/8% coupon!

Buyers are happy to take a certain loss of purchasing power.

[Dod101]

I will not copy Gan020's latest, but I think he worries too much or maybe just thinks too much. Take it as it comes and relax. There is not a lot you can do anyway and unless you have a feel for where the market is going just leave things alone. It has a habit of sorting itself out. The last financial crisis (and I would not call the current situation one) was very different because it was obvious that banks were being badly hit but this is much less clear and in any case, will not go on for ever.

At least where I live, it would be much more productive to take a walk in the fresh air and enjoy the early spring weather.

Dod

[scrumpyjack]

I quite agree Dod.

I think buyers of bonds are not 'happy' to buy at prices that guarantee a huge loss in real terms over decades. It is just that many buyers, eg insurance companies or pension funds, have no alternative. They have to buy assets that guarantee they can pay future pensions as they fall due.

Private individuals don't have to do that. So personally I would never touch bonds at current levels. But you have to do whatever is compatible with sleeping at night. For me I prefer to hold a cash buffer to cover several years expenditure and keep the rest in equities.

BTW the 2008 'financial crisis' was a walk in the park compared to 1974 when the FTSE lost 70% of its value and inflation reached 27%! I was all in equities then, which was stressful at times, but it all worked out in the end.

[Dod101]

I quite agree Dod.

I think buyers of bonds are not 'happy' to buy at prices that guarantee a huge loss in real terms over decades. It is just that many buyers, eg insurance companies or pension funds, have no alternative. They have to buy assets that guarantee they can pay future pensions as they fall due.

Private individuals don't have to do that. So personally I would never touch bonds at current levels. But you have to do whatever is compatible with sleeping at night. For me I prefer to hold a cash buffer to cover several years expenditure and keep the rest in equities.

BTW the 2008 'financial crisis' was a walk in the park compared to 1974 when the FTSE lost 70% of its value and inflation reached 27%! I was all in equities then, which was stressful at times, but it all worked out in the end.

In 1974 I was well away from the UK although, as I recall it, the problem was worldwide if you are referring to the first 'oil shock'. I was busily earning the crust which proceeds I am now living off. At that stage I was not personally in the market which was probably just as well. I recall though not long after I retired at the end of 1994 being able to buy relatively short dated bonds at or under par and keeping them until maturity and doing quite well from them, for what amounted to a guaranteed capital gain and reaping the income in the meanwhile. Sounds like another world.

Dod

[langley59]

Well these market conditions are now testing my resolve significantly.

By way of background I was on the cusp of buying the house of my dreams and thinking about retirement at the age of 48 in 2007 and then the following year I lost my job, my equity in the firm I worked for was wiped out and I had a 3 year wait until my rights to my pension fund were clarified, so I had a major reset. I then set about rebuilding and finally FIRE'd in 2017 making do with the small house I am still in and a less ambitious outlook. Last year my income from investments reached the level of my family's normal* annual expenditure for the first time and as of 31/12/19 I was a happy bunny (*normal excludes holidays, children's uni/college tuition fees and contingencies like private medical fees, for which I have separate pots of cash earmarked).

I try not to look at the market value of my equities and other investments which are perhaps a typical Lemon Fool mix of HYP shares, income Investment Trusts and ETFs and various others. I tell myself that it is the dividends which matter and the share prices will hopefully recover eventually, and even if they don't it doesn't matter as long as they keep paying, unless any of the individual companies goes bust of course. But will that 2019 year when income met expenditure be repeatable, and if not how long will it take to recover? To that end I have a cash float of 3 years normal annual expenditure which I hope is enough to ride out the storm. What do others think?

Psychology of investment once retired is a well named topic.

[EthicsGradient]

I try not to look at the market value of my equities and other investments which are perhaps a typical Lemon Fool mix of HYP shares, income Investment Trusts and ETFs and various others. I tell myself that it is the dividends which matter and the share prices will hopefully recover eventually, and even if they don't it doesn't matter as long as they keep paying, unless any of the individual companies goes bust of course. But will that 2019 year when income met expenditure be repeatable, and if not how long will it take to recover? To that end I have a cash float of 3 years normal annual expenditure which I hope is enough to ride out the storm. What do others think?

Psychology of investment once retired is a well named topic.

Everyone should assume that the overall level of dividend is going to go down this year, because business, and therefore earnings, are going to be significantly less for a few months. It's hard to see how any country that has to take special measures to preserve health (as the major economies have done) does not then go into recession. If companies have significant cash on hand to keep up a dividend in case of a dip in earnings, it's far more likely they will need to use it to fix the problems the recession will cause.

3 years' worth may be enough to ride it out; but it might be worth considering whether the balance of cash and investments you're left with at the end of that is what you feel happy about. At times, it might be better to sell something you don't feel has such good long-term prospects any more. Or, sadly, dip into the holiday fund.

[langley59]

3 years' worth may be enough to ride it out; but it might be worth considering whether the balance of cash and investments you're left with at the end of that is what you feel happy about. At times, it might be better to sell something you don't feel has such good long-term prospects any more. Or, sadly, dip into the holiday fund.

Thanks for the advice. One thing I have learned from this recent experience however is to be ruthless about selling investments which have disappointed, before they get worse....I know, I know. I have been gradually rationalising my portfolio and selling HYP shares and adding to ITs/ETFs but there are some which I thought might recover so I procrastinated. Sadly now they are worth much less and would not at present meet the objective you mentioned.