Understating Sequence of Return Risk

[Birchwood]

From my understanding "Sequence risk" affects mainly the first 20 years after we retire. The whole market is going into a cycle, up and down, how long or short it takes affects our withdrawal pattern. Thus if we have a long recession during the early part of retirement, it can be a tough miserable few years.
What it practically means is that we should withdraw less when the market is down and probably get more when it is up to make a balance.

[Danmar]

Quote:

Originally Posted by mathjak107 trying to spend only dividends or only interest is really not my idea of a retirement income . the issue is dying with to much money unspent may not be the greatest plan either . ideally you want to enjoy your money and spend some of it down while still leaving legacy money for heirs . this is what a good retirement withdrawal plan does . what about inflation adjusting ? dividends may not track your personal rate of inflation which can differ vastly from the cpi ? you still have sequence risk . the value of your dollars compounding after each dividend payment will be less at the gate each quarter unless you are offsetting the decrease in share price from the dividend being paid out by a enough of a gain . in an extended down turn this can be an issue . in reality getting a 6% total return with a 2% dividend and 4% appreciation is no different than drawing that 2% against a portfolio that has 6% appreciation and no dividend . they both are effected by the same thing .

Agree mostly, except we are talking about sequence of return risk. If you are forced to sell something to sustain your lifestyle at a bad time, this is sequence of return risk.

If I can live on the divs(I can) and the divs are close to a SWR (they are) I don't see the sequence risk? Agree I have div reduction risk and my portfolio may not be as diversified as many would like. Maybe these risks are comparable in size to sequence risk but I don't think so.

Agree that I will probably need to do something to prevent leaving too high a legacy for my daughter. But I can deal with this by liquidating some principal at an advantageous time. Not be forced into doing so.

Actual results for 18 years of investing. Total CAGR for total return about 12% about 3-3.5% of this divs rest(8.5-9%) cap appreciation.

[mathjak107]

Quote:

Originally Posted by nun Taking the dividends from a retirement account means they are taxed as income. From a non retirement account they are treated as dividends

actually michael kitces looked in to this and what he found was if equity's throw off dividends the tax deferred account was a better choice then the lower tax brackets of a taxable account for 2 reasons .

the fact that the dividends can compound tax deferred over time beat the tax difference from the special capital gains rates and the compounding capital gains tax deferred in the retirement account beat the equity's in the taxable account .

the 2nd reason is turnover . the more the turnover in equity's the worse they will do in a taxable account and that is true of funsds too .

you can see in your head after decades of paying taxes in the taxable account on dividends the lesser amount loses more compounding ability than the tax difference .

https://www.kitces.com/blog/asset-lo...-time-horizon/

[nun]

Quote:

Originally Posted by mathjak107 actually michael kitces looked in to this and what he found was if equity's throw off dividends the tax deferred account was a better choice then the lower tax brackets of a taxable account for 2 reasons . the fact that the dividends can compound tax deferred over time beat the tax difference from the special capital gains rates and the compounding capital gains tax deferred in the retirement account beat the equity's in the taxable account . the 2nd reason is turnover . the more the turnover in equity's the worse they will do in a taxable account and that is true of funsds too . you can see in your head after decades of paying taxes in the taxable account on dividends the lesser amount loses more compounding ability than the tax difference . https://www.kitces.com/blog/asset-lo...-time-horizon/

I was thinking of the withdrawal phase. I assume that most people have equities in their after tax accounts as they will have filled up their bond allocation in retirement accounts. When it comes to withdrawing funds taking qualified dividends from taxable accounts allows for some tax savings strategies depending on your income level and if you reinvest dividends in a retirement account the tax deferral compounds.

[mathjak107]

exactly the case that kitces looked under the hood and found that really may not be the best way to do it . dividends distributions and turnover can wipe away any tax advantage having the equity's in the after tax account . having low yielding bonds and cash may be a waste in the deferred account as well . unless you were in the zero capital gains bracket the savings from capital gains rates may be negated out .

this is just the opposite of what old school used to think . but they never looked at it with distributions and turnover in investments so the tax savings always appeared a no brainer . but not so .

[nun]

Quote:

Originally Posted by mathjak107 exactly the case that kitces looked under the hood and found that really may not be the best way to do it . dividends distributions and turnover can wipe away any tax advantage having the equity's in the after tax account . having low yielding bonds and cash may be a waste in the deferred account as well . unless you were in the zero capital gains bracket the savings from capital gains rates may be negated out . this is just the opposite of what old school used to think . but they never looked at it with distributions and turnover in investments so the tax savings always appeared a no brainer . but not so .

Given the choice between the immediate tax savings of 0% tax on qualified dividends from a taxable account and income tax on dividends from retirement accounts I think I'll take that rather than a generalized analysis.

[hnzw_rui]

Quote:

Originally Posted by mathjak107 exactly the case that kitces looked under the hood and found that really may not be the best way to do it . dividends distributions and turnover can wipe away any tax advantage having the equity's in the after tax account . having low yielding bonds and cash may be a waste in the deferred account as well . unless you were in the zero capital gains bracket the savings from capital gains rates may be negated out . this is just the opposite of what old school used to think. but they never looked at it with distributions and turnover in investments so the tax savings always appeared a no brainer . but not so .

I think growth rate was probably the biggest determining factor for "efficient asset location". Bond and other fixed income in taxable accounts could certainly be quite inefficient at the 6-10% interest rates of decades past. In today's low-rate environment, not so much.

Of course, the Kitces model assumes one is in the 25% marginal tax bracket and doesn't take into account the potential tax torpedo when you start drawing SS/pension nor the effects of RMDs. To be honest, I think tax drag mostly matters if you're re-investing dividends and capital gains distributions. If you're using the distributions (and maybe even selling shares) for your annual spending, then I think the tax treatment of LTCG and q-divs along with tax loss harvesting might be preferable. There's also the small matter of the complexity of drawing from tax-deferred accounts penalty free if you retired, say, in your 40s or something.

Really, if pensions and other income will put you in 25% or higher marginal tax bracket, best place to have stocks and other high growth vehicles is the Roth.

[nun]

Quote:

Originally Posted by hnzw_rui Really, if pensions and other income will put you in 25% or higher marginal tax bracket, best place to have stocks and other high growth vehicles is the Roth.

Yes that's perfect for lowering tax.

There are some practical income considerations when you are spanning the gap to 59.5 and beyond even if you do a 72t. One of those is keeping immediate tax to a minimum so that you maximize the money you have to spend. So if I can take qualified dividends from a taxable account any pay 0% tax (assuming I keep my income in the right tax bracket) that sounds a lot better than some potential deferred benefit.

In the real world most people have equities in tax deferred accounts along with fixed income and I would expect them to also have some equities and cash in taxable accounts.....certainly if they are going into ER.

[pb4uski]

Quote:

Originally Posted by nun Given the choice between the immediate tax savings of 0% tax on qualified dividends from a taxable account and income tax on dividends from retirement accounts I think I'll take that rather than a generalized analysis.

+1

[papadad111]

Quote:

Originally Posted by Birchwood From my understanding "Sequence risk" affects mainly the first 20 years after we retire. .

This is mostly dependent on the age one retires.

So I ask- For true early retires, those in 40's for example, it would seem that the risk of inflation is far greater over the course of a 40-45 year retirement than series of return risk.

Would it make sense that , in the above context, holding a 60/40 AA (45 years of retirement to cover) with the 40 percent earning next to nothing is a lot riskier *in total* than staying at 100 percent equity asset allocation yielding an approximate 2 percent dividend yield. ?

We've just been through 8 years of near zero interest rates.

[mathjak107]

inflation is part of the sequence of return risk equation when spending down . it is already built in to the result . in fact the worst case scenario we had to date 1965/1966 did not fail based on just market returns . it was inflation that did it in .

but just by definition sequence risk when spending down has to include inflation adjusting .

1966 stocks 10.23 - -bonds 7.85 -- rebalanced portfolio 9.56- - inflation 5.38

for comparison the 140 year average's were:

stocks 8.39--bonds 2.85%--rebalanced portfolio 6.17% inflation 2.23%

the biggest danger though is the first 15 years . the returns above were pretty ok . buit looking at the 15 year results you can see what made them worst case , inflation did .

1966-stocks minus .13%--bonds 1.08%--rebalanced .64%-- inflation 5.38%

[utrecht]

Quote:

Originally Posted by Birchwood From my understanding "Sequence risk" affects mainly the first 20 years after we retire. .

That's kind of like saying you only lose a football game if you score less points than your opponent.

"Sequence risk" implies there is more risk at the beginning of retirement. Well, the first 20 years IS retirement for the majority of people. Its at least half for most everyone so obviously the first 20 years are critical. I would say once you get past the first 5 years unscathed, you're in pretty good shape

[Danmar]

Quote:

Originally Posted by utrecht That's kind of like saying you only lose a football game if you score less points than your opponent. "Sequence risk" implies there is more risk at the beginning of retirement. Well, the first 20 years IS retirement for the majority of people. Its at least half for most everyone so obviously the first 20 years are critical. I would say once you get past the first 5 years unscathed, you're in pretty good shape

Yes, but it depends on how long your retirement is expected to be. I feel good that I have escaped sequence of return risk for the first 9 years of my retirement, but I am only 65 and hopefully have a long retirement left. So, I still should be concerned. Equivalent to a 65 year old retiring today.

[hnzw_rui]

Quote:

Originally Posted by Danmar Yes, but it depends on how long your retirement is expected to be. I feel good that I have escaped sequence of return risk for the first 9 years of my retirement, but I am only 65 and hopefully have a long retirement left. So, I still should be concerned. Equivalent to a 65 year old retiring today.

Ah, but how much was your starting retirement portfolio and how much is your portfolio worth now?

I reckon the situation is much less risky for someone who starts off with $1M and after 9 years has an inflation-adjusted portfolio of $1.5M versus someone who starts off with $1M but only has $500K inflation-adjusted after 9 years.

[Danmar]

Quote:

Originally Posted by hnzw_rui Ah, but how much was your starting retirement portfolio and how much is your portfolio worth now? I reckon the situation is much less risky for someone who starts off with $1M and after 9 years has an inflation-adjusted portfolio of $1.5M versus someone who starts off with $1M but only has $500K inflation-adjusted after 9 years.

It's a little more complicated for me. For the first 5-6 years of retirement I was still cashing out deferred compensation awards to fund our living expenses. Some of these cash outs were used to buy vacation properties. If I add these back my portfolio would be a little bigger than when I retired(perhaps by inflation). The awards were MTM in my initial retirement portfolio. This despite the fact we were spending heavily on other things like travel during this period. So all in all not a bad result especially when you consider the impact of the financial crises during the initial period of retirement.

[nun]

I retired at 52, about 18 months ago, and Ive been spending rental income and cash. I plan to keep doing that until next year when I'll be 55 and my pension will start. If I was spending from my investments this summer's correction would have been slightly worrying, but as I don't ever plan on spending from my investments sequence of return risk doesn't bother me.

[Danmar]

Quote:

Originally Posted by nun I but as I don't ever plan on spending from my investments sequence of return risk doesn't bother me.

Not even divs/interest? If not your heirs will certainly thank you.

[Cobra9777]

I retired at 52 two years ago. With interest rates near zero and stocks at lofty valuations, we were quite concerned about sequence of returns risk. In the year leading up to ER, we made the decision to take both pensions as an annuity, pay off the mortgage, buy two rental houses, increase our cash allocation to 5%, and tilt the taxable portfolio to high dividends.

At the moment, DW is still working OMY, but her pension annuity will replace her net pay exactly. So, our early spending is covered by her net pay/pension, my pension, rental income, dividends from the taxable account, and small withdrawals from the cash allocation, mainly just to cover occasional large discretionary items. This should easily carry us to 67-70 when SS and RMDs begin.

These actions probably sacrificed some long-term growth potential. But, with a long time horizon, we feel a lot better about near-term sequence of return risk compared to the alternatives. There's still a growing portfolio of stocks and bonds, sufficient to cover other long-term risks like inflation, longevity, and LTC. Also a monstrosity of a house that will be downsized at some point, further boosting the nestegg and cutting expenses.

I watch our investments and market volatility with interest as always. But with spending covered, I don't fret much about sequence of return risk, interest rate risk, what the Fed might do, price of oil, etc. My biggest problem is just getting past the rookie fears and actually spending some money.

[mathjak107]

i retired day 1 of the yaun drop . from that day on markets sucked . i am very concerned about sequence risk early on .

we will adjust our budget downward based on dec 31 balance .

i always thought i would be the unlucky one to pull the plug right on the eve of an extended drop .

bingo ! this is not china's fault , it is mine ha ha ha

the good news is i had a 50/50 allocation in mind but at the last minute decided to do a rising glide path in so i am at about 40% equity's at this point still averaging back in .

[nun]

Quote:

Originally Posted by Danmar Not even divs/interest? If not your heirs will certainly thank you.

That's the plan; rent, pension and SS checks from the US and the UK will more than cover my expenses.