Funding retirement through a stock market crash

I understand the possible behavioral benefit of the bespoke scenario, but really from a mathematical perspective the two scenarios are the same. The only difference is that retrospective market timing has been applied for the bespoke scenario where the asset allocation was allowed to vary throughout the market cycle. With the unitised investment the asset allocation was held constant. Either approach could work out better depending on how the market returns were timed.

So basically, in the bespoke scenario the investor took on more risk during the downturn by increasing their weighting towards equities and reducing cash and in this particular example it happened to work out for them. In a different scenario e.g. a longer downturn it would give a poorer outcome because they would run out of cash.

Agreed, there is a behavioural benefit.

From a mathematical perspective the two scenarios are similar but not the same. The asset class returns are assumed to be the same for consistency; however the level of draw down on each asset class is different in each scenario.

We haven’t applied retrospective market timing, rather we’ve applied rules to determine when changes are made:
1. Start with 2x years income in cash
2. Draw from shares annually to maintain 2x years income in cash
3. Use cash reserve to avoid selling shares after market crash
4. Ensure cash reserve is never less than 1x year income
5. Stay within +/- 10% of risk tolerance

The risk is the same in year 1. The investor does not deploy additional capital to increase risk or rebalance at lower points thereafter, though that could add value. Instead the changing % allocation to shares is a by-product of the compounding returns and the draw-down strategy.

As to whether or not the strategy is appropriate will depend on how the investor defines risk:
• As allocation to equities, then yes the risk does change through the cycle; or
• The likelihood of achieving their income goal - which is what the bespoke strategy aims to achieve.

As for when an investor would run out of cash in an extended down-turn, they would have 2-years cash reserve which will also be topped-up by income arriving from investments. As the cash reserve approaches $0, the fixed interest part of the portfolio could be sold-down, and we would hope bond prices have risen as a result of what would be an extended downturn. This gives the investor 5-7 years to ride out a down-turn before selling shares. In the diversified strategy the investor would be selling down their growth assets right through the down-turn.

Again, it’s not the only way but the strategy has given our clients comfort through market downturns.

Does this mean the best option for most retail investors is:
1 - Save up a cash buffer of 1 - 2 years living expenses,
2 - Don't sell in a panic after the market crash,
3 - Live off the cash buffer until the market returns to a 'normal' range,
4 - If you want to, sell some shares once they are back to a price where you aren't selling for a loss,
5 - Rinse and repeat through the next market crash.

That's not far off what I do, "Investor"

Yes, it's certainly a good option that has worked well for our clients over many years.

Also, income from the investments will continue to flow in each year, topping up the cash reserve automatically. Depending on the amount you draw annually, and the level of income from your investments, this may reduce the need to sell assets to top-up the cash holding.

Some, but not all, companies have reduced dividends in recent months to help strengthen the companies balance sheet. A short-term dividend cut is likely to be a better alternative than a capital raising that permanently dilutes your holding and future income.

My concern in having a cash reserve in Superannuation is if the fund refuses to release the money, as happened to some people during the GFC, with certain funds ( don't believe any were superannuation funds) refusing to release money or dramatically reducing payments eg from $1.18 down to $0.01 per unit.

That being said, I do intend having a cash 'bucket' within my superannuation to prevent me sellling down growth investments during the bad times.

I'm not sure I understand Michael, are you perhaps referring to managed funds that froze redemptions during the GFC? i.e. mortgage and property funds.
If so the 'refusal to release money' is due to lack of liquidity of the underlying investments. In simple terms, the investor is unable to withdraw capital because the fund:
1. Has no cash to pay the withdrawal; and
2. Is unable to find a buyer at a reasonable price.
For this reason, holding quality assets that match your liquidity requirements is crucial. The cash reserve should assist with getting through these periods.

Yes Richard, cash forms part of the interest bearing investments and both scenarios have the same starting equities allocation.
We experienced similar levels of comfort from our retiree clients knowing they had the cash reserve in place, meaning their lifestyle wouldn’t be impacted as a result of the market decline. This mitigated the need to sell units or hit the panic button.
Good point regarding the short-term guaranteed annuity – another option worth considering for retirees.
The bespoke strategy can be appropriate and produces good results for some. For others, the simplicity of the diversified fund is a better fit.

So the diversified fund has 1.3m equities 0.7m fixed income And the bespoke one has 0.65 * (1820) = 1.183m equities 0.35 * (1820) = 0.637m fixed income 180k cash How exactly do you come to the conclusion that the bespoke one grows faster in those first 4 years?

JD I'll think you'll find the $180,000 starting cash is a component part of the 35% allocation to interest bearing investments and not in addition too - so both portfolios start with the same equities allocation.
A point of note that Andrew didn't go into but that we would both experience in advising retirees - is that emotionally bespoke portfolio retirees respond better during the inevitable downturn in equities knowing they have the guaranteed cash reserve and can likely afford to await the also inevitable recovery. Some retirees facing a 15% or more fall in diversified unit prices and faced with selling units every month to meet pension income needs - hit the panic button and switch to Cash missing some or all of the recovery completely.
It is also possible for SMSF and Wrap retirees to replace the Cash account with a short term guaranteed nil RCV annuity matched to their expected drawings - a modestly higher interest rate than most Cash accounts but still provides the short-term guarantee of income. Dividends and distributions can then be used to rebalance the portfolio on a regular basis. Not for everyone as Andrew points out but well worth considering.

It doesn't add up that way either.

In the first year for example, the same equity return on each side would be the same, but the bespoke one has some of their fixed income in cash, which would still result in lower returns, not higher.

Going by the numbers given in the example, having cash is a drag on returns, which is fine provided the investor understands that and accepts it, however from what I can tell the numbers tell the opposite story.