Near Retirement Investment Strategy for "Floor" Fund

[Mercenary]

Hi all.

Any thoughts on what to do investment strategy wise if you're getting close to retirement and potentially have all you need to cover the basics?

That is, I've estimated my future essential expenses (my "floor") for my estimated lifetime, done the clever maths, and have what I need to meet these expenses, with a zero balance at the end of my life.

So where to invest it? No point taking any risk. I can do that with other funds I'm currently accumulating to make my retirement comfortable. The biggest risk right now for this floor fund is sequential risk - suffering a big loss(es) early on from which I cannot recover.

The options I have considered:

o Convention says move to bonds but these prices are currently falling and will no doubt continue to do so for now (and I'll be spending capital).

o Equities seem an unnecessary risk for this fund.

o Capital protection investment trusts seem not to perform.

o NS&I may work but the funds are in a SiPP (maybe I can take a lump sum and invest but not sure if I can then continue to pay into my SiPP).

o Maybe an annuity but I assume best to wait for interest rates to rise and I get closer to the time I will need the money.

Just to be clear, I'm talking about my floor fund so I'm not quite rolling in it! I will seek to grow other funds (with more risk) to cover discretionary expenditure and any errors in my assumptions.

TIA.

[tjh290633]

I think that you are missing the point. When you retire you need income, and there is plenty available from equities without taking undue risk. Fixed interest securities have two disadvantages - they are overpriced, and vulnerable to rising interest rates, and the income is by its nature fixed. You need a rising income.

Yes, you need a reserve fund to cater for unexpected items or a market fall back, but dividends are rather less volatile than share prices. Drawing down is a misconceived process. It is the income that you need to draw. Many of the available ITs have a long record of increasing their dividends, FRCL has just reported and you can read their report at https://www.investegate.co.uk/foreign-- ... 00049035G/ - they are not alone. They have their own dividend reserve fund, as do others, which allow them to get through the occasional dip without reducing their dividends, even if the their dividend income temporarily falls.

You don't know when your "end of life" will be, and you could well need to draw down your fund to pay for care.

For the "base fund" which you describe, I can see no better place than some of the big ITs.

TJH

[Lootman]

Convention says move to bonds but these prices are currently falling and will no doubt continue to do so for now (and I'll be spending capital).

Fixed interest securities have two disadvantages - they are overpriced, and vulnerable to rising interest rates, and the income is by its nature fixed. You need a rising income.

I think that both of you are making an assumption which is mostly true, but not totally true. A better categorisation than "bonds" or "fixed interest securities" would be "debt securities". The reason I say that is because there are debt securities whose payouts are not fixed. And there are debt securities that do well when rates rise.

I am talking here about instruments like money market instruments, short-dated debt, floating rate debt and inflation-linked debt. Such holdings could protect you if rates and inflation rise, without taking the risk of equities. Some mortgage-backed securities also rise in price and yield when things change.

Not that I disagree with TJH's conclusion here. And indeed I am over 90% invested in equities and have almost nothing in debt. But if risk aversion is the key then I would not rule out a mix of high quality debt securities.

[gbjbaanb]

o Convention says move to bonds but these prices are currently falling and will no doubt continue to do so for now (and I'll be spending capital).

Well, how long do you intend to live? Because if its more than a few months... it doesn't matter what bonds do today. Think what they'll do in 5 years, or 20.

So short-term speculation should be off the cards for you, so you need to decide how much you need to live off. Bonds are goo din that they are fixed interest, so you guarantee some income that won't change (unlike dividends) and the capital won't change (much, unlike stocks).

Personally, I think a good mix is best, bonds for a basic income, and various equities for the rest.

Have a look at: https://portfoliocharts.com/british-portfolios/ for suggestions of mixes of investments and historical returns,

[Mercenary]

Thanks guys.

Just to stress three things I mentioned:
o No need to retain capital (lower fund requirement)
o I am restricting myself here to my "floor" fund, I have other funds with more risk and return.
o Sequential risk.

The "clever maths" includes DCF, sensitivity analysis, etc based on a deep analysis of required expenditure and stress testing returns, inflation, longevity, etc.

[DrBunsenHoneydew]

What you are describing is an index-linked annuity, which would be a very reasonable thing for you to do in the absence of a defined benefit pension. To avoid downside volatility without a guaranteed income you could have an income bond ladder or simply a pile of cash and accept the low interest rates available as the price to pay for the volatility guarantee.

[Mercenary]

What you are describing is an index-linked annuity, which would be a very reasonable thing for you to do in the absence of a defined benefit pension. To avoid downside volatility without a guaranteed income you could have an income bond ladder or simply a pile of cash and accept the low interest rates available as the price to pay for the volatility guarantee.

Excellent. Yes, I think I am thank you (at least that or something very similar). I'm basing my approach on the "Floor" and "Upside" approach detailed here: http://monevator.com/secure-retirement-income/. That mentions an index linked government bonds ladder and annuities as you suggest. I have however encountered the problems mentioned in the article with the ladder: lack of frequent maturities and miserable returns (which may improve but at a loss of capital (bond prices)). And it's a bit too early to take an annuity, combined with the potential upside of higher rates (due to higher interest rates, and a shorter life span) if I wait.

So my question was whether there was anything similar, or temporary until I'm ready for annuities, that I can hold within my SiPP? Or maybe I have too quickly dismissed a bond ladder and it's actually possible. I looked at the retail bonds on offer at HL, AJ Bell, etc. Underwhelmed! Or have I missed something? Should I be looking at corporate bonds as well? Other bonds too like PIBS? Etc?

The best thing I have right now (wish I had more) are the old NS&I inflation certificates. They are rolling over and inflation protected and low risk (capital and institutional). I could cash them in at maturity as and when I need them. I just don't have enough and they are not something I can do with my SiPP funds.

To appease the other posters, I have an upside fund I'm filling up with ITs, income equity and bond ETFs, and specific shares. I'm also filling up other funds for capital costs, etc which are also backed by suitable (in relation to their purpose) investment types.

[Mercenary]

oBonds are goo din that they are fixed interest, so you guarantee some income that won't change (unlike dividends) and the capital won't change (much, unlike stocks). Personally, I think a good mix is best, bonds for a basic income, and various equities for the rest. Have a look at: https://portfoliocharts.com/british-portfolios/ for suggestions of mixes of investments and historical returns,

Thank you for the link. That looks very interesting. I'm starting to find a few more which are definitely worth looking at. I'm certainly going for bonds and equity mixes for my discretionary (upside) income but am not certain about bonds backing my essential (floor) income, except if they were in a bond ladder that enabled me to tap into any increasing rates/lower prices. My intention is to spend capital - I don't need to keep it for anyone.

[Lootman]

temporary until I'm ready for annuities

I can state with certainty that I will never be "ready for annuities" and for one simple reason. The money you pay for an annuity is lost, 100%, immediately. So if you have people you wish to leave money to, then that is a huge disadvantage. Or if you later wanted to draw down that capital and spend it, you can't.

I'd be confident that I could replicate an annuity via a mix of debt securities, preference shares, inflation-linked instruments, money market instruments and equities, without suffering the immediate loss of capital.

If a pension forces you into an annuity (no longer the case, I believe) then perhaps it cannot be avoided. But to voluntarily use your own after-tax capital to buy one has never struck me as desirable. Annuities are great business for insurance companies, which is why they lobbied so hard to force pensions to be converted into annuities. That should tell you something.

[gbjbaanb]

oBonds are goo din that they are fixed interest, so you guarantee some income that won't change (unlike dividends) and the capital won't change (much, unlike stocks). Personally, I think a good mix is best, bonds for a basic income, and various equities for the rest. Have a look at: https://portfoliocharts.com/british-portfolios/ for suggestions of mixes of investments and historical returns,

Thank you for the link. That looks very interesting. I'm starting to find a few more which are definitely worth looking at. I'm certainly going for bonds and equity mixes for my discretionary (upside) income but am not certain about bonds backing my essential (floor) income, except if they were in a bond ladder that enabled me to tap into any increasing rates/lower prices. My intention is to spend capital - I don't need to keep it for anyone.

I'd say you have that the wrong way round, bonds for the floor income, and equities for your risky-but-profitable discretionary income. The idea if guarantees, the bonds will pay the minimum you require, equities could go all over the place, like the times when stock markets dropped 50%.

A bond fund will spread bonds out so they'll have a mix of old, 8% yielders, and newer 4% yielders. As time goes on, they'll buy new bonds at whatever the market thinks interest rates will be.

[Mercenary]

Much as I appreciate the feedback, I'm really interested in practical answers to my questions than exclusively moving off topic to a more academic discussion on which is the best approach. Worth having such a discussion to a point to "kick the tyres" but bottom line is everyone has their own approach so there is no correct, one must have strategy. Bonds may be ideal if we were not in a rate raising cycle with a risk to capital which is an issue for me given my decision to draw down capital (yes, yes, other opinions are available!). Maybe I'm not helping by not explaining the overall approach across all my funds for the sake of brevity and focus.

I've done some more research on bond funds versus bond ladders and, such seems to be the standard operating procedure, there are many differing views. There are however some better commentaries which link back the choice to underlying requirements (e.g. retirement versus specific future expenditures). I've also used the Vanguard tool to look back at equity and bonds mixes over up to the last 20 years (although further back would be helpful as I've heard the current weakening bond bull is some 30 years old). That has given me more confidence about the role of bonds. And of course, I would (can afford) to average in to such a position over 1 to 2 years. Sequential risk is one of my top risks right now (yes it is!).

But I'm trying to think out the box here to see what else there might be other than the bond/equity answer. Always an important step but particularly important as we're currently at an inflexion point in a number of areas. I've been investing and trading for over 20 years and am an experienced finance professional so have a bit going for me. What I lack (following some time off) is a very good understanding of all the investing options. I would still ask the question though even if I thought I did!

[tjh290633]

If it is any help, I have looked at a theoretical bond ladder, using gilts, which has given me negative returns for each 5 year period since 2009-14.

Year   XIRR  
2013    0.21%
2014   -1.23%
2015   -1.64%
2016   -1.45%
2017   -0.47%
2018   -0.48%

I'm told there are clever ways of doing it, which I obviously have not used, but it looks a rather unsound principle to me.

TJH

[Mercenary]

If it is any help, I have looked at a theoretical bond ladder, using gilts, which has given me negative returns for each 5 year period since 2009-14.

Year   XIRR  
2013    0.21%
2014   -1.23%
2015   -1.64%
2016   -1.45%
2017   -0.47%
2018   -0.48%

I'm told there are clever ways of doing it, which I obviously have not used, but it looks a rather unsound principle to me.

TJH

Many thanks for that data point. It does seem to be more a US thing. Maybe bond funds or maybe they are just a different animal (not impressed with the Vanguard paper which, quelle surprise, argued they were better!). Maybe a quick look at the feasibility of a US bond ladder! At the very least, best I have a decent alternative strategy until the current inflexion points clear (accepting the danger there's always a reason not to proceed). I can model these alternatives. Just as well I enjoy doing this stuff!

[Alaric]

Annuities are great business for insurance companies, which is why they lobbied so hard to force pensions to be converted into annuities.

Your evidence for an assertion of lobbying?

Go back far enough in time and pension provision for individuals was deferred annuities. The notion that you accumulated a "fund" and then converted it to an annuity didn't really become the standard design until the 1970s.

Annuity pricing is based on gilt/bond yields and longevity. If rates appear poor/are poor it's because of conservative assumptions about how long we live and the low returns on fixed interest and indexed bonds in the years since Quantitative Easing. What no-one has ever managed to design at a retail level in a totally satisfactory manner is something that combines longevity guarantees with equity investment.

[Lootman]

Annuities are great business for insurance companies, which is why they lobbied so hard to force pensions to be converted into annuities.

Your evidence for an assertion of lobbying?

Three years working for one. Good enough for you?

Annuity pricing is based on gilt/bond yields and longevity. If rates appear poor/are poor it's because of conservative assumptions about how long we live and the low returns on fixed interest and indexed bonds in the years since Quantitative Easing.

My objections to annuities have nothing to do with the fickle notions of where rates are at. They are based on the idea that you hand over all your capital in return for a promise. And that promise is only as good as the solvency of the insurer, as folks who trusted Equitable Life discovered.

Annuities are the devil's work.

[Alaric]

And that promise is only as good as the solvency of the insurer, as folks who trusted Equitable Life discovered.

As far as annuities are concerned, guaranteed ones anyway, Equitable Life honoured their promises as has every other UK insurer. It was the attempt to combine annuities with equity investment in the form of with profit annuities that can unstuck.

[Lootman]

And that promise is only as good as the solvency of the insurer, as folks who trusted Equitable Life discovered.

As far as annuities are concerned, guaranteed ones anyway, Equitable Life honoured their promises as has every other UK insurer. It was the attempt to combine annuities with equity investment in the form of with profit annuities that can unstuck.

Those policy holders may have got lucky in that case. But the fact remains that you can hand over your entire life savings for an annuity, die the next day, and get nothing for it. That is a damning indictment of the product.

And given that I can derive a higher income stream than an annuity from secured investments, and maintain an inheritance, and have the possibilty of capital growth, why would I ever choose an instant sunk cost?

[Mercenary]

Once a ladder is up and running....

Many thanks. Is such a UK bond ladder possible for the retail investor to construct in the UK? If so, via whom and how? Maybe I'm not looking right but not something I seem able to do via say HL. Presumably I should be buying on issuance and not on the secondary market? And direct from the Treasury but then not in a SIPP?

[tjh290633]

Once a ladder is up and running....

Many thanks. Is such a UK bond ladder possible for the retail investor to construct in the UK? If so, via whom and how? Maybe I'm not looking right but not something I seem able to do via say HL. Presumably I should be buying on issuance and not on the secondary market? And direct from the Treasury but then not in a SIPP?

Why not? Any decent online broker will allow you to trade in Gilts. My approach is to choose rungs on the ladder by maturity date, buy 5 years before maturity and if the date is right, allow it to mature. Most gilts mature in March or September, so if you work on March, then sell September maturities 6 months early. Reinvest the cash, plus the interest received in the year, into the next selection with maturity 5 years ahead.

There are other methods but that is mine.

TJH

[AleisterCrowley]

Why not? Any decent online broker will allow you to trade in Gilts

HSDL (Halifax) insist you do it by 'phone rather than online - or this was the case when I asked a year or two back.
From memory one gets stung £25 for 'phone trades

(must be an ETF that does a similar job???)