SEQUENCE of RETURNS RISK, 4% RULE & RETIREMENT PLANNING on a Cashflow Plan!

One of the biggest fears for someone approaching or just about to retire is the point at which they begin drawing down on their pension pot, the pension pot that they have potentially spent decades building up. And it is that point at which hopefully they have some idea as to the value of their pension pot and to the likely amount that they will need to take out as an income to be able to provide them with the standard of living they are after. The two key risks at this stage that any retiree has to contend with is the percentage that they are looking to take from their pot, to ensure it is sustainable and doesn’t run out and the potential risk of significant volatility in the early years of retirement, known as sequence of returns risk.

From Will Bengen's research, well known for his research into the safe withdrawal rate in which he looked back at various time periods to see what impact certain asset allocations would have on a clients retirement and also how the volatility at various points in someone's retirement would impact the chances of their fund running out in retirement.

There are really two schools of thought to this process, one is the probability-based model, which tends to focus on the historical performance of markets over very long periods of time and then assumptions are made as to what sustainably can be taken and the asset allocation required, this being Will Bengen's area. The second is the safety first approach that would assume someone uses low risk assets, annuities and defined benefit benefit pensions to provide secure income that is less reliant on the stock market.

The issue for most retirees is that it will be unlikely that they will have enough value in their pension fund that will buy themselves a secure income that increases with inflation and that provides any kind of value on death. The demise of the defined benefit pension scheme also means that individuals are pushed further into the probability based approach. The probability based approach is really drilling down on likely outcomes, on weighing up and taking a calculated risk. The variability of future outcomes is huge but we have to base the future potential of an outcome within the parameters of what would be considered reasonable. So is what we are looking at reasoned and reasonable.

The conclusion that Will Bengen got to having looked at various periods of time and asset allocations was that depending on the asset allocation and period of time in question there is a percentage amount from which can be drawn from the fund that is sustainable and this was possibly oversimplified into the ‘4% rule’ and then after subsequent research completed later, the 4.5% rule which is based on a minimum of 30 years of longevity using a portfolio made up of 35% US large cap stocks, 18% US small cap and 47% intermediate government bonds with yearly rebalancing. Essentially a 50%50% split between bonds and equities.

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The information provided is based on the current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

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Keep in mind that the value of your investments can go down as well as up, so you could get back less than you invest.

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