My investment strategy

[vand]

Annuities are effectively an insurance policy against living for much longer than a person's life expectancy.

They aren't going to show a higher return than gilts when purchased because they are backed by gilts. So the expected return is than available on gilts (of a term roughly equal to life expectancy) minus the insurer's costs and profit.

This is not correct. Purchasing gilts on the open market doesn't take into any consideration for remaining life expectancy, or for any particular preexisting conditions you may have that would "reward" you with a higher rate. The highest paying gilts at the moment are around, what 5.25% on the short end of the curve? Yet if you are 75years old then you can lock in >7% with an annuity right now.

To match the payout available with an annuity the self-managed pot has to be willing to gradually sell off their capital and hope that it doesn't completely run down if they misjudge their remaining lifespan - the annuity buyer has outsourced this problem.

[SalvorHardin]

Annuities are effectively an insurance policy against living for much longer than a person's life expectancy.

They aren't going to show a higher return than gilts when purchased because they are backed by gilts. So the expected return is than available on gilts (of a term roughly equal to life expectancy) minus the insurer's costs and profit.

This is not correct. Purchasing gilts on the open market doesn't take into any consideration for remaining life expectancy, or for any particular preexisting conditions you may have that would "reward" you with a higher rate. The highest paying gilts at the moment are around, what 5.25% on the short end of the curve? Yet if you are 75years old then you can lock in >7% with an annuity right now.

To match the payout available with an annuity the self-managed pot has to be willing to gradually sell off their capital and hope that it doesn't completely run down if they misjudge their remaining lifespan - the annuity buyer has outsourced this problem.

Your 75 year old getting 7% is getting a higher "yield" than gilts because the 7% is a running yield, not the lower redemption yield which allows for the loss of capital (which is much lower). The insurer pays more than the gilt yield because they have already allow for the loss of capital on death (which the insurer gets). If you do a discounted cashflow calculation based on life expectancy then the return will be lower than the gilt redemption yield because of the insurer's costs and profit margin.

The insurer isn't going to back a lifetime annuity for a 75 year old by buying only short gilts unless they are making adjustments to their existing book of annuities, has some weird tax position or are taking a position on interest rate movements.

Yes, the 75 year old could match the gilt yield by buying gilts and then selling them off gradually in accordance with remaining life expectancy. But they've still got the risk to their income that arises if they live longer than their life expectancy.

[Oggy]

To match the payout available with an annuity the self-managed pot has to be willing to gradually sell off their capital and hope that it doesn't completely run down if they misjudge their remaining lifespan - the annuity buyer has outsourced this problem.

Exactly so....I would perhaps add that it also depends on how much you have in your pot. If you have enough so the return covers the spend, and the residual covers next year and so on, then maybe drawdown is the way to go? My very simplistic thinking is that if one has (say) a pot of 500K and it returns 5%/ann and your spend is 25K/ann - ignoring fees and other costs for this example - then you should be OK. Granted there will be fluctuations every year on the rate of return, but provided you don't exceed the spend, in good return years the pot grows to make up the shortfall of the bad years. Feel free to shoot me down in flames.....

[vand]

This is not correct. Purchasing gilts on the open market doesn't take into any consideration for remaining life expectancy, or for any particular preexisting conditions you may have that would "reward" you with a higher rate. The highest paying gilts at the moment are around, what 5.25% on the short end of the curve? Yet if you are 75years old then you can lock in >7% with an annuity right now.

To match the payout available with an annuity the self-managed pot has to be willing to gradually sell off their capital and hope that it doesn't completely run down if they misjudge their remaining lifespan - the annuity buyer has outsourced this problem.

Your 75 year old getting 7% is getting a higher "yield" than gilts because the 7% is a running yield, not the lower redemption yield which allows for the loss of capital (which is much lower). The insurer pays more than the gilt yield because they have already allow for the loss of capital on death (which the insurer gets). If you do a discounted cashflow calculation based on life expectancy then the return will be lower than the gilt redemption yield because of the insurer's costs and profit margin.

The insurer isn't going to back a lifetime annuity for a 75 year old by buying only short gilts unless they are making adjustments to their existing book of annuities, has some weird tax position or are taking a position on interest rate movements.

Yes, the 75 year old could match the gilt yield by buying gilts and then selling them off gradually in accordance with remaining life expectancy. But they've still got the risk to their income that arises if they live longer than their life expectancy.

If you place value on a transferable inheritance then your calculation makes sense. If, however, you are not bothered with that and want to run out of money on the day you die then the only way to do that is with a drawdown pot is to eventually sell off capital, for which you also assume the risk of capital depletion before your time is up.

With a drawdown pot you are forced to plan for tail end life expectancy fully understanding that you are also very likely going to leave money on the table because you won't be one of those tail end charlies.

[Alaric]

Yes, the 75 year old could match the gilt yield by buying gilts and then selling them off gradually in accordance with remaining life expectancy. But they've still got the risk to their income that arises if they live longer than their life expectancy.

Insurers such as Legal & General can earn higher yields than Gilts by investing in other forms of fixed interest. That these are not easily marketable isn't a major problem when used for matching annuity outgo. They may just keep the excess yield as profit, but some of it may end up in the hands of annuitants by virtue of offereing competitive rates.

As a general rule of thumb, annuity rates will track Gilt yields. When Gilts look attractive relative to equities, annuities will as well.

[hiriskpaul]

To match the payout available with an annuity the self-managed pot has to be willing to gradually sell off their capital and hope that it doesn't completely run down if they misjudge their remaining lifespan - the annuity buyer has outsourced this problem.

Exactly so....I would perhaps add that it also depends on how much you have in your pot. If you have enough so the return covers the spend, and the residual covers next year and so on, then maybe drawdown is the way to go? My very simplistic thinking is that if one has (say) a pot of 500K and it returns 5%/ann and your spend is 25K/ann - ignoring fees and other costs for this example - then you should be OK. Granted there will be fluctuations every year on the rate of return, but provided you don't exceed the spend, in good return years the pot grows to make up the shortfall of the bad years. Feel free to shoot me down in flames.....

Oggy, in such a scenario, drawing 5% from an asset growing at 5% but subject to volatility, the expected outcome is that of declining asset value. This may not seem obvious, but is mathematically the case. The higher the volatility, the greater the decline. With zero volatility, you see no decline.

Another (related) risk you have not considered is path dependent risk, something often called sequence of return risk. If you draw 4% from an asset growing at 5%, but subject to volatility, you may still run out of money if the returns come in the wrong order. Specifically, big declines early on in drawdown followed by large gains later.

[Oggy]

Hiriskpaul - I did say it was a simplistic view! I appreciate the points, but not sure what I can do about it unless I buy an annuity. Low cost global trackers look pretty stable and that is what I am invested in.

[hiriskpaul]

Hiriskpaul - I did say it was a simplistic view! I appreciate the points, but not sure what I can do about it unless I buy an annuity. Low cost global trackers look pretty stable and that is what I am invested in.

Depends what you mean by stable! Equity ETFs can easily fall 50% or more, or go into a multi-year bear market.

There are things you could do to mitigate sequence risk without impinging significantly on long term investment returns or buying an annuity.

The state pension is a good safety net to cover basic needs, but you are 8 (?) years away from it. To bridge the gap you could put £80k or so into a short dated, or ultrashort bond ETF, such as ERNS. Draw from that each year until you get your state pension.

Another thing to do is invest part of your portfolio in a short dated bond fund to reduce overall portfolio volatility. It is quite surprising how having just 10% in cash or short dated bonds can mitigate the truly terrible historical periods when equity markets melted. At the same time, 10% in cash would have had very little impact on the upside.

Warren Buffett has said that his wife's portfolio will be 90% S&P 500, 10% short dated bonds, so you would be Iin good company if you adopted something similar.

[Oggy]

Paul

I was thinking of transferring part of the pot in to Vanguard's equity/bond mix fund where you can select how much in equity/bonds say 50/50 for example, but I guess returns would fall off if the market doesn't bomb.

About 30% of my pot is in USB's S&P 500 tracker - following Mr Buffett's example. Rest in Fundsmith and various global trackers.

[Hariseldon58]

Paul

I was thinking of transferring part of the pot in to Vanguard's equity/bond mix fund where you can select how much in equity/bonds say 50/50 for example, but I guess returns would fall off if the market doesn't bomb.

About 30% of my pot is in USB's S&P 500 tracker - following Mr Buffett's example. Rest in Fundsmith and various global trackers.

Urbandreamer linked to “Beyond the 4% rule”. It’s a good introduction to this problem of investing for a retirement pot.

There is no simple solution, I have already given some details of my experience over the last 16 years, it’s working well so far !

You probably can reasonably expect 5% from a global equity return over time but that’s an average that will be highly volatile.
It’s naive in the extreme to think that you get 5% average equity return so I can take 5% a year, that volatility of returns makes a big difference, you may be lucky or unlucky . It’s the six foot man drowning crossings a river of average depth 5 feet !!!

The more wiggle room you have to adapt to circumstances the more likely a drawdown pot will work, if you have limited resources then an annuity provides certainty but even then you have to gamble on whether to have an RPI linked annuity or a flat rate.

There’s a huge amount of literature on this subject of how to drawdown a retirement pot to provide a lifetime income , lots of books and no definitive answer.

Many years ago I went to Oxford to read mathematics and one of the jobs ( I was told by school teachers ) that this might have led to was as an actuary, for such things as annuities and I remember looking at the numbers behind them. I decided being an actuary was not for me !!!

The lack of transparency makes them a profitable proposition for an insurance company. (provided the actuary gets his numbers right ! )

[hiriskpaul]

Paul

I was thinking of transferring part of the pot in to Vanguard's equity/bond mix fund where you can select how much in equity/bonds say 50/50 for example, but I guess returns would fall off if the market doesn't bomb.

About 30% of my pot is in USB's S&P 500 tracker - following Mr Buffett's example. Rest in Fundsmith and various global trackers.

Vanguard life strategy funds are OEICS. Expensive to hold in either HL or AJ Bell SIPPs. If you want something like that, a DIY approach using annually rebalanced equity and bond ETFs would be cheaper.

[Oggy]

Vanguard life strategy funds are OEICS. Expensive to hold in either HL or AJ Bell SIPPs. If you want something like that, a DIY approach using annually rebalanced equity and bond ETFs would be cheaper

...and for the benefit of a financial ignoramus like myself, can you elaborate on that DIY approach please! Do you simply mean buy a cheap 100% bond fund?

[Hariseldon58]

Vanguard life strategy funds are OEICS. Expensive to hold in either HL or AJ Bell SIPPs. If you want something like that, a DIY approach using annually rebalanced equity and bond ETFs would be cheaper

...and for the benefit of a financial ignoramus like myself, can you elaborate on that DIY approach please! Do you simply mean buy a cheap 100% bond fund?

The Vanguard Lifestrategy funds contain a mixture of a Global tracker with an over weighting of UK equities and an aggregate global bond fund ( except for the 100% equity option)

So the ETF equivalent could be a mix of three vanguard ETFs, VWRL for the Global Equity , plus VUKE FTSE 100 tracker ETF , roughly 4 parts VWRL to 1 part VUKE then the remainder for the bonds would be VAGP

This would be the distribution version, the accumulation funds would VWRP, VUKG and VAGS

Before you worry about which fund/ETF have a wider read about decumulation and drawdown strategies, then come back with questions, it’ll make more sense then.

[Wuffle]

A left field perspective.

A lifelong PAYE employee has less adjusting to do with an annuity. They do a job.
You have spent decades with a fixed amount coming in and that continues.

A more flexible individual has nothing to fear from sequence of return risk or longevity.
The semi part of semi - retirement is flexible, you just don't want it to be.
The 'my portfolio must throw off X' is flexible. It is possible to spend less, you just don't want to.
If this isn't true, see 'semi - retirement'.
The 'best' method for you is maybe about you not the maths.

W.

[skyshield]

Drawdown or annuity? It's a toss-up. Trackers are cool, Fundsmith too, but markets play hard to get. HL and AJ Bell? FSCS might have your back, but double-check.

[PrefInvestor]

I am not sure whether I would need to sell capital to get by in retirement. The funds held in the SIPPs would (hopefully!) grow annually by an amount to roughly what I would spend annually - or am I being optimistic? Clearly there would be good and bad fund years, but hopefully they would cancel each other out. As a very rough guide, I'd want the fund pot to grow @5% annually which I don't think is a big ask.

When you are young and in the accumulation phase of building your pension pot then yes global trackers are a sensible growth solution. But when you have retired what you need most of all is a guaranteed income stream which is as inflation proofed as possible such that the income generated by the portfolio will see out your remaining years. Yes you might get by with investing purely for growth and withdrawing some money from the portfolio occasionally to live on, but if the market has a bad year and your investments crater you could do very badly indeed - as capital lost in that way is not so easily recovered. I see that as a high risk retirement income option and not one that I’d like to take.

Many on the Lemon Fool invest mostly for income (and ideally some growth to go with it) and the UK is a good place to invest for income. You try investing for income in the US where many stocks don’t pay dividends and are very volatile, and if they do pay a dividend then there will be FX fees and withholding tax to worry about. If you are going that route then you need a multi-currency SIPP IMHO as using ISAs incurs additional costs.

Fixed interest investments CAN deliver both income and growth. We personally doubled our portfolio value between 2011 and 2018 by investing in preference shares. Bonds can also deliver useful income and growth, not comparable with the growth from US tech stocks maybe, but a lot more predictable and safer IMHO.

But as always we must all DYOR and make our own decisions. However I do feel that the dismissal of the UK market is mis-judged particularly from an income generation perspective. Your thoughts appear very capital value oriented to me....

ATB

Pref

[jaizan]

Forget it. One is insurance and the other an at risk investment portfolio;

The real value of an annuity is also "at risk". They either have no inflation indexation or have some pitiful increases up to 3%.

So if we have relatively high inflation for the next 20 years, you annuity can lose most of it's real value. Ultimately it's purchasing power that counts.

[tjh290633]

Forget it. One is insurance and the other an at risk investment portfolio;

The real value of an annuity is also "at risk". They either have no inflation indexation or have some pitiful increases up to 3%.

So if we have relatively high inflation for the next 20 years, you annuity can lose most of it's real value. Ultimately it's purchasing power that counts.

My annuity gives RPI up to 5%. Unfortunately, when the RPI exceeds that value, the annuity doesn't catch up when the RPI falls below 5%, but on the other hand it does not fall when RPI falls below zero. It resumes tracking the RPI when it rises again.

There is a risk, but a comparatively slight one.

On the other hand, the income from my investment portfolio has increased considerably more than the RP over its existence. It has fallen on occasions, such as in 2009-10, but has never fallen behind the increase in the RPI. I have reported this in various forums on this site. This might not be the case for a portfolio concentrated in a few holdings, where the risk to both capital and income are higher than for my current 35 holding portfolio.

TJH