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How bad could things get from a high point?
Old 07-30-2014, 04:16 PM   #1
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How bad could things get from a high point?

I have a model that I tweak to show me how much a 2 year decline could affect the portfolio. It seems to be a good thing to avoid getting a little too giddy at times. I'm tossing this out here because it might help someone.

I've adapted the modeling to show some portfolio compositions and how badly a $1 million portfolio would get hit. Here are the results and then I'll mention the modeling details:



Modeling details:
1) Monthly with stocks in the SP500 and bonds in 5 year Treasuries.
2) Time period is Jan 1969 to April 2014.
3) Assumes a 4% withdrawal rate (monthly withdrawals). If you have maybe 3% withdrawals in bad times just add back 2% loss you avoid over the 2 years.
4) No rebalancing except if the stocks go above the maximum allocation. This is my technique and I'm too lazy to change the model for other rebalancing options. Hopefully the results are still somewhat useful for others here.

For example, if you had a 50/50 portfolio you would never let the stocks go above 50% but they could drop a lot in a bad market. Your worse case portfolio during any 2 year period was experienced in September 1974 and would be $620,000. I chose 2 year drawdown as a metric because that is often the worst length of bear markets. For a 50/50 the table shows you would experience a -15% drawdown for 14% of the months from Jan 1969 to now.

Here is a picture of how things would have gone for a 50/50 portfolio since 1999:


The green circles are your absolute portfolio value. This plot does not show y-axis values but you get the rough picture here hopefully. The orange circles are the stock percentages monthly with the low in February of 2009 at 32% equities. The red diamonds just show -10% drawdown months. The blue diamonds show when stocks are sold to buy bonds because we are above the 50% equity allocation.

Now maybe FireCalc does a good job of showing this sort of thing. This may be redundant but I just thought it was a decent time to remember markets are not always friendly. Still you have to play the game.
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Old 07-30-2014, 04:29 PM   #2
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Gulp! It's sobering to see something like this. Repeating myself ... diversify, OMY, diversify, OMY, diversify, OMY, ..., oops, that's 3MY.
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Old 07-30-2014, 04:39 PM   #3
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I wonder how much the results would differ if withdrawals were made annually instead of monthly?
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Old 07-30-2014, 04:42 PM   #4
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I wonder how much the results would differ if withdrawals were made annually instead of monthly?
The impact might be considerable if the timing of the annual withdrawal coincided with the market low point.
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Old 07-30-2014, 04:46 PM   #5
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Good reminder to adhere to one's plan. Hopefully it's a plan that had a rational basis.
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Old 07-30-2014, 04:46 PM   #6
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Re-balancing only on the upside is almost sure to create a downward ratchet, no? May be better to pick a more conservative allocation and re-balance both ways.
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Old 07-30-2014, 04:52 PM   #7
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Re-balancing only on the upside is almost sure to create a downward ratchet, no? May be better to pick a more conservative allocation and re-balance both ways.
Hard to generalize about this. Go ahead, convince me.

BTW, I do have a setting in the simulation to rebalance into stocks based on a minimum stock percentage. It was zero for the above stuff.

EDIT: For the 50/50 case, it did not matter if I put in (1) no rebalance to stocks as in the above or (2) rebalance to stocks when stocks fall below 45%. The drawdown stats were the same.

Here is what the little chart looked like with the added light green circles being the "rebalance towards stocks" point:

.
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Old 07-30-2014, 05:09 PM   #8
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
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Old 07-30-2014, 05:12 PM   #9
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
That's how I do it...
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Old 07-30-2014, 05:14 PM   #10
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
No. That's what the 5-year Treasuries are for.
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Old 07-30-2014, 05:19 PM   #11
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
I actually implemented this as taking the spending from the FI component. So stocks were not sold to cover spending, just 5 year Treasuries.

If your FI consisted of maybe 80/20 of 5yr Treasuries and cash, then I think the basic returns would be reduced because you have less of the "term premium" from the intermediate bonds. On the other hand, if inflation hits like in the worst case drawdown 1970's, having the cash component might help.

If I were asking this question of my portfolio, I would add that to the model above and see what happens. I think it might be hard to generalize but my bet for the longer term (of maybe more then 15 years) would be maxing out on the 5yr Treasuries. I personally try to keep short term bonds and cash to a minimum.
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Old 07-30-2014, 06:28 PM   #12
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
+1

Makes sense to me.....
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Old 07-30-2014, 07:49 PM   #13
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That's why my target is 6% cash (as part of 40% total fixed income). The cash only earns 1%, but that is better than nothing.
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Old 07-30-2014, 08:06 PM   #14
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There are ways we can try to minimize damage in severe declines that lead to portfolio drawdowns. Probably highest on the list is selecting the AA appropriate for our circumstances and risk tolerances.

Even with pretty decent stock market timing, it is hard to avoid drawdowns over multyear periods. That is one lesson I've learned from my data analysis. Sometimes bonds and stocks can do somewhat poorly, like the 1970's for example.
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Old 07-31-2014, 11:06 AM   #15
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There are ways we can try to minimize damage in severe declines that lead to portfolio drawdowns. Probably highest on the list is selecting the AA appropriate for our circumstances and risk tolerances.

Even with pretty decent stock market timing, it is hard to avoid drawdowns over multyear periods. That is one lesson I've learned from my data analysis. Sometimes bonds and stocks can do somewhat poorly, like the 1970's for example.
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Old 07-31-2014, 11:34 AM   #16
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
This seems to be wise strategy, to avoid having to take withdrawals from a severely reduced portfolio. In essence the cash is a moderating effect.
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Old 07-31-2014, 11:42 AM   #17
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I wonder how much the results would differ if withdrawals were made annually instead of monthly?
Or that is what other income can be usd for. Pensions, Social Security, rental income, other earned income. It may also be a time to tighten your belt, as many strategies mention. When the portfolio does poorly, spend less.

At least that is my thought today, when I am still working.
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Old 07-31-2014, 12:11 PM   #18
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Regarding the 2009 low, the 2 year drawdown was -25% for a 50/50 portfolio. Reducing spending by 1% per year would not have helped a whole lot but who was to know that the -25% point in February 2009 was the low? From there things got better. But you never know about that until much later, when you can look back in the rear view mirror and relax.

BTW, I'm hoping for continued good times. Just wary of getting too giddy.
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Old 07-31-2014, 12:12 PM   #19
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Would this support a strategy of keeping a couple of years in cash and drawing from that instead of invested funds during down times, replenishing the cash during good times?
I actually have quite a bit in cash and cash equivalents drawing 4% and 3% interest with the ability of getting that interest routed to a checking account while not drawing down principal. For most, I have too much in cash. For me what is in the market is not to be touched for 10 years or more, perhaps given luck, not at all. I do try to get my cash invested such as those 3% PenFed CD's but haven't seen an opportunity like that since.

It's the way I can sleep at night.
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