Asset Allocation For Perpetual Capital

[AWOL]

Hi ,

I am struggling to work out asset allocation for my retirement capital with a goal of a perpetual fund that will be there for my disabled son if he cannot get work as an adult but will support me for my life first. At the moment I am 95% equity and 5% premium bonds (to cover short dips but not long term bear markets). I have run simulations but when one assumes returns based on inverse CAPE, bond yields and inflation things look ugly and bonds look dreadful in most scenarios but helpful in some. I have even had the word gold pop briefly into my head.

Frankly I have spent days running simulations and building models and came to the conclusion that around 1-1.6% draw down on at least 90% equities looks cautious but I cannot stomach anything below 2%. I have also concluded that there is such a range of possibilities including events and sequences never seen before that it's impossible to eliminate risk.

With so many variables I am paralysed and thinking of sticking with current allocation and 2% drawdown. This combined with about 7k of guaranteed income until state pension is comfortable as long as we don't have a long bear market.

It's hard to make a forever portfolio when the models use historic data that covers very different situations from extreme CAPE, extremely low gilt yields. Should I look at golden butterfly or is there a better approach?

Thanks,
AWOL

PS- Sorry if this should have been in retirement investing. I always struggle choosing between these two forums! I think I got it wrong.

[Dod101]

Do not struggle and do not worry. None of that will get you anywhere. I have been retired for more than 25 years and have had a more or less 90% allocation to equities and the other 10% or so mostly in cash (actually index linked N S & I certs and a few premium bonds.)

I have therefore lived through the tech boom and crash of 2000, the financial crisis of 2007/8 and the recent Covid problems. Today my funds are at their all time high. I draw the dividends which are around about 3.5/4.00% and if there are any that I do not spend I will very occasionally reinvest them.

Dod

[dealtn]

Frankly I have spent days running simulations and building models and came to the conclusion that around 1-1.6% draw down on at least 90% equities looks cautious but I cannot stomach anything below 2%. I have also concluded that there is such a range of possibilities including events and sequences never seen before that it's impossible to eliminate risk.

That suggests you don't have enough Capital yet in that case.

[AWOL]

Possibly but it's unlikely I'll go back to work now. I have £900k of capital and just under £8k of index linked income, no debt, and will get the full state pension but that's a while off yet. My wife is young, in a secure profession, has final salary pension, private pension, and investments so in a doomsday scenario I could in theory get her help but that's not the point. The point is to leave with the equivalent a similar amount of capital in real terms when I go. That's easily possible but it's so hard to predict future crash shapes and the right mitigation when the starting point is so different from the past.

[AWOL]

Do not struggle and do not worry. None of that will get you anywhere. I have been retired for more than 25 years and have had a more or less 90% allocation to equities and the other 10% or so mostly in cash (actually index linked N S & I certs and a few premium bonds.)

I have therefore lived through the tech boom and crash of 2000, the financial crisis of 2007/8 and the recent Covid problems. Today my funds are at their all time high. I draw the dividends which are around about 3.5/4.00% and if there are any that I do not spend I will very occasionally reinvest them.

Dod

You are probably right.

[dealtn]

The point is to leave with the equivalent a similar amount of capital in real terms when I go. That's easily possible but it's so hard to predict future crash shapes and the right mitigation when the starting point is so different from the past.

I agree it's entirely possible. But you appear to be looking for a higher degree of certainty than it just being possible, and your risk tolerance appears to be that "I cannot stomach anything below 2%".

Something has to give, there isn't a free lunch. You either stomach more risk, accept the possibility your certainty won't be satisfied, or acquire more capital to bridge the gap between the two. No Investment strategy is going to do that I fear.

[AWOL]

The point is to leave with the equivalent a similar amount of capital in real terms when I go. That's easily possible but it's so hard to predict future crash shapes and the right mitigation when the starting point is so different from the past.

I agree it's entirely possible. But you appear to be looking for a higher degree of certainty than it just being possible, and your risk tolerance appears to be that "I cannot stomach anything below 2%".

Something has to give, there isn't a free lunch. You either stomach more risk, accept the possibility your certainty won't be satisfied, or acquire more capital to bridge the gap between the two. No Investment strategy is going to do that I fear.

I was actually wondering if the opposite was true which is to change asset allocation to withstand more conditions, i.e. reduce risks.

[dealtn]

The point is to leave with the equivalent a similar amount of capital in real terms when I go. That's easily possible but it's so hard to predict future crash shapes and the right mitigation when the starting point is so different from the past.

I agree it's entirely possible. But you appear to be looking for a higher degree of certainty than it just being possible, and your risk tolerance appears to be that "I cannot stomach anything below 2%".

Something has to give, there isn't a free lunch. You either stomach more risk, accept the possibility your certainty won't be satisfied, or acquire more capital to bridge the gap between the two. No Investment strategy is going to do that I fear.

I was actually wondering if the opposite was true which is to change asset allocation to withstand more conditions, i.e. reduce risks.

I was thinking you wanted a perpetual fund to be their for your son in real terms. Reducing drawdown helps that, but amending the risk allocation to a lower (potential) return, albeit safer in terms of (nominal) capital preservation goes the other way.

Maybe I have assessed your situation wrongly.

[AWOL]

I agree it's entirely possible. But you appear to be looking for a higher degree of certainty than it just being possible, and your risk tolerance appears to be that "I cannot stomach anything below 2%".

Something has to give, there isn't a free lunch. You either stomach more risk, accept the possibility your certainty won't be satisfied, or acquire more capital to bridge the gap between the two. No Investment strategy is going to do that I fear.

I was actually wondering if the opposite was true which is to change asset allocation to withstand more conditions, i.e. reduce risks.

I was thinking you wanted a perpetual fund to be their for your son in real terms. Reducing drawdown helps that, but amending the risk allocation to a lower (potential) return, albeit safer in terms of (nominal) capital preservation goes the other way.

Maybe I have assessed your situation wrongly.

No I think you've got it right and I am being somewhat irrational or fearful when others are being greedy. I am usually a "leave everything well alone" guy however I have been unusually unsettled by seeing that the Schiller CAPE is at 38.36 which implies that I am walking a very fine line. On the up side, earnings have upside potential and I do expect a near term re-rating when the developed world reaches detente with COVID.

I think I am fretting about things beyond my control and probably need to go back to studied indifference.

[1nvest]

90/10 Buffett style has a good chance of being OK, but historic events such as -75% declines in real terms for both price index and income index (dividends) as occurred 1910-1920 along with also drawing a income!!!

My other primary preference is a Talmud style, third each in land (UK home), commerce (US stocks), reserves (gold). Get's tricky to backtest due to the likes of money being pegged to gold pre 1932 so in practice holding money deposited and earning interest was better.

Owing a home avoids having to find/pay rent, historically worth around 4.2% average 'imputed rent benefit'. Drawing 2% SWR from that, or 3% SWR from just US stock/gold historically worked OK whilst providing a inflation adjusted regular income. Which when supplemented with proportioned imputed rent of 1.4% = 3.4%. And where the home value is a form of late life care costs cover.

At times those in power/control can make odd decisions. Roy Jenkings/Dennis Healey for instance imposing 130% retrospective tax on the richest, that naturally resulted in a out flight of capital such that instead of pulling in more taxes as expected it had the reverse effect. Near all in stock still has a single concentrated risk factor, geopolitical/taxation risk. A UK home (£), US stocks (primary reserve currency), gold (global currency), diversified across land, stock and commodity (gold) assets bears less concentration risk, and concentration risk is a major risk factor especially when the investment horizon spans many decades.

Gold can be horrible, multiple decades of seemingly in perpetual decline, repeated taking some stock gains to buy more ounces of gold as part of rebalancing only to see the price of gold continue on further down. But equally that can accumulate multiple more ounces of gold such that when prices do soar, typically as stocks do poorly, then the accumulation of gold cost averaged into at relatively low prices can yield massive dividends, where it provides not only the source of income over such times but also reduces ounces held to buy more stock shares at relatively low prices/valuations.

From your OP however it sounds that you'd be better served with stock heavy - as you are. 90/10 Buffett advocated type style. The 10 part however is variable, according to ones comfort and needs. Asymmetric rebalanced, never sell reserves to add to depressed stock shares, use that to float you through bad stock times, along with having enough to cover unexpected expenses such as the cost of a new roof being needed at a time when stocks were down a lot. Multi £M portfolio value and 5% might be more than enough, factoring in that cash might even have halved in real terms i.e. inflation was the driver of lower stock prices and declines in 'cash' purchase power levels. Loss of purchase power is less of a issue if reserves/cash are invested in index linked gilts, whilst they 'cost' around 2%/year at recent levels, relative to 5% or 10% of total portfolio value, 0.1% to 0.2% is a relatively mild 'insurance' premium to pay.

A factor to consider is that no matter what asset allocation you hold, at times that could significantly decline in real terms especially when income was also being drawn. A low SWR based withdrawal approach is relatively safe whilst providing regular inflation adjusted income. The cost for that benefit is that the capital value of the portfolio is volatile, may at times have fallen to a third or even less of former inflation adjusted value, where in effect a 2% SWR rises to being 6% of the ongoing portfolio value, but where from such low valuations a 6% SWR still worked out OK overall. Mentally treat the capital value as though a annuity had been bought, i.e. 'all spent' but where in practice you still have control/access to the capital.

There is always the halfway house, 50/50 Talmud and 90/10, historically the worst cases for each of those didn't coincide, a form of risk reduction via style diversification.

Many say only use SWR as a guide, however I do like actually applying that in practice. 2% of initial portfolio value, uplift that £ amount by inflation as the amount drawn in subsequent years, and if drawn monthly that's a nice regular/reliable 'wage'. With ii I get a free trade/month as part of its monthly fee, so that can be used to sell some shares a few days before transferring the proceeds (T+3) into my regular spending account. I'm more at the opposite Talmud end to your stock-heavy preference. (Nearly) all in stock instates a sense of discomfort with how I'd feel if stocks were to drop a lot to potentially see £1M of former portfolio value reduced to a third or less. Or if a more extreme Labour government rose to power that 'heavily taxed the rich' but where the real rich had already flown the country to leave the 'rich' being more Joe Average individuals having to fill the hole (and more). Old Money, generational wealth, likes physical in hand assets, paintings that can be rolled up into a tube and moved to less punitive regimes. Transporting physical gold is a risk, however some offer backed by physical gold options where you can 'move' where your gold is securely stored at the press of a button, or if actually in-hand you can liquidate it, electronic transfer the capital and repurchase again at the target destination. Or simply bury it and deny having any until such times less punitive times are restored.

[1nvest]

The point is to leave with the equivalent a similar amount of capital in real terms when I go. That's easily possible but it's so hard to predict future crash shapes and the right mitigation when the starting point is so different from the past.

Investors are in effect rewarded for taking on volatility in real capital values. Perhaps your objective should be to leave a equivalent amount of inflation adjusted regular income, which a low SWR will tend to do. Whether that income arises out of 6% ongoing percentage of the capital value when the real value is down at a third, or 2% when values are relatively high. Only if being liquidated do ongoing capital valuations matter. A low SWR is less inclined to compound with poor stock rewards that otherwise drags down the capital value to levels where subsequent good-times even if great are insufficient to recoup former values. 4% SWR is borderline in that respect, can draw down to zero after 30 years. 3% is safer. 2% is about as close as you'll ever get to being perpetual for 50, 60 whatever years. IIRC 60/40 was found to be safer than 100/0 in that respect ... digging ...

... and that suggests that 75/25 was better/safer at 60 years/3.25% SWR than either all-stock or 50/50

[LooseCannon101]

I would keep your present allocation so long as the equity portion is well diversified e.g. global equity fund(s).

There is no way to protect yourself against short-term capital losses if you wish to preserve and increase the value of the investment pot. By short-term I would say 2-3 years. My investment pot, built up over 20 years, is currently 99% global equity fund and just 1% cash.

I trust the world economy more than the spending power of the British pound.

[AWOL]

I would keep your present allocation so long as the equity portion is well diversified e.g. global equity fund(s).

There is no way to protect yourself against short-term capital losses if you wish to preserve and increase the value of the investment pot. By short-term I would say 2-3 years. My investment pot, built up over 20 years, is currently 99% global equity fund and just 1% cash.

I trust the world economy more than the spending power of the British pound.

I have no fear of short term corrections, it's long term bear markets that I was getting twitchy about but in the long run we are all dead

I think I am sufficiently diversified although I intend to check my charges position. Last time I added it up I was paying 0.6% on average but I have made some changes this year.

42.5% passive ETFs
42.5% ITs globally diversified with UK small cap, Asia, and China overweight
15% Global Large Cap fund

[AWOL]

3% is safer. 2% is about as close as you'll ever get to being perpetual for 50, 60 whatever years. IIRC 60/40 was found to be safer than 100/0 in that respect ... digging ...
... and that suggests that 75/25 was better/safer at 60 years/3.25% SWR than either all-stock or 50/50

Historically 2% looks ultra safe and 75/25 was a very sweet asset allocation. I think it all depends on the inputs modelled given were we are.

Project Future Real Returns
Stocks for next 10Y 2.61%
Stocks after that 5.00%
Bonds for next 10Y 0.00%
Bonds after that 1.50%
Cash for next 10Y -1.00%
Cash after that 0.00%
Custom Series for next 10Y 0.00%
Custom Series after that 0.00%
Gold for next 10Y 1.00%
Gold after that 1.00%
Retirement Horizon (Months) 360
Final Value Target (%of initial) 100%

Gives these kind of scary results.

SWRs to target different Failure Rates

Failure Rates All Since 1926 Since 1950 CAPE<=20 CAPE>20 CAPE>30
0.00% 0.57% 2.25% 2.25% 2.03% 0.57% 2.25%
1.00% 2.33% 2.67% 2.58% 2.55% 1.87% 2.29%
2.00% 2.54% 2.90% 2.87% 2.74% 2.15% 2.33%
5.00% 2.88% 3.21% 3.19% 3.06% 2.42% 2.39%
10.00% 3.23% 3.57% 3.46% 3.53% 2.88% 2.51%
25.00% 3.98% 4.22% 4.07% 4.33% 3.35% 2.84%
50.00% 5.44% 5.98% 5.50% 6.37% 4.00% 3.18%

[1nvest]

I would keep your present allocation so long as the equity portion is well diversified e.g. global equity fund(s).

There is no way to protect yourself against short-term capital losses if you wish to preserve and increase the value of the investment pot. By short-term I would say 2-3 years. My investment pot, built up over 20 years, is currently 99% global equity fund and just 1% cash.

I trust the world economy more than the spending power of the British pound.

Funds whilst seemingly low-cost can involve hidden costs. S&P500 trackers for instance may be benchmarked to the S&P500NTR, the net total return mathematical index, that discounts dividends by 30% US dividend withholding taxes. Good funds tend to outperform that benchmark because they might only be incurring 15% withholding taxes such as under UK/Ireland US tax treaties. Other countries impose varying levels of dividend withholding taxes ranging through 0% up to perhaps 70% levels. Broad average perhaps 20%. Less noticeable when dividend yields are low and under a bull market, more of a issue when yields might be high and total return real losses are evident. 5% dividend, 20% taxation = 1% drag. In effect 50% if you're pulling a 2% SWR. And then fund fees/expenses on top. And perhaps real total return losses as well.

The old way used to be to buy into a bunch of globally diverse mega-caps, that individually might have economies larger than some countries and that might internally shift capital around in a tax efficient like manner.

IIRC Bogle's 'ideal' holding was to buy the 50 largest firms stocks in around equal capital measure and thereafter leave as-is. No rebalancing other than drawing income from the provided dividends and selling down the stock having the highest value at the time. Vanguard however couldn't market that. Others from that generation suggested fewer than 10 stocks were enough, 10% risk per holding can compare to what a broader stock index might be weighted into its largest stock. I seem to recall McDonalds for instance during the 2008/9 financial crisis saw little/no decline, its global expanse/currencies and business profile saw it unaffected. MIcrosoft is global software, HSBC is pretty much a global bank ...etc.

The counter suggestion is that you miss holding the stock(s) that make the greatest gains, however its scaled/fractal. 1000 stocks with the best making a 1000% gain, or one out of 10 stocks making a 10% gain. Most stocks in a set/index lag the broader average due to the right-tail best case uplifting that average, similar to a room of nine individuals each six-foot-tall, having a 10th individual who was a seven-footer entering the room resulting in 90% of the individuals in the room being below average height. The more shares, the more the best cases are diluted down. Fewer shares and the best case can be much lower of a percentage gain to compare.

Indexes have evolved. Dow and Jones devised three indexes of which the best has prevailed. At the offset investors would have had to predict that best case and had the foresight to fully load into it in order to have achieved the 'historic average'. More likely investors might have spread across all three and in so doing have lagged the 'average'. Index trackers that track indexes - mechanical methods are suggested as being the more productive - in hindsight. Other less rewarding indexes tending to fall into oblivion, or more out of sight such at the FT30.

[1nvest]

Project Future Real Returns
Cash for next 10Y -1.00%
Cash after that 0.00%
Gold for next 10Y 1.00%
Gold after that 1.00%

Prior to 1931 when gold/money were pegged it made more sense to hold T-Bills earning interest.
Since 1932 a UK investor who stuffed hard US$ and gold under a mattress rebalancing to 50/50 yearly, by the end of 2019 would have seen that stash having lost 0.6% annualised of purchase power. Had they invested the US$ in US T-Bills they'd have seen a 1.1% annualised increase in purchase power. Was pretty volatile along the way however. If instead US stock were held instead of US$ being invested in US T-Bills then the ride was a lot more smoother as stock and gold tend to have multi-year inverse correlations, and that yielded a 4.9% annualised real benefit.



Currency diversification of primary global reserve currency (US$) and global currency (gold) ... with stock and commodity asset diversity.

[BT63]

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That graph looks like the long term trend is accelerating since ~2008.


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[JohnW]

“Don’t look for the needle in the haystack. Just buy the haystack!”
“Owning the stock market over the long term is a winner’s game,
"Simply buy … a total stock market index fund..."
"The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing."
"Index funds eliminate the risks of individual stocks, market sectors and manager selection, leaving only stock market risk.”
https://financinglife.org/bogle-quotes/

IIRC Bogle's 'ideal' holding was to buy the 50 largest firms stocks in around equal capital measure and thereafter leave as-is.

I don't think you have.

[1nvest]

“Don’t look for the needle in the haystack. Just buy the haystack!”
“Owning the stock market over the long term is a winner’s game,
"Simply buy … a total stock market index fund..."
"The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing."
"Index funds eliminate the risks of individual stocks, market sectors and manager selection, leaving only stock market risk.”
https://financinglife.org/bogle-quotes/

IIRC Bogle's 'ideal' holding was to buy the 50 largest firms stocks in around equal capital measure and thereafter leave as-is.

I don't think you have.

Quotes from Index fund providers are a bit like a cigarette manufacturer suggesting you should smoke.

Bogle recommends the ultimate in buy-and-hold investing: a completely static portfolio. He would buy the 50 largest companies in the S&P 500 and then never buy another.
.
.
Alas, his successor as chief executive of the nonprofit Vanguard Group, John Brennan, doesn't plan to offer the product. Creating new portfolios annually (because newcomers would not be allowed into an existing portfolio) would be an administrative headache with each distinct one lacking sufficient economies of scale, Vanguard believes.

https://www.forbes.com/forbes/1999/0614 ... 9cad9c6874

[1nvest]

Project Future Real Returns
Cash for next 10Y -1.00%
Cash after that 0.00%
Gold for next 10Y 1.00%
Gold after that 1.00%

Prior to 1931 when gold/money were pegged it made more sense to hold T-Bills earning interest.
Since 1932 a UK investor who stuffed hard US$ and gold under a mattress rebalancing to 50/50 yearly, by the end of 2019 would have seen that stash having lost 0.6% annualised of purchase power. Had they invested the US$ in US T-Bills they'd have seen a 1.1% annualised increase in purchase power. Was pretty volatile along the way however. If instead US stock were held instead of US$ being invested in US T-Bills then the ride was a lot more smoother as stock and gold tend to have multi-year inverse correlations, and that yielded a 4.9% annualised real benefit.



Currency diversification of primary global reserve currency (US$) and global currency (gold) ... with stock and commodity asset diversity.

In US$ terms looks more regular (click the inflation adjusted tickbox in that link), so perhaps since 2008 is a reflection of relatively declining £ further compounded by Brexit ...such that foreign currencies such as US$/gold have bolstered £ based results.