Worst case scenarios

[MrFoolish]

I've written a spreadsheet for estimating my net worth into the future. So this has my income, pensions, spend, tax etc. It iterates to get a new figure for each year.

I can set 2 percentage constants, INF (inflation) and RETURN (return on my net worth, not inflation adjusted).

My investments are mostly in shares, pretty diversified, but certainly overweight in the UK by international standards (much less than a HYP though!)

I'm curious as to what people would think a reasonable worst case for INF and RETURN would be over the long term (say 20 years)? I'm toying with INF = 5% and RETURN = 2%. But I guess it comes down to how many black swan events we get, and how the heck can you predict this?

[scrumpyjack]

Well the Japanese stock market is now nearly back to the level it was at 33 years ago!

[MrFoolish]

Well the Japanese stock market is now nearly back to the level it was at 33 years ago!

Interesting point. I wonder how this has happened? I suppose China has gobbled up manufacturing and the US have grabbed the high tech and internet economy spaces.

[Midsmartin]

As I get a bit closer to retirement age, and now that index linked gilts have a positive yield, I'm dealing with the unknown by gradually buying more of these. But my actual pension funds are a bit limited so I'm relying more on my other investments.

Which doesn't really answer your actual question at all.

[scrumpyjack]

I've written a spreadsheet for estimating my net worth into the future. So this has my income, pensions, spend, tax etc. It iterates to get a new figure for each year.

I can set 2 percentage constants, INF (inflation) and RETURN (return on my net worth, not inflation adjusted).

My investments are mostly in shares, pretty diversified, but certainly overweight in the UK by international standards (much less than a HYP though!)

I'm curious as to what people would think a reasonable worst case for INF and RETURN would be over the long term (say 20 years)? I'm toying with INF = 5% and RETURN = 2%. But I guess it comes down to how many black swan events we get, and how the heck can you predict this?

I think worst case could be a lot worse than that but one could take that as a 'reasonable' worst case. I'm assuming that both are nominal (ie 2% - 5% = 3% negative return).

It would reduce risk to have most of your investments overseas (eg world tracker)

[Dicky99]

I'm curious as to what people would think a reasonable worst case for INF and RETURN would be over the long term (say 20 years)? I'm toying with INF = 5% and RETURN = 2%. But I guess it comes down to how many black swan events we get, and how the heck can you predict this?

Why not just use the 20 year averages for historic inflation and total return for e.g. a globally diversified fund of your choice and review the applied averages each year. You could adjust the averages according to how cautious you want to be with your calcs

[Steveam]

Interesting. I’ve no answer but have tried similar ideas on for size.

The problem with average over a period is that sequence risk is major … a 50% decline in the value of investable assets in year 1 is very different to the same on your death bed. Eventually I gave up on the guessing at the future approach but instead took to the free lunch which is diversification (although my diversification is global equities, property and gold; no bonds as I treat my two, small index linked pensions as bond like income).

Most of my expenditure is U.K.£ but I have a regular $ expenditure.

I hold a large cash or cash equivalent bucket to tide one over short term hiccups (no fireside selling). The cash is made up of real bank cash (being murdered by inflation), NSI Index linked certificates, and premium bonds for a flutter).

The above (hardly a strategy) suits me but is very circumstance dependent. I could live with a halving of my income - uncomfortable but not catastrophic. During difficult periods such as the GFC and Covid I cut my expenditure in half. I know I’d take actions if circumstances became really sticky.

Best wishes, Steve

[MrFoolish]

I think worst case could be a lot worse than that but one could take that as a 'reasonable' worst case. I'm assuming that both are nominal (ie 2% - 5% = 3% negative return).

It would reduce risk to have most of your investments overseas (eg world tracker)

Yes, 3% negative return was what I meant.

I suppose a world tracker is nominally less risky. But it will be mostly USA which is possibly overvalued. We could go round in circles debating this one!

[scrumpyjack]

Not just nominally. The UK represents only 3% of world GDP and given that your other assets (work, home etc) are UK, it is very risky IMO to have most of your investment portfolio in UK shares. Add to that the fact that the pound is one of the worlds weaker currencies and our national wealth looks to continue declining relatively.

You can always get trackers which give you predominantly international exposure but underweight USA, if you want, but I think the US is going to carry on becoming more successful.

[kempiejon]

I looked at modelling a few years ago but the outcomes seemed too wild especially as timescales lengthened. I suppose back testing is the only sort of data available. Little changes to inputs, returns and inflation can have such wildly different outcomes into the future, especially over the 30 odd years of retirement. I ran scenarios using https://firecalc.com/ which can show these differences. I know if I can grow my income, keep saving and investing without impacting my lifestyle too much, keep my spending within income, debt zero and stay relatively fit and active that'll have to be enough. A terrible sequence of returns could scupper anyone's plans. If I'm lucky I'll have both a small DB pension and some money from the state which are inflation linked but my main post employment income for hopefully a few years will come from my investments.

[MrFoolish]

Not just nominally. The UK represents only 3% of world GDP and given that your other assets (work, home etc) are UK, it is very risky IMO to have most of your investment portfolio in UK shares. Add to that the fact that the pound is one of the worlds weaker currencies and our national wealth looks to continue declining relatively.

You can always get trackers which give you predominantly international exposure but underweight USA, if you want, but I think the US is going to carry on becoming more successful.

I do have VWRL (world), VEUR (Europe) and some investment trusts with high international components. Plus a bit of a gamble on Vietnam. My UK companies tend to sell around the world. Would you call Unilever, for example, particularly risky?

[kempiejon]

Not just nominally. The UK represents only 3% of world GDP and given that your other assets (work, home etc) are UK, it is very risky IMO to have most of your investment portfolio in UK shares. Add to that the fact that the pound is one of the worlds weaker currencies and our national wealth looks to continue declining relatively.

You can always get trackers which give you predominantly international exposure but underweight USA, if you want, but I think the US is going to carry on becoming more successful.

I hold a portfolio of UK FTSE 350 shares built over many years. To balance that UK bias my SIPP is a mix of Vanguard etfs focused on USA, EM, Japan, Asia(exJPN) and Europe(exUK) and an ISAs in a global tracker Vanguards VWRP.

[tjh290633]

If you look at the FTSE100 index since its peak at the end of 1999, the folly of investing in index linked products is clear. The argument is, of course, not to invest in that index. But can you rely on any other index?

I maintain that selective investing, following well defined criteria, can consistently outperform indices over long periods. Coupled with nominally equal weight portfolios, and the avoidance of transient fashions like the dot-com mania, the desired results can be obtained.

Selective reinvestment of dividends will enhance the returns, until such time that income has to be withdrawn.

TJH

[MrFoolish]

If you look at the FTSE100 index since its peak at the end of 1999, the folly of investing in index linked products is clear. The argument is, of course, not to invest in that index. But can you rely on any other index?

I maintain that selective investing, following well defined criteria, can consistently outperform indices over long periods. Coupled with nominally equal weight portfolios, and the avoidance of transient fashions like the dot-com mania, the desired results can be obtained.

Selective reinvestment of dividends will enhance the returns, until such time that income has to be withdrawn.

TJH

But you seem to be comparing the simple capital performance of the FTSE100 with your portfolio where you re-invested the dividends. I'm not sure this is a fair comparison.

[vand]

The future worse case scenario can always exceed anything that has happened in the past.... so while it can be fun to speculate, the truth is that no one has a clue, and imo it's not a good use of energy to try to project such things. Que sera sera etc

[MrFoolish]

The future worse case scenario can always exceed anything that has happened in the past.... so while it can be fun to speculate, the truth is that no one has a clue, and imo it's not a good use of energy to try to project such things. Que sera sera etc

I kind of agree. But if you wish to retire early, you have to judge the safety margin one way or another. Perhaps it's back to the 4% rule?

[tjh290633]

If you look at the FTSE100 index since its peak at the end of 1999, the folly of investing in index linked products is clear. The argument is, of course, not to invest in that index. But can you rely on any other index?

I maintain that selective investing, following well defined criteria, can consistently outperform indices over long periods. Coupled with nominally equal weight portfolios, and the avoidance of transient fashions like the dot-com mania, the desired results can be obtained.

Selective reinvestment of dividends will enhance the returns, until such time that income has to be withdrawn.

TJH

But you seem to be comparing the simple capital performance of the FTSE100 with your portfolio where you re-invested the dividends. I'm not sure this is a fair comparison.

No I'm not. I am calculating my portfolio as income units, where the dividends do not roll up in the units, and accumulation units where they are rolled up. It is the income units that I am talking about here.

Reinvesting dividends increases the number of income units but not their value. The number of accumulation units remain unchanged but their value increases.

TJH

[Lootman]

Well the Japanese stock market is now nearly back to the level it was at 33 years ago!

Interesting point. I wonder how this has happened? I suppose China has gobbled up manufacturing and the US have grabbed the high tech and internet economy spaces.

But also Japan at the time was about 40% of global market cap. It is now about 10%. There was a mania for all things Japan in the 1980s. Its property market was also very inflated.

The US is over 50% of global market cap now but IMHO that is more justified.

[vand]

The future worse case scenario can always exceed anything that has happened in the past.... so while it can be fun to speculate, the truth is that no one has a clue, and imo it's not a good use of energy to try to project such things. Que sera sera etc

I kind of agree. But if you wish to retire early, you have to judge the safety margin one way or another. Perhaps it's back to the 4% rule?

It wasn't clear that this was in reference to FIRE portfolios, in which case SORR is much more important than INF/RETURN.

4% rule is definitely a good starting point. Even better if you then factor in any state pension due to come online, and if you are willing/able to vary your expenditure if a SORR-negative event occurs early on.

IMO if you want to avoid worse possible outcomes then there are strategies that do just that - full annuities, fixed-term annuities, and asset allocations that have historically been far more suitable for drawdown than a stock-heavy portfolio. Of course trouble is that people always want to have their cake and eat it.

[kempiejon]

Since 1999 The FTSE100 with dividends reinvested is up 4% a year according to Schroders’ calculations.
https://www.schroders.com/en-gb/uk/inte ... nvestment/
https://d2csxpduxe849s.cloudfront.net/m ... F862F4.jpg

I think it looks like it doubled in the past 10 years.
https://uk.investing.com/indices/ftse-1 ... turn-chart