How to maximise your Ruin Age?
Robert Davies, Fund Manager, VT Maven Smart Dividend UK Fund
At a recent investment seminar a presenter from a well-known financial institution introduced the audience to the concept of “The Ruin Age”. This was devised by Moshe Milevsky, a Canadian actuarial academic, and is the age when a pensioner exhausts their pension pot and runs out of money.
The seminar was largely focussed on the volatility of investment returns and looked at the implications for pensioners who had opted for income drawdown rather than annuities and how their fortunes were dependent on the timing of drawdowns. Milevsky says that the Ruin Age for an individual is almost as sensitive to the sequencing of returns as it is to the average return of a portfolio. Starting to draw down your portfolio in a bad year for the markets can significantly shorten the time until you run out of money. He makes the point that volatility of returns is therefore more important in the drawdown stage, than the accumulation stage because money extracted in a down year crystallises a loss that cannot be recouped. The converse in the accumulation stage, adding money at a market peak, is at least moderated by the compounding benefit of dividends in later years.
In real life this thought process is more relevant to the academic than the pensioner. Timing retirement is hard enough without having to consider if the stock market might be about to fall.
However, Robert Schiller, the Nobel Prize winning economist, showed that dividend income is much less volatile than capital values. So selecting a fund that generates more of its return from dividends than capital growth will reduce volatility. Moreover, dividend income is easy to extract, does not involve trying to time the market and does not incur costs so a high yielding fund should be able to support a higher drawdown and help maximise the Ruin Age.
There is of course no getting away from the fact, that for a given level of income, a large pension pot will last longer than a small one. So in simple terms dividing the size of the pot by the drawdown provides an estimate of how many years the fund will last.
In 2013 Credit Suisse and the London Business School calculated that the annualised mean dividend yield for world equities had been 4.1% since 1900. It is probably fair to say that there is a higher degree of certainty that dividends will be maintained than there is of relying on capital returns for decades to come. Nevertheless, it is helpful to make a stab at estimating how long the declining rump of capital will last after costs.
According to the 2015 Barclays Equity Gilt Study UK equities have delivered an annualised capital return of about 6.8% since 1945. Assuming that figure can be maintained, and then deducting fund management costs, it is possible to project an annual return. This will be reduced if the fund is held on a platform, with its associated costs, and is also subject to adviser fees as a percentage of the fund.
So it should be possible to estimate a Ruin Age by taking a projected pension pot at a planned retirement date and subtract the estimated annual cash outflow i.e. the excess of the drawdown over the dividend income in the first year. Then increase the residual fund value by the estimated growth after all costs. Repeat the exercise for every year until you reach the Ruin Age.
Although the increase in the residual value each year is likely to be a modest factor in the calculation, depending on the yield, it is worth estimating how likely it is that return will be generated each year. One way to assess that is by knowing the volatility of the fund and gives the investor a measure of how much its capital value tends to move around. Most fund comparison tables will have a column showing this figure. The lower it is the higher the chance that you can make a meaningful estimate of your Ruin Age.
Some will argue that funds focussing less on income and more on capital growth will deliver higher overall returns which would increase the Ruin Age. History does not support that argument; a great deal of evidence suggests that the market gets too excited about growth stocks, it then pays too much for them which subsequently has a negative impact on returns. The other point is that capital growth is more volatile than income and there is therefore less chance of actually reaching the Ruin Age.
So it seems as if the best chance of maximising the Ruin Age might be to select high income funds with low volatility.