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Equity / Bonds Ratio with DB/DC Mix

Including Financial Independence and Retiring Early (FIRE)
xxd09
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Re: Equity / Bonds Ratio with DB/DC Mix

#444852

Postby xxd09 » September 23rd, 2021, 9:39 pm

Just to clarify
Set your desired retirement income
Deduct your DB and State Pension income
The remaining income comes from your investment portfolio
Using my 60/40 guidelines you can then roughly assess how much savings you would need
That’s the simple bit
More savings,work longer or both or may be you have enough saved already?
xxd09

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Re: Equity / Bonds Ratio with DB/DC Mix

#444864

Postby Newroad » September 23rd, 2021, 10:08 pm

Hi xxd09.

Indeed to clarify - as per my earlier example (3) - there is no desired/target retirement income (as it happens, this is true for me). I'll accept what I get.

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.

Hence, the problem at hand - to what extent, if any, does the DB expectation affect how the DC allocation split should be made.

Regards, Newroad

PS I do understand what you are saying if a desired/target retirement income is instead the end goal, irrespective of the risk (lesser or greater) taken to get there

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Re: Equity / Bonds Ratio with DB/DC Mix

#444869

Postby tjh290633 » September 23rd, 2021, 10:19 pm

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.

TJH

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Re: Equity / Bonds Ratio with DB/DC Mix

#444872

Postby Newroad » September 23rd, 2021, 10:23 pm

Hi TJH.

Yes, I have been following it.

However, the 60/40 in this topic only for purposes of discussion (though, I suppose, my actual 66/34's and 75/25 are real).

The salient question of this topic, the one I think JohnnyCyclops was asking and the one I certainly am, is to what extent a DB income stream might be formally measured so as to affect the 40 (or the 34, or the 25, or any other such number).

Regards, Newroad

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Re: Equity / Bonds Ratio with DB/DC Mix

#444878

Postby xxd09 » September 23rd, 2021, 10:52 pm

I think you will find it hard to set up a functional plan if a basic parameter like some sort of desired retirement income is missing
I understand the urge to optimise but a desired income would add focus
I found in retirement for instance that I was spending as much as when I was working
My portfolio could stand this
That might be a guideline to aim for
Few of us would be aiming to spend more that our working salary in retirement
If “Optimising” is the desired plan however then go for as much equities in your portfolio as your stomach acid can handle!
xxd09

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Re: Equity / Bonds Ratio with DB/DC Mix

#444880

Postby Newroad » September 23rd, 2021, 11:11 pm

Hi xxd09.

I disagree on both the need for a desired retirement income (to have a plan) and that increasing equity allocation to some tolerance level represents optimisation.

However, exploring either of those discussions would ideally be the subject of another topic - they're not (IMO at least) directly germane to this one. The former is ruled out by the example parameters set and the latter by the assumption of the hypothetic person that 60/40 is the right split (I am not insisting this is correct in reality - though it may possibly be, or thereabouts).

Regards, Newroad

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Re: Equity / Bonds Ratio with DB/DC Mix

#444883

Postby JohnnyCyclops » September 23rd, 2021, 11:38 pm

Newroad wrote:Hi TJH.

Yes, I have been following it.

However, the 60/40 in this topic only for purposes of discussion (though, I suppose, my actual 66/34's and 75/25 are real).

The salient question of this topic, the one I think JohnnyCyclops was asking and the one I certainly am, is to what extent a DB income stream might be formally measured so as to affect the 40 (or the 34, or the 25, or any other such number).

Regards, Newroad


Yes, you’ve got it, and also with your three options earlier. A little late for me, so a more considered reply tomorrow or the weekend. Many thanks, Newroad.

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Re: Equity / Bonds Ratio with DB/DC Mix

#444893

Postby AWOL » September 24th, 2021, 5:54 am

JohnnyCyclops wrote:
Newroad wrote:Hi TJH.

Yes, I have been following it.

However, the 60/40 in this topic only for purposes of discussion (though, I suppose, my actual 66/34's and 75/25 are real).

The salient question of this topic, the one I think JohnnyCyclops was asking and the one I certainly am, is to what extent a DB income stream might be formally measured so as to affect the 40 (or the 34, or the 25, or any other such number).

Regards, Newroad


Yes, you’ve got it, and also with your three options earlier. A little late for me, so a more considered reply tomorrow or the weekend. Many thanks, Newroad.


Personally I prefer the ERN google sheet I mentioned above but another method is to use the RPI linked annuity to work out an equivalent cash value for the pension benefits. This can be done for DB pension or by somebody approaching state pension and wishing to keep a similar risk profile after retirement. Ideally rebalancing is done taking into account the current equivalent annuity rates. https://www.hl.co.uk/retirement/annuiti ... -buy-rates

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.

Note that for the above example I invented an RPI annuity rate at 55 that made the arithmetic simple although it happens to be close to the RPI annuity at age 60.

Another approach some people take it to do a similar calculation based on dividing income by bond rates but in the current environment I think the answer from this is too large and I think bonds are less appropriate as one does have access to the capital with bonds whereas the annuity approach is reasonable as it is an equivalent as one doesn't have access to the capital after purchase like with DB pensions.

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Re: Equity / Bonds Ratio with DB/DC Mix

#444895

Postby Itsallaguess » September 24th, 2021, 6:30 am

xxd09 wrote:
I think you will find it hard to set up a functional plan if a basic parameter like some sort of desired retirement income is missing

I understand the urge to optimise but a desired income would add focus
I found in retirement for instance that I was spending as much as when I was working
My portfolio could stand this

That might be a guideline to aim for

Few of us would be aiming to spend more that our working salary in retirement


I'd agree that a desired retirement income is one of the key planks when considering this type of discussion, but I just wanted to mention how surprised I've been over the years when I've been taking this into account in my post-working plans, regarding that 'retirement spending', and how post-retirement funding can often be really quite different to the regular working wages seen previously, often for some or all of the following reasons -

1. Over a long investment lifetime, investments can often largely be sheltered from tax, which means that for a given level of tax-facing wages, a lower 'non-tax-facing' amount is often adequate to provide the same level of retirement 'cash in hand'

2. As I've moved towards the back end of my working-life, I've found that a larger and larger percentage of my regular wage is being used for investment purposes, and my retirement plans are to cut back on that funding requirement once I move into that post-work phase...

What has remained of my regular wages, after the removal of all 'work-related' deductions (income-tax / national insurance / pension payments / share-save etc..), and then after the removal of my regular investment funding, has been sufficient for me to live on for many years, and has been successfully recorded and tracked in my Microsoft Money package, and it's when I look at *that* level of retirement funding-requirement where I can really appreciate that it's actually only a moderate percentage of my current working salary...

In fact looking at a recent set of pay-slips, I can see that to take home 100% of my 'cash in hand' wages, I've actually had to start with a cash figure around 30% higher than that, taking into account all the various work-related deductions, and then of that remaining 100% 'cash in hand' wage, I'll probably invest around half of it, so taking all of that into account, my 'yearly retirement income' could potentially be around 30% of my normal 'top-line' salary, and still provide exactly the same 'actual lifestyle funding' as my current working salary...

This was a bit of an eye-opener for me once I saw it all calculated on a working spreadsheet, so I think anyone getting too 'wedded' to the idea of replicating their current salary in their retirement phase might do well to consider this area in more detail as well, as it's clearly an important driver for most of our retirement planning...

I only mention this because of your phrase above that you were 'spending as much as when you were working', and I think it's important to be clear on the fact that for many of us, final-spending can often stay roughly the same in both a working-life and a retirement-phase, but where overall income in each of those phases could possibly be quite drastically different....

Cheers,

Itsallaguess

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Re: Equity / Bonds Ratio with DB/DC Mix

#444899

Postby Dod101 » September 24th, 2021, 7:12 am

I cannot contribute to this discussion but after many years of retirement I can say with some confidence that you non retirees worry far too much. Just get on with life and make sure that at retirement you have an aim or even requirement for your retirement income, deduct the DB pension (if any) and be sure you are left with roughly 25 times your net required extra income as capital. Problem solved. As Swill I think it was has said, you do not need bonds at all. although as it happens I have always held some bond funds(maybe 10%, now down to 5% at most). They have been not much good as a capital investment but do provide an assured income and provide some diworsification.

Dod

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Re: Equity / Bonds Ratio with DB/DC Mix

#444909

Postby Itsallaguess » September 24th, 2021, 7:46 am

Dod101 wrote:
I cannot contribute to this discussion but after many years of retirement I can say with some confidence that you non retirees worry far too much.

Just get on with life and make sure that at retirement you have an aim or even requirement for your retirement income


I'm not 'worrying' though - I'm 'aiming', and hoping to calibrate that aim as best I can and with as good an understanding and appreciation of any underlying issues as I can...

There's a difference....

Cheers,

Itsallaguess

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Re: Equity / Bonds Ratio with DB/DC Mix

#444910

Postby Dod101 » September 24th, 2021, 7:59 am

Itsallaguess wrote:
Dod101 wrote:
I cannot contribute to this discussion but after many years of retirement I can say with some confidence that you non retirees worry far too much.

Just get on with life and make sure that at retirement you have an aim or even requirement for your retirement income


I'm not 'worrying' though - I'm 'aiming', and hoping to calibrate that aim as best I can and with as good an understanding and appreciation of any underlying issues as I can...

There's a difference....

Cheers,

Itsallaguess


I certainly never went into my retirement or before it with any of these 'aims'. What i did at retirement was took some advice, mainly on asset allocation. It was sensible at the time but after more than 25 years, I am left with the small bond funds and about three years spending in cash. Otherwise my investments are all equities. It is right surely to have aims and to check that you are moving in the right direction but then just get on with life.

I do not think JC should think of a DB pension as an investment. There is nothing he can do about it as it is all invested behind the scenes and whatever happens in the markets should not affect its guarantee. That is for the pension trustees to worry about not him. His concern is that they maintain their guarantee to him.

Dod

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Re: Equity / Bonds Ratio with DB/DC Mix

#445016

Postby jonesa1 » September 24th, 2021, 12:47 pm

Working out how to optimize returns requires making assumptions which may be utterly wrong. Portfolio allocations, such as 60/40, attempt to avoid the worst impacts during bad times and take some benefits from the good times, they are very unlikely to be optimal, but with conservative assumptions can (hopefully) sustain a target burn rate. The approach I've ended up with is based on defining a target net income which gets uplifted each year to reflect an arbitrary measure of inflation. The DB pension providers well over half of the income, investments cover the gap and in a few years the gap should reduce when my state pension is paid (temporarily because inflation continually erodes the value of the DB pension). The investment portfolio holds enough cash to cover 3 - 4 years of gap funding, plus some "wealth preservation" assets, with the rest in equity ITs The withdrawal rate from the investments is currently less than 3%. Given that I could manage, if really necessary, on just the DB income, my allocation is possibly too cautious.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445018

Postby xxd09 » September 24th, 2021, 1:01 pm

Is it just my impression or is it true that investors in their flight from bonds are going to equities and cash only portfolios
ie 100% equities and a few years( 3-8 ) living expenses in cash
This makes for a very high performing but very volatile portfolio
As long as equities keep going up all will be OK but is this the real world?
xxd09

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Re: Equity / Bonds Ratio with DB/DC Mix

#445035

Postby Alaric » September 24th, 2021, 1:39 pm

xxd09 wrote:Is it just my impression or is it true that investors in their flight from bonds are going to equities and cash only portfolios
ie 100% equities and a few years( 3-8 ) living expenses in cash
This makes for a very high performing but very volatile portfolio
As long as equities keep going up all will be OK but is this the real world?
xxd09


With interest rates the way they are, there's not so much choice for a decent return. Cash or near cash is held against the risks to a drawdown investor of equity dividend cancellations and market crashes. Arguably a collective fund of short dated Corporate Bonds could be considered near cash if there isn't an absolute requirement of capital protection.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445039

Postby ursaminortaur » September 24th, 2021, 1:55 pm

jonesa1 wrote:The DB pension providers well over half of the income, investments cover the gap and in a few years the gap should reduce when my state pension is paid (temporarily because inflation continually erodes the value of the DB pension).


UK DB pensions have legally had to provide a minimum level of indexation for pensions built up from 1997 onwards (though many provided it before then and many others retrospectively applied it to what had been built up in their DB pension before 1997).

https://commonslibrary.parliament.uk/research-briefings/sn05656/

Defined Benefit (DB) pension schemes provide pension benefits based on salary and length of service. There are statutory minimum requirements on them to:

Index pensions in payment in line with inflation, capped at 5% for benefits accruing from service between April 1997 and April 2005, and at 2.5% for benefits accruing from April 2005 – known as Limited Price Indexation (LPI) (Pensions Act 1995, s51);
Revalue the deferred pensions of early leavers in line with inflation capped at 5%, and at 2.5% for rights accrued on or after 6 April 2009 (Pension Schemes Act 1993).

Importantly, these are statutory minimum requirements -there is nothing to prevent schemes from making more generous arrangements through their scheme rules.


Many DB schemes rules will provide more generous indexation than these legal minimums.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445065

Postby Newroad » September 24th, 2021, 3:05 pm

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

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Re: Equity / Bonds Ratio with DB/DC Mix

#445071

Postby Dod101 » September 24th, 2021, 3:20 pm

xxd09 wrote:Is it just my impression or is it true that investors in their flight from bonds are going to equities and cash only portfolios
ie 100% equities and a few years( 3-8 ) living expenses in cash
This makes for a very high performing but very volatile portfolio
As long as equities keep going up all will be OK but is this the real world?
xxd09


That is certainly what I do (but add in a very small amount in bonds) With a fairly conservative portfolio it is not unduly volatile. In any case, so what? I live off the income and so although I regard capital as very important, I am quite prepared to see it drop significantly at times, the latest being in March 2020 when my portfolio value dropped briefly by about 25% from its peak a few weeks earlier. That is not comfortable but on the whole values tend to recover fairly quickly unless we hit a long term recession. Is this the real world? You gotta believe so! Would I have been better with 25% in bonds? I don't think so and cannot see the benefit. That is the real world and if you intend to live off your investments you had with respect, better get used to it.

Dod

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Re: Equity / Bonds Ratio with DB/DC Mix

#445104

Postby jonesa1 » September 24th, 2021, 5:22 pm

ursaminortaur wrote:
Many DB schemes rules will provide more generous indexation than these legal minimums.


Sadly, mine isn't one of them, no guaranteed uplifts on pension earned pre-1997 (the trustees have negotiated some recent increases, but the default is zero and that's likely to be the long term reality) and statutory (CPI capped at 5% or 2.5%) since then. The pension closed to existing members (making us all deferred members) several years ago, nearly half my pension has no guaranteed indexing.

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Re: Equity / Bonds Ratio with DB/DC Mix

#445114

Postby Hariseldon58 » September 24th, 2021, 5:50 pm

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.


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