How do you mitigate "sequence of retuns" risk early on?

[hnzw_rui]

Certainly you could do that or any of a variety of other schemes. But how you manage that bucket is going to effect how it impacts portfolio survivability.

If you're auto-refilling it when it reaches zero that means pulling a large chunk of cash out of your portfolio all at once. And because you're depleting that cash bucket during bad market times, it seems likely that you'll also be refilling it from a portfolio hit by those same bad markets. That could actually make things worse rather than better.

It's not clear to me what kind of advantage this provides over the standard rebalancing approach. Although it wouldn't surprise me if someone could model a clever strategy that seems to offer some benefit.

One could refill the cash bucket only during up years.

 

[RetireAge50]

About to retire next year. Pension covers half of expenses. Portfolio the other half. Portfolio also covers another 50% of expenses as goof around money. Plan to stay about 75% stocks and in a bad sequence will just cut back on the goofing around.

 

[heyyou]

Muddle through

We retired in 2005 with a buffer of cash. As tightwads, we just spent less during 2008-9 by watching expenses, traveling less, eating out less often. Currently with 35% in bonds, next time we will just sell from them. As mentioned by others, don't sell from the assets that have depressed prices.

SOR is mostly a risk for those who have no room to adapt to less than steady market returns. We like retirement so well that staying home is okay with us, and we live in a LCOL area so we can live on 3% of portfolio value annually while we are waiting to start SS at age 70. We can adapt as needed.

 

[youbet]

If you're auto-refilling it when it reaches zero that means pulling a large chunk of cash out of your portfolio all at once. And because you're depleting that cash bucket during bad market times, it seems likely that you'll also be refilling it from a portfolio hit by those same bad markets. That could actually make things worse rather than better.

It's not clear to me what kind of advantage this provides over the standard rebalancing approach. Although it wouldn't surprise me if someone could model a clever strategy that seems to offer some benefit.

No, no, no....... You aren't taking me literally enough G4G. When I said "the cash fairy squirts in a new supply!" I meant "the cash fairy squirts in a new supply." The same cash fairly that gave you the cash to hold "outside your portfolio" just gives you some more. You don't take cash out of your portfolio. Just get it from the cash fairy.

Got it?

Personally, I don't believe that there is such a thing as "cash outside a portfolio." If it's something you control and can spend, it's in your portfolio. You've just got a different name on it. It's semantics. And I don't believe in holding much true cash (under 1%) although I do hold a 45% fixed allocation.

I retired mid-2006 right into the 2008 - 2009 debacle and fought off SOR monsters by spending divs and int from the taxable portion of the portfolio and a couple of CD's as they matured.

 

[Ken11]

On average holding cash decreases portfolio returns
So, rather than go above about 5% cash i hold a home equity line of credit on my paid for house.
If equities really tank ill live on my home equity. Being leveraged by a few years worth of income seems like a good bet in this circumstance. This would have worked wonderfully in 08-09i if i had been retired at that time

 

[Markola]

OK, though that's a risk trade, too. HELOCs are subject to requalification on the bank's terms and if housing prices plunge at the same time you are borrowing for living expenses, one could see the HELOC called or at least the interest rate skyrocket. I'm not that much of a gambler, personally, but YMMV.

 

[Gone4Good]

OK, though that's a risk trade, too.

Heh, heh, heh, heh, isn't it all?

Of course the more clever we get with our strategies the more likely we'll run into risks we didn't even know existed.

 

[bmcgonig]

OK, though that's a risk trade, too. HELOCs are subject to requalification on the bank's terms and if housing prices plunge at the same time you are borrowing for living expenses, one could see the HELOC called or at least the interest rate skyrocket. I'm not that much of a gambler, personally, but YMMV.

That happened in 2008 apparently. Lots of HELOCs got cancelled. Read an article recently recommending a reverse mortgage LOC for just that reason, as they can't be cancelled.


Sent from my iPad using Early Retirement Forum

 

[rodi]

I took a HELOC out right after retiring. I have no plans on drawing for it. I also think there's little likelyhood of them withdrawing the HELOC before the period (10 years?) is up since it's on a paid for SoCal house and we have no other debt.

My thinking is that it could provide income smoothing for tax purposes... If we have a big expense that is more than our cash reserve - we could spread it over 2 tax years to lesson the tax hit. (Much of our funds are in tax advantaged accounts).

 

[Fedup]

How do you mitigate "sequence of retuns" risk early on?

I had a HELOC in 2000, large amount that allowed me to think clearly and not panicked. I never did use it so it was closed in 2008-2009 time frame. Now I have another large HELOC that would cover at least 10 years of additional expense so I can sleep easily. My expenses are cover 95-99% by pensions/SS/ rental income.
I have my HELOC from PenFed.


Sent from my iPad using Early Retirement Forum

 

[marko]

Heh, heh, heh, heh, isn't it all?

Of course the more clever we get with our strategies the more likely we'll run into risks we didn't even know existed.

K.I.S.S.!

I have my dividends (and sometimes cap gains) sequestered in a separate low risk account. Three years worth. Don't have to worry about "a bad time" to sell equities.

We draw our expenses from that with twice a year transfers to checking but never more than about 3%.

+1 on G4G's earlier comment on Firecalc's 4% SWR. The "S" stands for SAFE!

 

[Chuckanut]

I think the real tool to have in case the market tanks in the first 5-7 years of retirement is minimal mandatory spending obligations. IOW, not a lot of debt or financial commitment. In this way one can cut spending to help ride out the storm.

The other tool is to consider one of the variable withdrawal methods mentioned in other threads of this group. These methods tend to help one smooth over the ups and downs of the market. The idea is that in a down time, one ratchets down spending to preserve capital, but in such a way that drastic changes in spendable cash funds are minimized. And, in up years it allows one to increase spending, enjoy the fruits of one's investments, while not over spending to the point of risking failure [-]if[/-] when the market goes down again.

 

[pb4uski]

On average holding cash decreases portfolio returns
So, rather than go above about 5% cash i hold a home equity line of credit on my paid for house.
If equities really tank ill live on my home equity. Being leveraged by a few years worth of income seems like a good bet in this circumstance. This would have worked wonderfully in 08-09i if i had been retired at that time

While I concede that holding cash depresses portfolio returns, at least in my case and I suspect many others, the impact is not very significant.

For example, my AA is 60/34/6. Let's say that nominal returns are 7%, 4% and 1% respectively. My AA has a weighted average return of 5.62% and a 60/40/0 has a weighted average return of 5.80% so the drag of 6% cash is only 18 bps but the peace of mind is worth the cost IMO. That 6% cash, along with taxable account dividends would support our living expenses for 2-3 years if necessary.

 

[Ken11]

While I concede that holding cash depresses portfolio returns, at least in my cash and I suspect many others, the impact is not very significant.

For example, my AA is 60/34/6. Let's say that nominal returns are 7%, 4% and 1% respectively. My AA has a weighted average return of 5.62% and a 60/40/0 has a weighted average return of 5.80% so the drag of 6% cash is only 18 bps but the peace of mind is worth the cost IMO. That 6% cash, along with taxable account dividends would support our living expenses for 2-3 years if necessary.

At 6% cash you and i agree on the minimal impact on returns
Thats about my limit.
The 18bps is a certain cost year by year
I might never have to pull the trigger on my home equity line

 

[pb4uski]

...I might never have to pull the trigger on my home equity line

True, but OTOH it might not be there when you most need it. That happened to some people during the financial crisis.

 

[akck]

The year before I retired, I started moving to cash to cover what would be needed in the following year. I also had several individual bonds that would mature within 18 months. During the first retirement year, I continued moving to cash for the next year, with the idea to always have one year of cash on hand. I've kind of revised this in year 3, only having cash on hand to cover 2 quarters, as more income sources come online. Once we make it through year 3, sequence risk goes down for us as we can forego withdrawing from retirement investments if we need to do so and 5 years later, income sources are projected to exceed expenses. So for us, the first 2 years were very critical and we lucked out with them being good years.


Sent from my iPad using Early Retirement Forum

 

[Ken11]

True, but OTOH it might not be there when you most need it. That happened to some people during the financial crisis.

Not if you arrange a line of credit
The bank is obligated under its terms
My line is for only 50% of my homes value
I can withdraw cash the week after a hurricane destroys the house because the bank requires homeowners insurance

 

[imoldernu]

As the least savvy of all who post here, no thoughts except survival for the next 8 to 10 years. Have confessed ignorance, I wonder if the next recession, dip, adjustment or whatever... will have the same type of recovery as we've seen in the past several downturns.

This article deals with inflation and debt as a percent of GDP. Will the current level of debt make for a different kind of recovery?

Article from 2014
Inflation And Economic Recovery | Investopedia

If the U.S. continues to increase its debt and continues to borrow money via Treasury issues, it may have to deliberately inflate its currency to eventually retire those obligations. Investors, retirees or anyone with fixed income investments will in effect be paying down those obligations, as their holdings decrease in value as prices rise.

Noticed that no one spoke of gold.

 

[TimSF]

I ER'ed in 2013 at 50. My strategy has been to budget for a spend rate of about 3.5% for the next 10 years or so and to create an additional buffer with a little part time w**k to cover 10-20% of my spend (thereby depressing my withdrawal rate to 3% or less), in case the market would get truly bad. (And the w**k is only stuff I really want to do, i.e. it is fun-work for me.)

 

[bmcgonig]

Not if you arrange a line of credit

The bank is obligated under its terms

My line is for only 50% of my homes value

I can withdraw cash the week after a hurricane destroys the house because the bank requires homeowners insurance

I really don't think the bank is obligated. They can pull the line. They did during the financial crisis. The house isn't insured against Lehman


Sent from my iPad using Early Retirement Forum

 

[pb4uski]

Not if you arrange a line of credit
The bank is obligated under its terms
My line is for only 50% of my homes value
I can withdraw cash the week after a hurricane destroys the house because the bank requires homeowners insurance

Perhaps the bank is obligated, but you may not be able to get the money when you need it and you won't have the funds to sue them to enforce the contract so you could be SOL.

In 2008 major home equity lenders including Bank of America, Countrywide Financial, Citigroup, JP Morgan Chase, National City Mortgage, Washington Mutual and Wells Fargo began informing borrowers that their home equity lines of credit had been frozen, reduced, suspended, rescinded or restricted in some other manner. Falling housing prices have led to borrowers possessing reduced equity, which is perceived as an increased risk of foreclosure in the eyes of lenders. On January 27, 2010, a federal judge refused to dismiss a class action lawsuit against Chase for freezing HELOC loans. Courts have held that a bank may freeze a HELOC in instances where a home's value decreases substantially, which is deemed by courts as a 50% reduction in value.

 

[Fedup]

That's not the case with us. We still had huge equity in 2008, the bank was Washington mutual and it decided to close it because it had zero balance.


Sent from my iPad using Early Retirement Forum

 

[rayvt]

Although it wouldn't surprise me if someone could model a clever strategy that seems to offer some benefit.

Done. https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls

You can vary all sorts of parameters to your heart's content. SWR, cash bucket size, asset allocation, etc. Most importantly, *** Rule for refilling cash bucket ****.
BTW, that last -- refilling the cash bucket after you draw it down -- is the killer.

Spoiler: Cash bucket does nothing good financially. The benefit is purely emotional. Kitces said it all in an article: Cash bucket is a mirage, which does nothing significant. Simply doing an annual rebalance accomplishes everything that the cash bucket is purported to do.

 

[Ken11]

Perhaps the bank is obligated, but you may not be able to get the money when you need it and you won't have the funds to sue them to enforce the contract so you could be SOL.

During 07/08 my local real estate market declined less than 30%
With only 50% of value covered by the line of credit the risk of the bank pulling the credit seems a second order concern. However its not zero risk as you point out.

 

[2017ish]

Our approach will be much like others mentioned. No pension and should retire at 57/56. HELOC to cover one year of free spending (3 of hunker down), and drawdown assets via fixed percentage withdrawals from an 75/25 portfolio. The fixed percentage will ease much of the sequence of return risk.

We have flexibility because our initial retirement spending (if we quit today) would be 2/3 to 3/4 discretionary; spending less as markets fluctuate will not be difficult--we are comfortable now with discretionary spending far less than we plan for retirement.