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Introducing the LemonFools Personal Finance Calculators

Building SIPP for the wife

Including Financial Independence and Retiring Early (FIRE)
tjh290633
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Re: Building SIPP for the wife

#133703

Postby tjh290633 » April 21st, 2018, 10:20 am

GeoffF100 wrote:
tjh290633 wrote:
GeoffF100 wrote:Nonetheless, there is small probability that he will live a lot longer. He cannot afford to take many risks. If there is a bear market, he has very little chance of sitting it out. Hence the heavy bond allocation.


Past experience has been that it is better to sit out bear markets. Usually the income flow is maintained while share prices do their own thing.

You obviously have your own agenda.

TJH

Our man is 90. His life expectancy is 5 years. His cost of staying alive is £10K p.a. There is no social security system. He has £100K. He can invest his money in an index linked bond ladder yielding 0% real (better times than now, but not historically good). Alternatively, he can buy equities. The rule says he should invest £80K in the bond ladder, and 20K in equities. That looks reasonable to me.

Our man ignores this advice and buys equities. A severe bear market strikes. His £100K pot is now worth 30K. "No problem," you say "sit it out." He runs out of money after 3 years and starves.

My agenda is common sense.


Your agenda is based purely on drawing down capital.

The 90 year old will have invested 25 or 30 years ago and will have been drawing some of the income, reinvesting the rest and keeping his capital intact. The income continues during the downturn. If he only needs £10k to live on, he must be a hermit.

It is probable that he will soon need to go into care and will have to be self funded. A decent care home costs £50-60k per year. He would not last much over a year in your model.

TJH

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Re: Building SIPP for the wife

#133733

Postby GeoffF100 » April 21st, 2018, 12:39 pm

tjh290633 wrote:
GeoffF100 wrote:
tjh290633 wrote:
Past experience has been that it is better to sit out bear markets. Usually the income flow is maintained while share prices do their own thing.

You obviously have your own agenda.

TJH

Our man is 90. His life expectancy is 5 years. His cost of staying alive is £10K p.a. There is no social security system. He has £100K. He can invest his money in an index linked bond ladder yielding 0% real (better times than now, but not historically good). Alternatively, he can buy equities. The rule says he should invest £80K in the bond ladder, and 20K in equities. That looks reasonable to me.

Our man ignores this advice and buys equities. A severe bear market strikes. His £100K pot is now worth 30K. "No problem," you say "sit it out." He runs out of money after 3 years and starves.

My agenda is common sense.


Your agenda is based purely on drawing down capital.

The 90 year old will have invested 25 or 30 years ago and will have been drawing some of the income, reinvesting the rest and keeping his capital intact. The income continues during the downturn. If he only needs £10k to live on, he must be a hermit.

It is probable that he will soon need to go into care and will have to be self funded. A decent care home costs £50-60k per year. He would not last much over a year in your model.

TJH

Wouldn't it be great if everyone could afford that. Most people cannot, or have other priorities. A quarter of UK households have less than £100 savings:

http://www.thisismoney.co.uk/money/arti ... ws-25.html

Many pensioners have to survive on less than £10K p.a. However, you get much the same picture if you multiply the numbers in my example by five for someone in care.

Even if we do have far more money than we need in old age, most of us would not like to see most of it disappear in a stock market crash just before we die, and look down from a cloud to see the market recover again, just after we had passed it on to be spent.

The age in bonds rule does assume draw down of capital, but that is too risky for some. Buying an annuity makes more sense for some people, even at the present miserable rates.

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Re: Building SIPP for the wife

#133734

Postby GeoffF100 » April 21st, 2018, 1:11 pm

Quint wrote:The main point here is that a strategy that requires selling down equities to generate an income is not good in a long bear market. A decent sized cash and or bond holding would be needed as a safety net. A strategy where you live on the natural yield of the portfolio will hold up better in a bear market. Investment trusts are one of the products that can help with this..

That is a fundamental mistake. There have been many examples of bear markets where the inflation adjusted income from equities more than halved and took more than twenty years to recover. A mixed portfolio is better than an all equity portfolio because you can sell down bonds in a bear market. You can always reduce risk by reducing the amount of income you are drawing in a bear market. It is no less risky to take all the dividend income from a portfolio of high yielding shares than it is to take the same income from a portfolio of low yielding shares. In the long run, the increased capital growth from the low yielders compensates for the lower dividend.

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Re: Building SIPP for the wife

#133786

Postby tjh290633 » April 21st, 2018, 6:48 pm

GeoffF100 wrote:Wouldn't it be great if everyone could afford that. Most people cannot, or have other priorities. A quarter of UK households have less than £100 savings:

Many pensioners have to survive on less than £10K p.a. However, you get much the same picture if you multiply the numbers in my example by five for someone in care


I don't think that we need concern ourselves with those people who have no savings.

You have this fixation with drawing down capital.

GeoffF100 wrote:
Quint wrote:The main point here is that a strategy that requires selling down equities to generate an income is not good in a long bear market. A decent sized cash and or bond holding would be needed as a safety net. A strategy where you live on the natural yield of the portfolio will hold up better in a bear market. Investment trusts are one of the products that can help with this..

That is a fundamental mistake. There have been many examples of bear markets where the inflation adjusted income from equities more than halved and took more than twenty years to recover. A mixed portfolio is better than an all equity portfolio because you can sell down bonds in a bear market. You can always reduce risk by reducing the amount of income you are drawing in a bear market. It is no less risky to take all the dividend income from a portfolio of high yielding shares than it is to take the same income from a portfolio of low yielding shares. In the long run, the increased capital growth from the low yielders compensates for the lower dividend.


You have also neglected the effects of inflation on bond income and prices. The same force that pull down equity income also pulls down bond income, and also causes bond prices to fall.

If you want income that rises at or faster than inflation, there is no alternative to investing in equities.

TJH

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Re: Building SIPP for the wife

#133790

Postby GeoffF100 » April 21st, 2018, 7:04 pm

As I have said, you can use inflation linked bonds if you are worried about inflation. We recently had a link to a chart showing 60% equities and 40% bonds outperforming 100% equities for the US market over many decades. Mixed portfolios are the usual choice. If people do not like annuity rates, the usual alternative is draw down. There are countless books on draw down. It is not great. If you want certainty and can afford it, buy an annuity.

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Re: Building SIPP for the wife

#133813

Postby GeoffF100 » April 21st, 2018, 9:29 pm

The ITs that the OP is using are likely to have total costs, including transaction costs, that are about 1% p.a. more than the cheapest global tracker. This capital is being stripped out to no good effect. The OP would be better to draw that capital down and put it in his own pocket.

Overseas shares usually have big buy back programs, because dividends are usually taxed less favourably than capital gains. He can draw this capital down without depleting his capital any more than if that capital was returned as dividends.

Income funds are much less well diversified than a world tracker. High yields are restricted to some shares in some sectors in some countries. Less diversification increases the variability of returns, and reduces the risk adjusted return.

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Re: Building SIPP for the wife

#133829

Postby tjh290633 » April 21st, 2018, 10:53 pm

GeoffF100 wrote:As I have said, you can use inflation linked bonds if you are worried about inflation.


You may have noticed that I-L Gilts tend to have negative redemption yields.

TJH

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Re: Building SIPP for the wife

#133847

Postby GeoffF100 » April 22nd, 2018, 7:05 am

Index linked gilts currently have a real redemption yield of about -1.5%, with respect to RPI inflation. You just buy a little more of them to give the inflation linked amount that you need at maturity. CPI inflation is about 1% less than RPI inflation. The real redemption yields are about -0.5% with respect to CPI inflation. The negative real yield is reflection of low nominal interest rates. The implied inflation rate has not risen much.

Some UK index linked corporate bonds have positive real redemption yields. In the US, TIPS have positive real redemption yields.

The role of bonds in a portfolio is not just to make a profit by themselves. It is also to avoid selling equities at unfavourable prices, and provide dry powder to buy equities when their price falls.

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Re: Building SIPP for the wife

#133913

Postby mickeypops » April 22nd, 2018, 2:02 pm

Another interesting discussion about investing for dividend income, or drawing down capital from (for example) index funds.

I fall into the dividend camp. I'd rather risk having to tighten my belt for a year or two in a bear market if the dividend income falls, than be forced to sell off some capital and damage future wealth. Dividend income tends not to fall as heavily as capital values in such circumstances, I believe.

This approach brings with it the peace of mind of not worrying about the state of the markets - just enjoy life and watch the dividends roll in.

I also invest primarily in ITs.

MP

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Re: Building SIPP for the wife

#133938

Postby bluedonkey » April 22nd, 2018, 5:26 pm

I don't pretend to have thought all of this through as thoroughly as other posters here. Thank you to all who have contributed. There's a "but" coming ... but doesn't a simple cash reserve deal with this issue?

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Re: Building SIPP for the wife

#133993

Postby Quint » April 22nd, 2018, 10:48 pm

The crux of the matter is there are several ways of achieving the same goal.

If there were one sure fire method we would all be doing it.

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Re: Building SIPP for the wife

#133995

Postby Quint » April 22nd, 2018, 10:53 pm

bluedonkey wrote:I don't pretend to have thought all of this through as thoroughly as other posters here. Thank you to all who have contributed. There's a "but" coming ... but doesn't a simple cash reserve deal with this issue?


Exactly, it can be cash, bonds, gold or a combination of the above.

I have my reserve in cash and premium bonds, outside of the Sipp, so while the Sipp is 100% equities the overall portfolio is not.

Also we still have human capital so in the medium term (5 - 10) years we can still earn if we need to.

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Re: Building SIPP for the wife

#134029

Postby GeoffF100 » April 23rd, 2018, 8:36 am

bluedonkey wrote:I don't pretend to have thought all of this through as thoroughly as other posters here. Thank you to all who have contributed. There's a "but" coming ... but doesn't a simple cash reserve deal with this issue?

Currently, the best cash account pays 1.25%, but the best 5 year bonds protected by the FSCS pay 2.65%:

https://www.moneysavingexpert.com/savin ... t-interest

The bonds win here. You can use a 5 year bond ladder, so that one matures every year. There is similar pattern for cash ISAs. If you buy bonds from within a stocks and shares ISA, you get a les interest for the same level of risk, but you can buy and sell whenever you wish, and do not have the hassle of transferring each account when it matures.

As I have said, the return from safe bonds has fallen, which has caused investors to sell them in favour of higher risk assets. As a result, the expected return from equities has fallen by more than the fall in the return from safe bonds. Vanguard expects 3% to 5% return from equities over the next decade:

https://www.vanguardinvestor.co.uk/arti ... value-cape

Nonetheless, equities are very volatile, so the actual return could be much higher or much lower than the expected return. Is it worth taking all that risk for an additional expected return of about 0.5% to 2.5%, 1.5% perhaps?

Should we be following the crowd, buying equities and pushing the prices higher and the expected returns lower; or should we be increasing our bond allocation?

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Re: Building SIPP for the wife

#134031

Postby Alaric » April 23rd, 2018, 8:48 am

GeoffF100 wrote: but the best 5 year bonds protected by the FSCS pay 2.65%:


These are locked in bank deposits, not tradeable like equities, gilts or retail corporate bonds.

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Re: Building SIPP for the wife

#134045

Postby GeoffF100 » April 23rd, 2018, 9:28 am

Alaric wrote:These are locked in bank deposits, not tradeable like equities, gilts or retail corporate bonds.

That is what I said. If you want your bonds to be instantly tradeable, you have to accept more risk for the same return, but still very much less risk than investing in equities. I have got both locked in bank deposits and instantly tradable bonds.

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Re: Building SIPP for the wife

#134059

Postby GeoffF100 » April 23rd, 2018, 10:01 am

Actually, some the FSCS protected bonds do allow "instant access", NS&I Guaranteed Growth Bonds, for example, but there is a penalty, and they usually pay less interest. Bond OEICs trade on a forward price, and are not strictly instant access either. I use of mixture of bank deposits and bonds with varying access times.

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Re: Building SIPP for the wife

#134077

Postby Stanley117 » April 23rd, 2018, 11:20 am

GeoffF100 wrote:Should we be following the crowd, buying equities and pushing the prices higher and the expected returns lower; or should we be increasing our bond allocation?


I am struggling with the question of "What bond allocation is it sensible for an investor have" and what type of Bonds should be used as they vary in risk level (FSCS protected, Gov Bonds ETF, Corporate Bond ETF, Bond OEIC Fund, High Yield )

I am 64 so does that mean I should start with the assumption that 64% % of the capital value of my investments should be in Bonds.

If you have some safe pension income should that be taken account of in your Bond Allocation ?

What about our homes - most of us have a substantial investment in UK Domestic property ?

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Re: Building SIPP for the wife

#134112

Postby GeoffF100 » April 23rd, 2018, 12:55 pm

As I have said 64% in bonds would be a reasonable starting point if that is all you had in the world, and you needed the money stay alive.

At the other end of the scale, we have someone who has an index linked pension that exceeds their needs even if they have to go into care. Plainly they can buy whatever investments take their fancy. If the proceeds are going to a good cause, they will want to act in the best interest of the beneficiary. Of course, the beneficiary will want the money now, but lets exclude that possibility. Perhaps, our investor wants the investments as a back stop, in case something goes badly wrong. Would the beneficiary prefer a certain inheritance, or the maximum expected value, whatever the risk? A common default allocation is 40% bonds / 60% equities. Perhaps the bond allocation should be higher when the dumb money is shunning safe bonds and flooding into riskier investments. 60% bonds / 40% cash, perhaps.

I would suggest that, in most cases, your house is somewhere to live, and should not be added to your "equity" investments. A possible exception is if your intend to downsize.

You can only calculate a net present value for your pension income of you know how long you are going to live. You could die tomorrow. If you are investing to fund your own expenditure, I would subtract the pension from your income requirement, rather than count it as a bond investment.

A good approach is to decide how much of your investment is ear marked to fund your own expenditure, and how much is ear marked to fund an inheritance.

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Re: Building SIPP for the wife

#134134

Postby Itsallaguess » April 23rd, 2018, 1:44 pm

GeoffF100 wrote:
I would suggest that, in most cases, your house is somewhere to live, and should not be added to your "equity" investments. A possible exception is if your intend to downsize.


I'd agree with both of those points, but to be honest, if it's available, then the 'downsize option' doesn't sound like too bad a Plan-C -

Plan-A - Internally-generated income (dividends or realised investment capital) is large enough and lasts long enough to maintain a long and happy retirement. This might include an element of over-supply that can be re-invested to create a larger 'income-buffer'

Plan-B - Cash, or near-cash reserves are available that should last a relatively small number of years should an extreme market-downturn occur, where dividends or equity-prices experience large falls. Hopefully dividend payments and equity prices would regain most of their falls before these reserves are depleted completely, allowing more normal service to resume and Plan-A to be picked back up.

Plan-C - Rather than have too much in terms of cash, or near-cash reserves (which might simply be a level of cash that takes too long to generate, meaning retirement might be put off for some years...), having the option to release built-up equity in a house, and downsize to a smaller home, seems to be a useful option to have as a Plan-C, in the absence of a more appropriate 'Plan-C' solution.

Personally, I think there would be a great deal of belt-tightening if Plan-A were to struggle due to a market-downturn, which would hopefully serve two purposes -

1. Prolong the need to activate Plan-B.

2. Help, as much as possible, a move into Plan-B depleting my cash-reserves as slowly as possibly, thus reducing the chances of Plan-B being fully exhausted, and hence not even opening up the possibility of Plan-C being needed at any point.

But still, possibly having large amounts of equity in a home can be useful in the mix, when considering the potential options, and certainly if someone might consider the alternative might be to carry huge amounts of cash or near-cash in Plan-B, without considering the possibility of such a Plan C option......

Cheers,

Itsallaguess

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Re: Building SIPP for the wife

#134140

Postby GeoffF100 » April 23rd, 2018, 1:54 pm

Itsallaguess wrote:Plan-C - Rather than have too much in terms of cash, or near-cash reserves (which might simply be a level of cash that takes too long to generate, meaning retirement might be put off for some years...), having the option to release built-up equity in a house, and downsize to a smaller home, seems to be a useful option to have as a Plan-C, in the absence of a more appropriate 'Plan-C' solution.

The problem with Plan-C is that a global recession that smashes share prices and dividends is likely to smash house prices too. If you do plan to downsize it might be better to do it while house prices are high. Ideally, you want your back stop option to be a really safe one.


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