The Yield Shield, 4 Percent Rule and CPF Life – A Perfect Retirement Combo?
In our previous explorations of the common approaches used for financing one’s retirement, whether it is an annuity like CPF Life, a safe withdrawal rule from a portfolio like the 4 percent rule, or using high yield stocks in a Yield Shield portfolio, our conclusion usually is that each of these approaches has its merits, but somehow falls a little short of being a perfect plan. When we combine them however, they can usually give a much better outcome in safeguarding retirement finances.
In our previous blog post, Does the Yield Shield protect Retirement Finances, we find that a Yield Shield portfolio of high dividend, blue chip stocks protected retirement assets fairly well for the last decade in Singapore. This portfolio allowed us to survive the 2008 recession and market downturn, and in fact, ends up with more money in 2019 than in 2008, despite constantly drawing down 4% of the value of the initial portfolio in every year since 2008! This is a different outcome from the US. There, a stock portfolio has higher capital gains and lower dividend yields, described here and here.
The performance of the Yield Shield 2008 – 2019
However, just as one swallow does not a summer make, one ten-year period or one downturn does not give definitive proof that the Yield Shield works for all market downturns. So let us take a more in-depth look at the Yield Shield portfolio here. Using simulations, we can test across a wider range of scenarios spanning 20 to 40 years of retirement.
Assumption, assumptions, assumption …
Let’s start with the assumptions used for our previous blog post Does the 4 Percent Rule work in Singapore.
Assumptions used for testing the 4 percent rule
| Annual Returns | Standard Deviation of Annual Returns | Annual Fees | |
|---|---|---|---|
| Stocks | 5.07% | 26.32% | 1.00% |
| Dividends | 2.80% | 1.09% | 0.00% |
| Bonds | 2.80% | 0.00% | 0.00% |
| Inflation | 2.00% | 0.00% | NA |
When we tested the Yield Shield portfolio of high dividend blue chips in Does the Yield Shield Protect Retirement Finances, the portfolio never paid our less than 4.55% of the initial portfolio value as dividends from 2008 to 2019, and in many cases, paid even more. Let’s assume the dividend yield is the higher of 4.55% of the initial value of the portfolio, or 4.55%. But at the same time, there is no free lunch! The higher dividend yield of the Yield Shield portfolio is offset by the lower expected capital gains on the stocks. So let us use these assumptions for the Yield Shield portfolio instead:
Assumptions used for testing the Yield Shield
| Annual Returns | Standard Deviation of Annual Returns | Annual Fees | |
|---|---|---|---|
| Stocks | 3.32% | 26.32% | 0.25% |
| Dividends | 4.55% | 0.00% | 0.00% |
| Bonds | 2.80% | 0.00% | 0.00% |
| Inflation | 2.00% | 0.00% | NA |
Note that the combined capital gain + dividend yield is the same as before for the STI ETF portfolio. Also note that we have reduced the fees on the Yield Shield portfolio to 0.25% from 1%. The Yield Shield implies a DIY approach to retirement, so there will be savings on fund management fees.
Yield Shield Success Rates
The success rates for withdrawal rates of 3%, 3.5% and 4% on the Yield Shield portfolio are below. In retirement, withdrawal from the portfolio is Dollar Cost Averaging in reverse. You hope that you will not sell down the portfolio when the market hits a downturn, so as not to “sell low”. The Yield Shield, with its higher dividend yield, uses dividends to cover living expenses, and also uses excess dividends which to re-invest into the portfolio, which is to “buy low”.
Success Rates for the Yield Shield in retirement
| Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
|---|---|---|---|---|---|
| 4.0% | 99% | 93% | 82% | 71% | 59% |
| 3.5% | 100% | 99% | 95% | 84% | 73% |
| 3.0% | 100% | 100% | 100% | 97% | 89% |
With 100% of assets invested in a Yield Shield portfolio, the retiree can withdraw 3.5% inflation adjusted for at least 30 years. Once we adjust for the likelihood of surviving util the age of 95 for a 65 year old retiree, which is roughly 10% for men and 20% for women, there is really less than a 1% chance that the Yield Shield approach with a 3.5% withdrawal rate can fail in retirement. In practice, the Yield Shield can sustain other more complex spending patterns or profiles in retirement than just an inflation adjusted one, as we show here.
Now, 3.5% does not seem a lot until we remember that using a mix of the STI ETF and Singapore Savings Bonds only allows a 2% to 2.5% withdrawal rate to make the money last 30 years! Even if we adjust the withdrawals lower in a downturn, it does allow withdrawals of more than 2.5% to 3% annually. So the Yield Shield approach is indeed a much safer way to manage your assets and money in retirement!
But is putting 100% of your assets into stocks, even if they are high dividend blue chips, really safer? To test this, we look at a portfolio where only 80% is in the Yield Shield, with 20% in deposits. The results are below:
Combining the Yield Shield with Bonds
| Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
|---|---|---|---|---|---|
| 3.5% | 100% | 97% | 90% | 81% | 71% |
It is not surprising that the outcomes are worse once we have bonds mixed with the Yield Shield. This is because bonds will not allow us to keep ahead of inflation over 30 years. This is even so when the bond allocation decreases over time. It is also why many others advocate being 100% in stocks for the long run, even in retirement.
Combining the Yield Shield with CPF Life
In 4 Ways the 4 Percent Rule can work in Singapore, we find retirement financing works better when we combine different approaches. One of the best tools for retirement is an annuity. However, an annuity is not a cure-all, because of the loss of financial flexibility and liquidity. For example, retirement spending is not always constant, due to emergencies which require bigger outlays every now and then. This is especially so when we get older and out-of-pocket healthcare expenses rise.
Many people might also wish to leave a legacy or bequest to their heirs, or to charity. Putting everything into an annuity does not allow for this, as there is nothing left over when you pass on. Instead, keeping some savings in investments during retirement allows for this option, which explains the popularity for safe withdrawal rules like the 4 percent rule.
How can we combine the Yield Shield, the 4 percent rule, and an annuity like CPF Life? Let’s look at some examples. Mr A, 65 years old, was able to meet his Full Retirement Sum (FRS) 10 years ago. The FRS has grown to $200,000, and is put into a CPF Life Escalating annuity plan. He also has another $200,000 of savings invested into a Yield Shield stock portfolio. How does his retirement look like?
Suppose Mr A withdraws between 3% and 4% of the initial value from his Yield Shield portfolio every year adjusted for inflation of 2%. His CPF Life annuity pays another 5.4% of the invested value every year as well. What is his likelihood of having a 30-year worry free retirement?
Success Rates for a 50:50 CPF Life:Yield Shield Allocation
| Yield Shield Withdrawal Rate | CPF+Yield Shield Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
|---|---|---|---|---|---|---|
| 4.0% | 4.70% | 99% | 95% | 84% | 74% | 65% |
| 3.5% | 4.45% | 100% | 99% | 95% | 87% | 79% |
| 3.0% | 4.20% | 100% | 100% | 100% | 98% | 92% |
This 50:50 allocation of his savings between the CPF Life annuity and the Yield Shield is ever better than just the Yield Shield alone. It allows Mr A to draw 4.45% a year, or $17,800, from his total savings of $400,000. It also allows him to keep something in reserve for a rainy day, or for a bequest, as shown below:
Median amount left in the Yield Shield after withdrawals
| Yield Shield Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
|---|---|---|---|---|---|
| 4.0% | $198,000 | $180,000 | $148,000 | $112,000 | $64,000 |
| 3.5% | $234,000 | $230,000 | $216,000 | $194,000 | $160,000 |
| 3.0% | $274,000 | $284,000 | $292,000 | $292,000 | $284,000 |
So, not only does Mr A get to enjoy the fruits of his lifetime’s labour, but his $200,000 in the Yield Shield has a good chance of still being there, and maybe a bit more, at the end of the day!
Another example of combining the Yield Shield and CPF Life
Now let’s take another example. Ms B, retires at age 65, with the Full Retirement Sum, and $400,000 in a Yield Shield portfolio. So in this case, her CPF Life Escalating Plan annuity will form one third of all her assets at retirement. What does her worry-free retirement chances look like?
Success Rates for a 33:67 CPF Life:Yield Shield Allocation
| Yield Shield Withdrawal Rate | CPF+Yield Shield Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
|---|---|---|---|---|---|---|
| 4.0% | 4.45% | 99% | 94% | 84% | 74% | 64% |
| 3.5% | 4.15% | 100% | 99% | 96% | 94% | 89% |
| 3.0% | 3.80% | 100% | 100% | 100% | 98% | 91% |
Again, this 33:67 allocation between a CPF Life annuity and the Yield Shield are better than the Yield Shield alone. It allows Ms B to draw 4.15% a year, or $24,900, from her total savings of $600,000. It also allows her to keep something in reserve for a rainy day, or for a bequest, as shown below:
Median amount left in the Yield Shield after withdrawals
| Yield Shield Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
|---|---|---|---|---|---|
| 4.0% | $400,000 | $364,000 | $300,000 | $232,000 | $136,000 |
| 3.5% | $464,000 | $452,000 | $424,000 | $380,000 | $308,000 |
| 3.0% | $548,000 | $568,000 | $584,000 | $584,000 | $568,000 |
Once again, there is a better than 50% chance that Ms B will end her retirement with as much money as when she started, which is helpful for higher future healthcare bills. Sure, $400,000 in 30 years’ time is only about half of what it was back at the start, but it is still substantive!
Concluding thoughts: Combining the Yield Shield, 4 Percent Rule and CPF Life in Retirement
Retirement is when we take a well deserved break from a lifetime of labour and enjoy what we sow earlier. In the ideal world, we would draw a pension which should suffice for our needs. In an imperfect world, we need to plan ahead to have a worry-free retirement.
The tools for securing our retirement have been around for a long time – annuities, investments, and withdrawal rules. In theory, we should put as much as possible into an annuity to protect against longevity risk. However, in reality, our spending is not constant over time, and we still need liquid reserves to deal with the emergencies that crop up later in life. So let’s forget about theory and focus on what can and should be done.
So, the key takeaways from this blogpost can be summarized as follows:
- If expenses in retirement are 4% of total assets, put up to half of your assets into an annuity and the rest in a Yield Shield portfolio
- If expenses are 3.5% or less of total assets, you can put less into an annuity, for example, a third or a quarter of the total assets
- Only if expenses in retirement are really low, at 2% or less of your total assets, can you consider doing away with an annuity
Do keep reading this blog for our future post where we shall also look at putting all these findings together to work out how much it costs to retire early in Singapore. Also, here we have seen both the good and bad cases, where the investments were able to sustain the retiree through retirement, and where they couldn’t. How do you know if you still have enough to carry on, especially after going through a market downturn? We address this question here.
*Here’s an update on combining CPF Life with a Yield Shield portfolio!
*Here’s an update to how we can build a Yield Shield portfolio for 2020!
*Here’s an update on why dividends matter in investing more generally!
*Here’s an update on why rebalancing the portfolio periodically is not really necessary!
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