Sequence of Returns

[golfnut]

I see alot of articles how important good returns are iro of portfolio survival in the years immediately after retirement. Two questions:

1) how many yrs immediately after retirement are we talking about at a minimum? ie. 5 yrs? 10yrs?

2) What equity returns constitute good returns? 5%? 8%? 10%?

We've been at approx. a 45/45/10 split.

Just curious.

 

[Meadbh]

I think what's important is that the initial returns are positive, because withdrawing from a shrinking portfolio at the outset has a much greater impact than the same scenario later. As for the time period, the longer you are in positive territory the better, but I have seen a lot of discussion about the Retirement Risk Period being the five years prior to and following retirement.

http://www.ifid.ca/pdf_newsletters/pfa_2006feb_sequencing.pdf

Be aware of the retirement risk zone

 

[REWahoo]

I think what's important is that the initial returns are positive, because withdrawing from a shrinking portfolio at the outset has a much greater impact than the same scenario later. As for the time period, the longer you are in positive territory the better, but I have seen a lot of discussion about the Retirement Risk Period being the five years prior to and following retirement.

http://www.ifid.ca/pdf_newsletters/pfa_2006feb_sequencing.pdf

Be aware of the retirement risk zone

+1

The sooner, deeper and longer the downtown, the more likely you'll go bust. Too many other variables to be more precise.

 

[W2R]

I see alot of articles how important good returns are iro of portfolio survival in the years immediately after retirement. Two questions:

1) how many yrs immediately after retirement are we talking about at a minimum? ie. 5 yrs? 10yrs?

2) What equity returns constitute good returns? 5%? 8%? 10%?

We've been at approx. a 45/45/10 split.

Just curious.

I didn't look up any figures, but I can tell you from personal experience (having retired in 2009) that 5 yrs of a booming market has had an utterly mind boggling effect on my portfolio growth. If you can manage to retire in a year equivalent to 2009, you'll be sitting pretty for sure.

On the other hand, the 2009-2015 boom can't last forever, I suppose. If I was retiring today I'd prepare for a crash pretty soon. I'd want to figure out what my portfolio value would drop to in a crash like the 2008-2009 crash, and make sure I would have plenty even if something like that, or worse happened just after retirement.

 

[Meadbh]

Also, it's not the frequency of returns, but the sequence of returns, that matters.

 

[hnzw_rui]

On the other hand, the 2009-2015 boom can't last forever, I suppose. If I was retiring today I'd prepare for a crash pretty soon. I'd want to figure out what my portfolio value would drop to in a crash like the 2008-2009 crash, and make sure I would have plenty even if something like that, or worse happened just after retirement.

Yeah. Ideally, you'd have income from other sources (e.g. SS, pension or emergency cash) to cover expenditures so you can avoid touching your portfolio to give it time to recover. I believe a 50/50 balanced fund dropped by 30% or so from 2007 (need around 43% gain to recover). S&P 500 was down like 50% (need 100% gain to recover). And those numbers are assuming you don't withdraw anything in the meantime.

 

[golfnut]

Also, it's not the frequency of returns, but the sequence of returns, that matters.

Thanks, I did mean sequence of returns

 

[Alan]

Thanks, I did mean sequence of returns

I'll fix the thread title...


ETA
I retired a few months after W2R and have similar comments on how good it has been to have had such a good run of returns in the first few years

 

[Cut-Throat]

I see alot of articles how important good returns are iro of portfolio survival in the years immediately after retirement. Two questions:

1) how many yrs immediately after retirement are we talking about at a minimum? ie. 5 yrs? 10yrs?

2) What equity returns constitute good returns? 5%? 8%? 10%?

We've been at approx. a 45/45/10 split.

Just curious.

Sequence of Returns matter when using a Fixed Inflation Adjusted WR such as 4%. Taking a SWR into the teeth of a bear market sucks enough out of the portfolio that there is not enough left for the portfolio to recover if the market does turn around.

If you do get past the first 10 years, your portfolio will last probably last you just fine. But, here is where another problem comes in and is much more common. You are left with a 'Big Pile' at the end of your life, which you didn't get to spend and/or worked much longer than you needed to. I regard leaving a Big Pile at the End as Also "Failure".

A much better alternative is to employ VPW, which will decrease WRs if your portfolio starts declining. In reality most people will do this anyway. No one takes an inflation adjusted WR year after year into a bear market anyways. So, you might as well have a plan that works and can backtest against history. And if you do want to 'leave' something to someone, just don't include it in VPW.

SWRs are a planning tool for retirement and I have never seen anyone actually employ it. However, I am actively employing VPW.

 

[Animorph]

My understanding is that it all depends on the actual year to year withdrawal percentage you are taking. With a median 4% rule scenario the portfolio grows with time and the year to year withdrawal percentage gets smaller and smaller. Hence the initial larger percentage withdrawal years are all at the start of retirement. That makes them the "critical" years.

To my mind, the number of critical years is the length of time it takes for your portfolio to grow enough to get your year to year withdrawal rate (every year) below the 100% safe SWR. At that point you are "safe" from sequence of returns. At least as far as historical calculations can tell you. The time it takes you to get there will depend on your asset allocation, the market's behavior, and the remaining length of your retirement.

For example, say you retire at 4% WR but want to get to 3% to feel 100% safe. Your portfolio needs to grow an extra 33%. If you're 100% stocks and returns are the "average" 10% and inflation is an average 3%, then you have 10% - 4% - 3% = 3% extra portfolio growth per year. At that rate it will take roughly 10 years until you reach the point where you are taking just 3% or less from your portfolio each year. Of course you could just get an extra 33% portfolio growth the first year and be done with it. On the other hand, your portfolio could drop 50% the first year and you'd be taking an 8% withdrawal. Take that 50% drop when your year to year withdrawal has fallen to 2% and you're only up to a 4% WR an still safe. Plus you'll have fewer retirement years to cover at that point, so no big deal.

That's sort of the FIRECalc view. If you are concerned with your ending balance, it will certainly be better if you are taking a smaller percentage of your portfolio each year, so early high growth is nice. You can also see that it would be nice to have initial high growth if you were going to take a simple percentage of portfolio each year. That would make it less likely that you would have to take a cut in income to below what you started with.

 

[Running_Man]

I believe 5 years is a key if there is a good size up move because as others have commented that makes your withdrawal rate lower. Once you are at 10 years you have also eliminated a sizable chunk of the length of time your portfolio needs to last, so that if you have achieved above average growth lowering your withdrawal rate while also lowering time needed your % of safe withdrawal rate has increased drastically.

On the other hand if the first 5 years has dropped your portfolio 20% or more there needs to be some considerable action taken.

 

[Options]

Dirk Cotton has some excellent posts regarding sequence of returns:

The Retirement Café: RIIA Webinar -- Sequence of Returns Risk

The Retirement Café: The Implications of Sequence of Returns Risk

The Retirement Café: Clarifying Sequence of Returns Risk (Part 1)

The Retirement Café: Clarifying Sequence of Returns Risk (Part 2, with Pictures!)

 

[Running_Man]

Dirk Cotton has some excellent posts regarding sequence of returns:

The Retirement Café: RIIA Webinar -- Sequence of Returns Risk

The Retirement Café: The Implications of Sequence of Returns Risk

The Retirement Café: Clarifying Sequence of Returns Risk (Part 1)

The Retirement Café: Clarifying Sequence of Returns Risk (Part 2, with Pictures!)

He advocates for a percentage of portfolio withdrawal to avoid sequence of return risk to call the drop in payouts that happen with a decline market risk instead of Sequence of returns and claims by doing this you have eliminated the sequence of return risks.

In an example in the series after the ones you posted, he showed a portfolio using a 2.5% withdrawal, because when he looked at the data a 4.5% withdrawal he was using later had a failure in year 11, would have income drop to $16,000 a year from a starting value of $25,000 with a portfolio starting with 1MM dollars!

His "solution", of having a large annual variable income swings on a 2.5% initial withdrawal rate in order to eliminate sequence of return risk to the terminal value of a all valuable portfolio is a non-starter for the vast majority of retirees.

Of course I think he also advocates a very large position (15 years) in TIPS and offsetting that with an investment portfolio that you withdraw 2.5% from so for a retirement of 40K you would need 15K per year coming off in TIPS (or 225K invested in tips) and be willing to vary income from that, with the idea being after 15 years a normal 4% withdrawal rate from the portfolio will be ok.
He seems focused with making sure there is a large estate for heirs, even tho his subtitle of his blog is retirement planning for the unwealthy. His advice is great for people concerned with leaving an estate, but for me not knowing 4 years down the road if I will be spending 31K per year or 51K per year is not a budgetable process and therefore a non-starter.

 

[Lsbcal]

I see alot of articles how important good returns are iro of portfolio survival in the years immediately after retirement. Two questions:

1) how many yrs immediately after retirement are we talking about at a minimum? ie. 5 yrs? 10yrs?

2) What equity returns constitute good returns? 5%? 8%? 10%?

We've been at approx. a 45/45/10 split.

Just curious.

I ran VPW to show how this tool's recommended withdrawals would have faired in a bad retirement year like 1968 (bad sequence of returns in early years).

This is for a 65 year old, with a 45/55 AA who wants to make a $1M portfolio last up to age 100.

At age 72 the portfolio is nearly halved as shown in the inflation adjusted balance column. Also even with an increase in the percentage withdrawal the inflation adjusted allowed spending is decreased a lot. After age 79 things start to get better as inflation receded and a historic bull market appeared.

 

[golfnut]

Lsbcal,

Thanks for the vpw illustration. I assume this 65 yr old still had some coin left after year 35? Yrs. 2001 and 2002 were not too kind to us investors.

 

[Lsbcal]

Lsbcal,

Thanks for the vpw illustration. I assume this 65 yr old still had some coin left after year 35? Yrs. 2001 and 2002 were not too kind to us investors.

Actually the portfolio went to zero at year 35 as per the VPW depletion plan to age 100. Suppose we set the depletion to age 115, that gives a 4.0% withdrawal rate in the first retirement year. Then the sequence looks like the following with less spending in one's 70's but you could really live it up in your 90's ( not my cup of tea):

 

[hnzw_rui]

Actually the portfolio went to zero at year 35 as per the VPW depletion plan to age 100. Suppose we set the depletion to age 115, that gives a 4.0% withdrawal rate in the first retirement year. Then the sequence looks like the following with less spending in one's 70's but you could really live it up in your 90's ( not my cup of tea):[/IMG]

More like providing money for the nursing home.

 

[haha]

More like providing money for the nursing home.

I believe that we will eventually realize that those nursing home years do not add to lifetime satisfaction. Instead they subtract from it. Gradually the stigma of suicide will be at first lessened, and then erased, and the end of life bloodsuckers both medical and domiciliary will be vanquished.

Ha

 

[nun]

A diversified portfolio gives you the chance to adjust the sources of your income to mitigate sequence of withdrawal issues.

In the extreme example if having everything invested in a single stock you have no defense against a downturn and at the other extreme with an annuity a downturn is unimportant to you. Most investors should be somewhere in the middle.

 

[Options]

He advocates for a percentage of portfolio withdrawal to avoid sequence of return risk to call the drop in payouts that happen with a decline market risk instead of Sequence of returns and claims by doing this you have eliminated the sequence of return risks.

In an example in the series after the ones you posted, he showed a portfolio using a 2.5% withdrawal, because when he looked at the data a 4.5% withdrawal he was using later had a failure in year 11, would have income drop to $16,000 a year from a starting value of $25,000 with a portfolio starting with 1MM dollars!

His "solution", of having a large annual variable income swings on a 2.5% initial withdrawal rate in order to eliminate sequence of return risk to the terminal value of a all valuable portfolio is a non-starter for the vast majority of retirees.

Of course I think he also advocates a very large position (15 years) in TIPS and offsetting that with an investment portfolio that you withdraw 2.5% from so for a retirement of 40K you would need 15K per year coming off in TIPS (or 225K invested in tips) and be willing to vary income from that, with the idea being after 15 years a normal 4% withdrawal rate from the portfolio will be ok.
He seems focused with making sure there is a large estate for heirs, even tho his subtitle of his blog is retirement planning for the unwealthy. His advice is great for people concerned with leaving an estate, but for me not knowing 4 years down the road if I will be spending 31K per year or 51K per year is not a budgetable process and therefore a non-starter.

The purpose of posting the links was to give an overview of sequence of returns risk, which Cotton explains relatively well, IMO. He states:

we can eliminate SOR risk from terminal portfolio values, or eliminate it from annual payouts, but not both. If we eliminate it from annual payouts, we introduce the risk of portfolio failure.

By basing our spending strategy on a constant percentage of remaining portfolio values, we can shift SOR risk to annual payouts, where it seems to do less harm.

Cotton is not the first, nor I suspect will he be the last, to use a variable portfolio withdrawal strategy. I'll be using a variation of it, as I have no intention of shifting risk to terminal PF value. There are many ways to manage SOR risk, as evidenced in one of the many links he provided in his posts (this one contains many additional useful embedded links):

Sequence of Returns Risk Misunderstood by Many Retirees

 

[Fermion]

Don't forget about SS which can offset some of the sequence of return issues.

Someone retiring with a 4% SWR that encounters a bad market pushing them up to an 6% SWR might consider taking SS early which could drop their SWR back to 4% or even lower with the same spending.

I haven't given a lot of thought to what I would do if faced with an extreme down market and a rapidly dwindling portfolio...would I take SS early to protect my remaining assets or delay SS and continue to spend down?

If the market dropped 50% and I was able to take SS early, I might really consider doing so and hoping the market and my portfolio recovered over the next several years.

 

[Cut-Throat]

Actually the portfolio went to zero at year 35 as per the VPW depletion plan to age 100. Suppose we set the depletion to age 115, that gives a 4.0% withdrawal rate in the first retirement year. Then the sequence looks like the following with less spending in one's 70's but you could really live it up in your 90's ( not my cup of tea):

Well, not only is it not your cup of tea or mine, it's not that realistic, so it is not much of a 'Plan'.

I have a number of acquaintances that are in their 80s and their 'Life' is pretty much over. Most things have been done, and they don't really want to do that much anymore.

Sure, there is always the odd 1 in 100 - 90 year old that is ready for most anything, but these are the anomalies. When you plug in 115 into a retirement calculator and get 'weird' results, don't be surprised. It is much better to plug in age 100 and at age 90 (If by a slim chance you even make it that far) and then reevaluate.

The biggest 'Failures' I see in people's Retirement Planning is that they will probably leave a Huge Pile at the end of plan. Which either means they scrimped in retirement or didn't retire early enough. Either way it is a Failure in my Book.

 

[Lsbcal]

I think we are basically on the same page CT. After I took a serious look at VPW I came around to your point of view. That said, a lot depends on one's portfolio size and spending habits. Some will find a 4.5% withdrawal more then enough -- that could be the couple with maybe $5M. I'm not quite there yet myself but find that 4.5% allows for a fullfilling retirement. Many here will have a smaller portfolio and so 4.5% will be easily spent ... and then some.

 

[bmcgonig]

He advocates for a percentage of portfolio withdrawal to avoid sequence of return risk to call the drop in payouts that happen with a decline market risk instead of Sequence of returns and claims by doing this you have eliminated the sequence of return risks.



In an example in the series after the ones you posted, he showed a portfolio using a 2.5% withdrawal, because when he looked at the data a 4.5% withdrawal he was using later had a failure in year 11, would have income drop to $16,000 a year from a starting value of $25,000 with a portfolio starting with 1MM dollars!



His "solution", of having a large annual variable income swings on a 2.5% initial withdrawal rate in order to eliminate sequence of return risk to the terminal value of a all valuable portfolio is a non-starter for the vast majority of retirees.



Of course I think he also advocates a very large position (15 years) in TIPS and offsetting that with an investment portfolio that you withdraw 2.5% from so for a retirement of 40K you would need 15K per year coming off in TIPS (or 225K invested in tips) and be willing to vary income from that, with the idea being after 15 years a normal 4% withdrawal rate from the portfolio will be ok.

He seems focused with making sure there is a large estate for heirs, even tho his subtitle of his blog is retirement planning for the unwealthy. His advice is great for people concerned with leaving an estate, but for me not knowing 4 years down the road if I will be spending 31K per year or 51K per year is not a budgetable process and therefore a non-starter.

He actually doesn't recommend a variable withdrawal rate. He's a floor and upside investor:

http://theretirementcafe.blogspot.com/2013/09/sequence-of-returns-risk-whats-that-mean.html

He states:

Having read my last few posts on this topic, it would be reasonable to assume that I would advise retirees to spend down stock portfolios based on a percentage of remaining portfolio balance and not one based on constant-dollar withdrawals. But I don't.

I advise retirees to set aside the capital they need to generate enough income to cover non-discretionary spending in a safe TIPs bond ladder or fixed annuities. Then you will have some certainty that you can pay the bills. If you have cash left over, then invest that amount in stocks. None of the three (fixed annuities, TIPs ladders, or buy-and-hold stock portfolios) are exposed to SOR risk.


Sent from my iPad using Early Retirement Forum

 

[nun]

If you have low expenses going into retirement you will also minimize sequence of returns issues. This is where the old chestnut if paying off the mortgage works in your favour.