Cash & Bonds Total Return Investing in Retirement

Discussion in 'Other Asset Classes' started by Nodrog, 5th Feb, 2018.

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  1. Nodrog

    Nodrog Well-Known Member

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    For total return asset allocators it can be confusing for some in how to manage cash flow in retirement. Typically the defensive component of the portfolio is a quality Bond Fund during the Accumulation years. Of course a Bond Fund offers liquidity, interest income and acts as a volatility dampener on the overall portolio given it’s inverse relationship to equities (most of the time). But unfortunately a Bond Fund makes it difficult at times to manage reliable cash flow in retirement given unknown capital return and interest income at a future point in time. That is, reliable Liability Matching. Of course the typical response is to just withdraw from the best performing asset class. But the relationships / Correlations sometimes don’t work as expected. A large Cash buffer is another option but the return can be low at times. And remember one tends to be more conservative and nervous once in retirement so “SURPRISES” from Equities is bad enough let alone surprises from the BOND FUND as well!

    Alternatively Term Deposits (also known as GICS in the US / Canada) quite often offer a higher rate of interest than Gov’t Bonds, are guaranteed by the Gov’t to $250k per banking institution in Australia, have NO FEE and one knows the interest income and guaranteed capital return for the duration of the Term Deposit. But it’s main disadvantage is liquidity (eg for rebalancing / opportunitistic buying).

    Not everyone has the luxury of not having to draw down capital in retirement. Hence I thought the following articles offered a useful strategy for the total return investor. In particular rather than bonds vs Term Deposits the strategy combines both the Bond Fund for liquidity and Term Deposits for a guaranteed known capital / interest return for reliable Liability Matching being living expenses. Importantly Cash is included to meet short term liquidity needs.

    A better way to generate retirement income

    This second article might even be useful for the nervous Accumulator as well as the Retiree:

    The Most Boring Battle Ever: Bond ETFs or GICs? – Canadian Portfolio Manager Blog

    I found this table from the above quite useful:
    0FDA40C6-C1BE-4505-BA73-FB99B7B9891D.jpeg
    This isn’t my investing approach so @The Falcon, @Redwing, @Ross Forrester and others who follow the Total Return approach may wish to dissect this and comment further.
     
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  2. Zenith Chaos

    Zenith Chaos Well-Known Member

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    Very interesting.

    I've been reading about stockmarket history and the importance of decreasing volatility, aka Beta. In a nutshell: if your portfolio loses 30% for example, you need a lot more - i.e. 42% return, to get back to even. Therefore, decreasing volatility (how far it goes up and down) is a way to increase overall return, particularly if you can decrease volatility when the market crashes. One of the ways to decrease volatility is to have a bond (or cash etc) allocation.

    One of the excellent solutions suggested around here is to hold 3 years spending in cash, which reduces the need to sell stocks when they are low. However, this 3 year cash buffer is in fact equivalent to reducing volatility. For example, if spending is 5% of the portfolio (a simple round figure that seems to approximate reality), it means that the 3 years cash on hand is equivalent to having around 15% in bonds / cash.

    Over the very long term, 100% buy and hold equities will give superior returns, but there have been 10 year periods where bonds have returned better than equities.

    The conclusion if you are approaching retirement (including early retirement), where you are relying on portfolio return to survive, it may be wise to progressively decrease volatility by increasing allocation to cash / bonds to the point that it reaches around 3 years of your spending (or as a percentage of your portfolio, half of what you are willing to lose). One should be able to obtain sufficient money to live from dividends, cash, and then selling bonds without having to sell equities. Maintain the 3 year allocation into retirement and consider increasing allocation to bonds / cash in situations where valuations appear extreme.

    * No GICs in available via my super provider, but it may be a valid option for non-super funds.

    Not advice.
     
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  3. Nodrog

    Nodrog Well-Known Member

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    The ideal scenario (nerves permitting) is to have enough wealth to be able to live on interest and dividends alone after stress testing the portfolio against worst historical market events.

    Even Jack Bogle says “stocks for their dividends, bonds for their interest”. But again only useful if you have enough wealth to do this.

    I don’t hold Bond Funds as they don’t serve much purpose in our case. Cash and TDs (at times) along with dividends suit us fine. And when it comes to the risk free part of our portfolio I don’t want any surprises.
     
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  4. SatayKing

    SatayKing Well-Known Member

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    I suspect JB was, possibly inadvertently, ripping off John Burr William from the 1930's tome Theory of Investment Value:

    A cow for her milk,
    A hen for her eggs,
    And a stock, by heck, for her dividends.

    Another bon mot from Mr William.

    If a man buys a security below its investment value he needs never lose, even if the price should fall at once, because he can still hold for income and get a return above normal on his cost price.

    Totally tangential to the discussion her. I tend to do that.
     
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  5. Nodrog

    Nodrog Well-Known Member

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    Always a source of wisdom you are @SatayKing. I didn’t realise you owned a cow and some chickens as well as LICs:cool:.
     
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  6. SatayKing

    SatayKing Well-Known Member

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    It's Canberra, my good fellow. Don't you know they keep up the tradition of providing public servants, even former consultant ones, cows and hens for the 300 sqm blocks on which we reside in splendor?

    Serious note, the second quote from JB William can easily be applied to LIC's and the respective NTA. Reason why I was hoeing into PIC until I let it slip I was and some unnamed person priced it out.

    Bloody early for thread drift isn't it?
     
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  7. Nodrog

    Nodrog Well-Known Member

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    We generally use a cash buffer approach of around three years generous total living expenses. But it has increased in recent times. Probably will continue to do so as we get older. We have also stress tested our portfolio against a Great Depression type of event both financially and psychologically as best we can.

    An all equity portfolio with a cash buffer of a few years living expenses is fine provided you’ve got the intestinal fortitude to hold your your nerve if the market falls 50% or more. The whole risk vs risk free portfolio allocation decision has little to do with performance but mostly sleep at night factor.
     
  8. Intrigued_again

    Intrigued_again Well-Known Member

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    All we did was check what tax and costs we had to pay if we sold that was enough to make you vomit, certainly didn’t come from "intestinal fortitude"
     
  9. Nodrog

    Nodrog Well-Known Member

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    Well we’re set with:

    1. LICs for their dividends.

    2. Chickens for their eggs:
    B6A978DF-825C-4C12-9A26-1B0A5FE457D6.jpeg

    3. Neighbours cows for their milk:
    2BE734A2-DA9F-4A5D-8A10-23EDFF53BD5A.jpeg
     
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  10. Nodrog

    Nodrog Well-Known Member

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    Tax not so much of an issue with SMSF holdings but transaction costs can add up:).

    Ok so now we need to replace the Sleep at Night Test with the Vomit Test:D:

    35CE62C5-00CD-40D1-9965-73ACF6EED9C6.jpeg
     
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  11. Ross Forrester

    Ross Forrester Well-Known Member

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    We have a cash buffer for disaster in our offset accounts. The smsf has a zero cash buffer with a continual dollar cost averaging strategy.

    So in terms of our bucket theory our bucket is dry. Mum and Dad have 7 years in Cash.

    And they look at their shares daily and panic when the dividends are lower than last quarter.

    The only way I have seen to reduce market beta is cash and a few limited (classical) bonds. Otherwise you cannot get rid of all beta by diversifying outside Cash.

    “We’re all in this together” - Ben Lee
     
    Last edited: 5th Feb, 2018
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  12. Zenith Chaos

    Zenith Chaos Well-Known Member

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    Beta can not be completely removed, not even by cash. However, cash, bonds, even hedging are valid ways of reducing beta. I like cash over bonds because it is my loaded gun in preparation for a crash. Bonds are a gun without bullets kept on my country property.
     
  13. The Falcon

    The Falcon Well-Known Member

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    You can reduce single market beta (1.0) without significant return drag with unhedged international equities (0.8) and Listed Property (0.6) .....before your get to the standard diversifiers of fixed interest, cash, metals etc.
     
  14. Nodrog

    Nodrog Well-Known Member

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    Trouble with Correlations is they sometimes don’t work when you need it the most. ASX 200 / AFI vs AReits (LPTs) during GFC below. Then again looking at the chart one could say they are uncorrelated but in the wrong direction:). But I admit to being biased against AReits. Probably in part due to Thornhill, @SatayKing and GFC experience:

    7EFE64F7-5C76-4617-8671-232503D170AC.jpeg
     
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  15. The Falcon

    The Falcon Well-Known Member

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    Well obviously. Nothing works all the time. I can’t give you a guaranteed way to get rich. Imagine if circumstances were reversed and we had a banking crisis post GFC. The charts would look very different. Hindsight is a cracker.
     
  16. Nodrog

    Nodrog Well-Known Member

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    Nope, not good enough. I want a Guarantee or a refund.
     
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  17. Anthony Brew

    Anthony Brew Well-Known Member

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    Wow I never saw this graph before.
    What was the reason that the LIC's/EFT's did not crash anywhere near as severely as the all ords?
    And would that reason make it more stable generally or was luck part of it?
     
  18. Nodrog

    Nodrog Well-Known Member

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    STW (ASX 200) ETF pretty much matches the all ords performance wise. Not sure what you’re meaning. Listed property is the shocker. Larger LICs likely fell less than the index due to their ability to vary from the underlying value of the portfolio (NTA). Long term loyal LIC shareholders (eg charities / retirees) tend to sit tight resulting in NTA premium increasing. And others look to buy in as they consider these older LICs a safer place to be compared to buying shares directly or buying the index. Because these LICs have been around so long there a perceived level of safety regardless of whether it’s true or not.
     
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  19. SatayKing

    SatayKing Well-Known Member

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    Hmm, maybe because the older LIC's didn't sell anything, unlike many direct investors, and kept the dividends rolling in. Plus buying with cash held and raised through Share Purchase Plans.

    It is amazing how the power of dividends is overlooked by many including all those expert market commentators. Seems they focus mainly of price movements.
     
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  20. Anthony Brew

    Anthony Brew Well-Known Member

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    Sorry, didn't look closely and saw ASX200 on the bottum graph and saw LIC at the top and didn't realise the ASX200 was for listed property.

    So for the LIC's their value depends on people buying and selling, the same as with ordinary stock, and does not rely on the actual stocks that makeup the LIC's individual stock proportions which I assumed would have dropped a lot with the market drop?