Sequence of Return Risk

[Deleted User]

Very neat little article:
 https://awealthofcommonsense.com/2021/02/the-best-way-to-manage-sequence-of-return-risk/

Punch line:

1. Someone retiring in 2000 with 1M in a balanced 60/40 portfolio would be very comfortable today with 1.3M.

2. Had he put it all in 100% stocks, he’d be a nervous wrack with  $470K.  

Quite a difference. 

Albermarle

Good article against not having a balanced portfolio.  I suppose a counter argument could be that if withdrawals were stopped in the bad years by using a cash buffer , then this risk would be mitigated even for a 100% equity portfolio. ( probably ) 

shinytop

I suspect a 2 year cash buffer would make quite a difference.  I wonder also what it would look like if the 40% bonds, which looked to have a good return, were replaced with cash with a steady but small negative drag. All hypothetical of course...

michaels

Deleted_User said:

Very neat little article:
 https://awealthofcommonsense.com/2021/02/the-best-way-to-manage-sequence-of-return-risk/

Punch line:

1. Someone retiring in 2000 with 1M in a balanced 60/40 portfolio would be very comfortable today with 1.3M.

2. Had he put it all in 100% stocks, he’d be a nervous wrack with  $470K.  

Quite a difference. 

Lets compare two different asset allocations over a single 20 year historic period and gain insight from the results?

SORR is about whether just using historic datasets is reasonable when estimating worse case (which pretty much gives the 4% rule) whether we should use monte carlo which would give us a much lower safe withdrawal rate (and even this still depends on future performance being guided by the past.

In this instance emphasis is put on bond returns during a strong upward phase of the generally longer bond cycle.  Over the next 20 year sit is entirely possible that we will see the historically unusual combination of share price stagnation and increasing bond yields.

Based on historic experience my portfolio of 70% shares, 30% 'cash' should be good for 4.38% SWR given my drawings and other income profiles - but none of the 100+ years of monthly historic data started from where we are now in terms of bond yields and stock market valuations so is 'all of history' really a good guide to the future?

Dead_keen

shinytop said:

I suspect a 2 year cash buffer would make quite a difference. 

The two years' cash would have been used up at the end of the second year and the $470,531 would ending up being $486,225. 

Croeso69

Dead_keen said:

shinytop said:

I suspect a 2 year cash buffer would make quite a difference. 

The two years' cash would have been used up at the end of the second year and the $470,531 would ending up being $486,225. 

Surely a 3 year buffer would make a difference then? Year 4 is positive.

Thrugelmir

Trouble is UK investors trade in £ not $. Fluctuating exchange rates would have produced a very different outcome. Never wise to read US centric articles. 

Dead_keen

Croeso69 said:

Dead_keen said:

shinytop said:

I suspect a 2 year cash buffer would make quite a difference. 

The two years' cash would have been used up at the end of the second year and the $470,531 would ending up being $486,225. 

Surely a 3 year buffer would make a difference then? Year 4 is positive.

That's right.

Prism

Croeso69 said:

Dead_keen said:

shinytop said:

I suspect a 2 year cash buffer would make quite a difference. 

The two years' cash would have been used up at the end of the second year and the $470,531 would ending up being $486,225. 

Surely a 3 year buffer would make a difference then? Year 4 is positive.

It is positive but still a fair bit lower than the starting point. In fact just as the value recovers in 2007 then it drops all over again. You probably needed a 10 year + cash buffer to avoid selling equities at a loss - however at other time points that would have been a drag.

jamesd

Deleted_User said:

2. Had he put it all in 100% stocks, he’d be a nervous wrack with  $470K.  

With the 2% inflation increases his income for year 21 would be $59,437. Even skipping the future increases he has enough for 7.9 years vs a plan that might have been 30 total, 10 left. He'd need to take a nominal cut of 21% and skip future increases to make it. Skipping inflation increases after a down year would avoid more than 15% of the 21% cut.

Albermarle said:

Good article against not having a balanced portfolio.

It's worth noting that he was taking 4% rule income without the 40% bonds used to get to 4% being safe. He greatly breached the rules.

Dead_keen said:

The two years' cash would have been used up at the end of the second year and the $470,531 would ending up being $486,225. 

Presumably set up to take dividends and interest so even one year might last for three years of payments, depending on investment mix and timing vs payments.

shinytop

Dead_keen said:

shinytop said:

I suspect a 2 year cash buffer would make quite a difference. 

The two years' cash would have been used up at the end of the second year and the $470,531 would ending up being $486,225. 

Sorry slip of the finger I did mean to say 3, it's about what I use myself...