The Lemon Fool

FredBloggs wrote: This article, in my opinion, in the Telegraph makes interesting reading for those considering starting now on the high income from equities route.

From the article

Last year, Morningstar said it was safe to take just 2.5pc a year, assuming the pot needed to last 30 years and had a 40pc allocation to the stock market.

I'm not sure where they put the remaining 60%, but if it's in cash or bonds yielding 1% or 2% with inflation risk, it's not a total surprise that the recommended withdrawal rate is way down.

Surely you are better off getting 4% even if the income or portfolio value nosedive every so often, than 2%? That's particularly if the 4% has a reasonable expectation of increasing with inflation.

Alaric wrote:

FredBloggs wrote: Surely you are better off getting 4% even if the income or portfolio value nosedive every so often, than 2%? That's particularly if the 4% has a reasonable expectation of increasing with inflation.

We are all used to short, sharp drawdowns lasting a few years followed by a rapid recovery. The risk here would be if the income and portfolio value nosedived and stayed down for a prolonged period. That has not happened for a long time, mid 60s to mid 70s probably the last time it happened, so is a scenario off most investors radar.

The various research behind the article is saying that based on current asset prices and growth expectations, there is a reasonable chance that investing for a 4% income yield will NOT deliver an income that keeps pace with inflation. The higher the drawdown rate/income yield taken, the higher the risk of failure.

There would be a difference between someone with a newly invested portfolio and someone whose portfolio had been invested for some years/some years ago.

If one had had one's portfolio invested for a good few years, its return (as in "dividend income") should have already grown and thus be higher and continue to be so, unless there were a lot of dividend cuts taking place.

richfool wrote:There would be a difference between someone with a newly invested portfolio and someone whose portfolio had been invested for some years/some years ago.

If one had had one's portfolio invested for a good few years, its return (as in "dividend income") should have already grown and thus be higher and continue to be so, unless there were a lot of dividend cuts taking place.

What difference? What is the difference between someone with a historic portfolio, built over many years, who now needs to withdraw say a 2% current yield and a new investor building a portfolio and needing 2%?

hiriskpaul wrote: who now needs to withdraw say a 2% current yield

The article also mentions annual fees. If you incur an annual fee of 2% of your investments, you need to earn 4% to get 2%.

Targeting to leave an inheritance of zero is of itself a high risk strategy from the longevity viewpoint. Surely the inheritance target should be at least a few years' worth of income? If you only ever take the income rising with inflation, the inheritance would likely be the initial portfolio value revalued with inflation.

richfool wrote:There would be a difference between someone with a newly invested portfolio and someone whose portfolio had been invested for some years/some years ago.

As a new investor I set up a 100% Global equity portfolio with similar weightings to the VWRL but using the six regional etfs - VUSA, VUKE, VMID, VERX, VAPX and VFEM.

As the capitalised value of my DB pension amounts to 40% of my equity etfs - I just consider the DB pension as the fixed income part so I just regard I have a 60/40 % equity/fixed income portfolio overall.

Hopefully I should get dividends and capital growth. The equity value does however does fluctuate with the movements in the value of the pound. (I am dreading a very big move up in the pound's value though)

TimR

Alaric wrote:

hiriskpaul wrote: who now needs to withdraw say a 2% current yield

The article also mentions annual fees. If you incur an annual fee of 2% of your investments, you need to earn 4% to get 2%.

Targeting to leave an inheritance of zero is of itself a high risk strategy from the longevity viewpoint. Surely the inheritance target should be at least a few years' worth of income? If you only ever take the income rising with inflation, the inheritance would likely be the initial portfolio value revalued with inflation.

I agree that low fees are really desirable.

The drawdown models don't really target a specific legacy, but typically it is more likely than not that there will be a legacy, even with 4%+ withdrawal rate. If you just take the natural yield on the portfolio, ignoring Armageddon scenarios, you will never run out of money and definitely leave a legacy, but will have to cope with fluctuations in income. That is a very prudent approach to take, but the higher the natural yield of of the portfolio, the higher the risk that the income will not grow with inflation. The natural yield of my SIPP is over 6%, but I am not expecting the income to grow with inflation.

I have had a look for this new research, but have not been able to find it. I did come across this though, which may be related:

http://www.morningstar.co.uk/uk/news/16 ... nsion.aspx

hiriskpaul wrote:What difference? What is the difference between someone with a historic portfolio, built over many years, who now needs to withdraw say a 2% current yield and a new investor building a portfolio and needing 2%?

Agreed there is no difference between taking 2% from a portfolio, old or newly invested.

My point was that a historic portfolio would likely be earning/producing a higher (dividend) income than a newly invested portfolio. E.g. perhaps 5.5% as against a newly invested portfolio perhaps producing 3.5%. (So if one is taking 2% from both, there is a bigger margin left, - more leeway).

richfool wrote:My point was that a historic portfolio would likely be earning/producing a higher (dividend) income than a newly invested portfolio. E.g. perhaps 5.5% as against a newly invested portfolio perhaps producing 3.5%. (So if one is taking 2% from both, there is a bigger margin left, - more leeway).

You mean 5.5% of the originally invested amount presumably? (If not, then why wouldn't the newbie buy the same portfolio today?)

So not really comparing like with like.

Scott.

Just to illustrate a bad outcome from taking the natural yield of a portfolio, I have looked at the Barclays equity/gilts study. In 1965 the historic yield of the UK stock market was 5.2%, but if you took all the income every year, the actual income (before taxes) would have dropped by 50% in real terms by 1975. The inflation adjusted income did not really start to grow much until about 1981, but then recovered rapidly until finally exceeding the starting income in 1987.

The period from 1996 to 2015 also saw a drop and recovery in the inflation adjusted income, but this time the drawdown was nowhere near as severe, the worst year being 2003, when it was down by about 24%. The starting yield in 1996 was 3.7%.

FredBloggs wrote:My view is known here. Equity income is very expensive now and fundamentally risky, more than it ever has been in recent decades.

By what measure is equity income very expensive?

FTSE yield is 3.65, not unusually low historically

Equity dividend yield is historically very high compared with fixed income.

FTSE 100 is 7% higher than it was 17 years ago.

Equities, and the income from them, are of course fundamentally risky (volatile) but that's always the case.

BoE

http://www.telegraph.co.uk/investing/ne ... ion-drops/

Telegraph reports that a new Morningstar study suggests SWR for UK-shares investors could be much lower than for US-shares ones. Several assumptions seem to have been made in the study (40% allocation to shares 60% to bonds; 1% management fee).

I could not find the Morningstar article, but found a similar study they released in May 2016 (with slightly more optimistic conclusions)

http://media.morningstar.com/uk%5CMEDIA ... tirees.pdf

This topic has been covered in another post, on the Investment Strategies board.

Maybe the topics could be merged. Though I think this board would be the more appropriate location.

https://www.lemonfool.co.uk/viewtopic.p ... 135#p88135

There is another (new) post on this subject, on the Retirement Investing (FIRE) board.

Maybe the two topics could be merged. Though I think the Retirement Investing (FIRE) board would be the more appropriate location.

https://www.lemonfool.co.uk/viewtopic.p ... 152#p88152

The Morningstar article was published on October 11th. It is here:

http://www.morningstar.co.uk/uk/news/16 ... .aspx?ut=2

MDW1954

MDW1954 wrote:The Morningstar article was published on October 11th. It is here:

http://www.morningstar.co.uk/uk/news/16 ... .aspx?ut=2

MDW1954

This is a really bad article. The author doesn't seem to understand where the US 4% rule comes from.
It isn't an urban legend it is the result of studies done on historic US stock market returns.

http://www.investopedia.com/terms/f/fou ... t-rule.asp

The four percent rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976. Prior to the early 1990s, 5% was generally considered a safe amount for retirees to withdraw each year. Skeptical of whether this amount was sufficient, in 1994, financial advisor William Bengen conducted an exhaustive study of historical returns, focusing heavily on the severe market downturns of the 1930s and early 1970s. Bengen concluded that even during untenable markets, no historical case existed in which a 4% annual withdrawal exhausted a retirement portfolio in less than 33 years.


Wade Pfau extended Bengen's research to investigate SWRs for other countries

https://finalytiq.co.uk/withdrawal-rate ... k-clients/


Since the concept of perfect foresight is wishful thinking, Pfau’s results for a 50/50 portfolio puts SAFEMAX at 3.43%. But if a 10% probability of failure is acceptable, then the SWR is 4.01%. Interestingly, a withdrawal rate of 5% has a failure rate of a whopping 55.6%! Pfau later revisited the research to see if global diversification improves the SWR. He found that with a 50/50 portfolio the SAFEMAX is 3.26% and where a 10% failure rate is acceptable, the SWR rate is 3.55%. This indicates that the SWR actually worsened for UK retirees.

Also worth noting that Wade Pfau has a website on safe withdrawal rates which is updated with new figures for the US market fairly frequently see

https://retirementresearcher.com/dashboard/

and the section
(2) Sustainable Spending from Volatile Portfolios



Ironically given how bad this latest Morningstar article is they have a fairly good right up of this and look at what the SWR for the UK should be which they published in 2016 suggesting a rate of 2.5% for the UK (though they appear to get this by extending the portfolios right back to 1900 rather than back to 1926)

http://media.morningstar.com/uk%5CMEDIA ... tirees.pdf

The Morningstar piece is just an interview with Dan Kemp, who has apparently updated a paper he wrote in 2016 on "Safe Withdrawal Rates for Retirees in the United Kingdom". The 2016 paper can be found here:
https://media.morningstar.com/uk/MEDIA/ ... tirees.pdf

The old paper seems to address some of the criticisms here - for example, he is aware of where the 4% figure came from:

"Research by Bengen (1994), among others, suggests an initial safe withdrawal rate from a portfolio is 4% of the assets, where the initial withdrawal amount would subsequently be increased annually by inflation and assumed to last for 30 years (which is the expected duration of retirement). "

He goes on to discuss the problems translating this finding to UK retirees, then proposing alternative ideas. His conclusions begin:

"This paper provides a relatively comprehensive overview of safe withdrawal rates for retirees based on both historical returns and forward-looking returns. Overall these findings suggest that financial advisers and retirees in the United Kingdom should use lower initial safe withdrawal rates than noted in prior research — the lower end of the range now starts towards 2.5% or 3.0% and not the previous 4.0%."

Given that this 2016 version has now been revised, it does not seem too useful to review it in much more detail.

Unfortunately, the revised paper doesn't seem to be published yet - at least, a Google search did not find it. So it appears we just have the spinoff publicity to go on at this point. Perhaps we should wait for the revised paper itself to appear before dismissing it completely!

Has anybody considered that this might be written by people who have an interest in the state returning us all to annuities....

I know this is an overly simplistic way of looking at things, and takes no account of inflation, but at 1.9% drawdown, even if you get zero investment returns, spending your capital will take in excess of 50 years.

Just take the natural Income, dividends no less. 3.5% is available from several ITs that have increased dividends for over 20 years. I'm quite happy with a basket of I&G ITs combined with some capital preservation trusts. I'm not saying it will increase by RPI every year but it should be ok.

For most impending retirees tax should not be a probable as they should have invested the max in peps and ISAs, even with average skill, and or luck, that total must be about £600k each, by now.