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  • Writer's pictureNoel Watson

The most efficient way to blow up your retirement plan

Updated: Jun 13


Introduction


Last week, we examined the impact of living too long on retirement income sustainability and found that it was not as great as might be expected for our example clients. Today, we investigate other variables that impact retirement outcomes.


Ian and Janet


We will again be using Ian and Janet, and a summary of their situation is below:


Ian, 62, and Janet, 58, are both in good health and considering retiring next year. Together, they have a retirement portfolio of £1,000,000.


We will make the following assumptions:


  • Both Ian and Janet will not receive a state pension.

  • Taxation and taxation optimisations are ignored.

  • They do not plan to gift to their children or leave a legacy.

  • They are not expecting any inheritances.

  • They do not want to plan for potential care home fees.

  • They are not planning to downsize.

  • Expenditure will increase in line with inflation each year.

  • They are not planning on purchasing a secure income (e.g., annuity) at any stage.

  • Fees are 1.1% per annum, which covers advice, fund and platform fees, and is typically what a client with this amount invested would pay with Pyrford Financial Planning.

  • Their portfolio consists of 70% equities and 30% bonds, broken down as follows:

    • 42% developed market equities (large and mid-cap).

    • 14% developed small-cap value equities

    • 14% emerging markets

    • 30% bonds


We will assume spending starts at £51,500 per annum, and for all scenarios, we will evaluate:


  1. The historical success rate

  2. The safe withdrawal rate (SWR)

  3. How long the money lasts in the worst case



Baseline case: 30-year retirement


As can be seen from the below:


  • The historical success rate is 84%.

  • The SWR is 3.86%.

  • The worst-case historical scenario has the investment pot running out when Janet is 74.





Not diversifying


We have looked at the downsides of not diversifying a retirement portfolio many times previously:



We will replace the current portfolio, which consists of:


  • 42% developed market equities (large and mid-cap).

  • 14% developed small-cap value equities

  • 14% emerging markets

  • 30% bonds


with a portfolio solely consisting of US total market equities.


  • The historical success rate has fallen 7% to 77%.

  • The SWR has fallen 1% from 3.86% to 2.86%.

  • In the worst historical case, the money runs out four years earlier at Janet's age 70.





Not taking enough equity exposure


Challenge two of our 4% rule series examined the impact of reducing portfolio equity content on success rates, and below, we evaluate how it fares versus the other scenarios.


Our baseline portfolio consists of 70% equities and 30% bonds, broken down as follows:

  • 42% developed market equities (large and mid-cap).

  • 14% developed small-cap value equities

  • 14% emerging markets

  • 30% bonds


We will now adjust the top-level asset allocation to 30% equities and 70% bonds with underlying holdings as follows:

  • 18% developed market equities (large and mid-cap).

  • 6% developed small-cap value equities

  • 6% emerging markets

  • 70% bonds


  • The historical success rate has fallen 36% to 48%!

  • The SWR has fallen 0.95% from 3.86% to 2.91%.

  • The worst case has the money out around 3.5 years earlier at Janet's 70.5.




For reference, a client with 50% equities and 50% bonds, broken down as follows

  • 30% developed market equities (large and mid-cap).

  • 10% developed small-cap value equities

  • 10% emerging markets

  • 50% bonds


has the following outcomes:

  • 71% success rate.

  • SWR of 3.5%.

  • The money is exhausted when Janet's is 74, the same as the baseline case.




  • 60% developed market equities (large and mid-cap).

  • 20% developed small-cap value equities

  • 20% emerging markets


we see the following:


  • 91% success rate.

  • SWR of 3.78%.

  • The money is being exhausted at Janet's 72.5 in the worst case.





Investor misbehaviour


Investor misbehaviour leads to a gap between the returns a given portfolio generates and the returns the investor actually receives. Examples of misbehaviour include performance chasing and "buying high and selling low." This gap is known as the behaviour gap.


There is much research on how much the investor underperforms their chosen investment. Challenge fourteen in our 4% "rule" series identified this behaviour gap as ranging from less than 1% to over 5% per annum.


Boring Money's analysis of the bestselling funds/ETFs on the Hargreaves Lansdown platform in March 2024 shows where investor money has been directed. One could argue this is investor misbehaviour in real time!




We can arguably see similar from investors across the pond. According to research from State Street Global Advisors.


"Long-term investors’ aggregate allocation to fixed income, relative to equities, has not been this unbalanced since before the global financial crisis (GFC)".


As the article points out, with U.S. equities outperforming bonds in recent years, this imbalance may be partly related to investors not rebalancing their portfolios, not solely due to performance chasing.


Given the range of behaviour gaps, for our example, we will assume the behaviour gap is 3%. Add fees for platform and investments (no adviser fees as this is a D.I.Y. investor), and the total fees are 3.5%. We will use the same portfolio as the baseline case to focus on investor misbehaviour. Realistically, investor misbehaviour is more likely to go hand in hand with undiversified portfolios, and we explore this in our double bubble example below.


  • The historical success rate plummeted to 49%.

  • The SWR has fallen over 1% to 2.84%

  • The worst case has the money running out three years earlier at Janet's 71.






Paying high fees


Our baseline case uses total fees of 1.1% per annum. Our research on ongoing financial advice fees (financial advice, platform, and investment fees) suggests that the average is between 1.75% and 2.18% per annum. However, these are averages; we have seen cases where ongoing fees approach 3% per annum. For this example, we will assume fees of 2.5%.






Double bubble - not diversifying and investor misbehaviour.


As mentioned above, these two should probably be grouped together, with misbehaving investors tending to performance chase (buying high and selling low) and investing in what is working now (which, by definition, tends not to be a diversified portfolio).


In our analysis of how much needed to be saved for a moderate retirement, we used John Dalton as an example of misbehaviour. John had invested his retirement funds in U.S. tech based on their recent strong performance, and his misbehaviour was costing him 3% per annum, the same as our example above and one we will also use for this example (total fees of 3.5%)


  • The historical success rate has fallen 22% to 62%

  • The SWR has fallen 1.79% from 3.86% to 2.07%!

  • The worst case has the money out 6 years earlier at Janet's 68.






There are many "John Daltons" in the world, and we find them to be typically outspoken in their disdain for the value a financial adviser can provide. As we point out in point 7 of "Ten reasons why we might not be the right financial adviser for you," it's fair to say our investment approach wouldn't be a good fit for a performance chaser!



Conclusion


There are a number of ways to measure how the above scenarios fare versus each other in terms of the efficiency of blowing up a retirement plan. Focusing on just the historical success rate, we can see that a portfolio consisting of 30% equities gave the worst outcome, closely followed by investor misbehaviour. If we compare safe withdrawal rates, we can see that the "double bubble" has by far the worst outcome, and this is also the case for the worst-case longevity.



Our view is that of the three measures, the safe withdrawal rate and worse-case longevity, are where we would focus, as this identifies how much of an adjustment might need to be made if investment returns and/or inflation are not favourable, particularly in early retirement.


In a perfect world, retirees would have outcomes that closely align with the baseline case. In reality, there are many out there paying high financial adviser fees or having a portfolio with an equity content that is too low to give a reasonable chance of a successful outcome. However, we feel that both options will likely give better outcomes than our "double bubble" example. Judging by the HL best buy tables, there seem to be many investors who are at risk of falling into the "double bubble" trap. As can be seen from the two screenshots below, the range of outcomes for the "double bubble" scenario is far greater than for the baseline case. The best cases for both scenarios have a final balance of just north of £6m (in real terms), but as identified above, the "double bubble" worst case is far worse and would, therefore, get our vote for the most efficient way to blow up a retirement plan.





Want to find out more?


Please contact us if you want to build a retirement plan that gives you the best chance of retirement success.



About us


The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.


Our office telephone number is 01932 645150.


Our office address is No 5, The Heights, Weybridge KT13 0NY.


Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.


Although best efforts are made to ensure all information is accurate, you should not rely on this blog for your personal situation or planning.


The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.



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