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When do you actually "know" that sequence of return risk may impact a portfolio?
Old 03-29-2018, 07:03 AM   #1
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When do you actually "know" that sequence of return risk may impact a portfolio?

Sequence of return risk is probably the number one factor which worries me about the "health" of my retirement portfolio. My question is : when does one know or realize that sequence of return risk is taking place?

For example. Take a retiree with a $1,000,000 portfolio with 50% invested in the S&P 500 and 50% in interm. bonds. Further assume this is all in a taxable account and the retiree is withdrawing 4% annually ( total return with dividends at 2% and withdrawal from earnings at 2%).

Now , we have a scenario akin to the start of the "lost decade" , the first 3 years of the 2000's where the S&P 500 had losses of 9, 12, and 22%.

When does the light bulb go off and the retiree says" Hey I need to reduce my withdrawal rate....take more from bonds/cash......reduce expenses , etc."

Does this occur after 1 qtr? Six months? The full year? I would hate to wait until the end of the year of 2002 when the S&P 500 tanked for 22% already. How does one distinguish between a "drop" in the market and the start of a true bear market which is where sequence of return becomes an issue?

Curious what others think.
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Old 03-29-2018, 07:39 AM   #2
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i believe the 4% rule survived the lost decade. Sequence of return will always impact a portfolio; I would hope a retiree would know that before using the 4% rule.

I’m sorry. I don’t think I understand your question. But based on the lost decade, hindsight suggests the smart thing would’ve been to stay the course.
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Old 03-29-2018, 07:39 AM   #3
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I use VPW so I'd adjust after the first year. I don't recall how other VPW plans start, but with mine I started at 3.0% WR and increase by .05% for the first X years.

(Edited to reflect 9% S&P drop on a 50/50 portfolio)
So the first year I'd be able to withdraw $30K. If I also lost $45K I'd be down to $915,000 at the end of the year. At 3.05% I could withdraw $27,907. That would hurt, but that's why I retired with a buffer.

Luckily that didn't happen to me, and I also didn't actually switch to VPW until a few years in. But I like this method because I don't have to make any judgement calls like when I have to bail on the 4%+inflation withdrawals, or when it's safe to increase withdrawals after a good run. I automatically make gradual adjustments each year.
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Old 03-29-2018, 07:45 AM   #4
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Hindsight works well, too

It's easy to recognize a long term market drop in its early stages.

Just rev your DeLorean up to 88 miles per hour...

Seriously, cooch96 is right. There is a SOR risk always out there. If you made provision for it as part of your allocation strategy from the beginning then you'll be fine.
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Old 03-29-2018, 08:00 AM   #5
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SOR has not been a concern of mine for a couple of reasons. Markets go up and markets go down. Over my working life my income fluctuated considerably as well. Decades of making adjustments has somewhat conditioned me to these situations. It also encouraged me to save aggressively and invest more than probably needed for the rainy days. On top of that my old school "never touch the principal" mentality gives another layer of cushion. Just keep plodding along.
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Old 03-29-2018, 08:05 AM   #6
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Like so much with investing, you don't know. So, you plan in advance.

In my case, my long term AA goal is 70-30. But my retirement AA is 60-40. I have excess bonds (cash) to support my spending in the early years. My AA glide path is 70-30, 69-31, 68-32, etc.

My spending remains constant(4% or so) and independent of market fluctuations. I spend from bonds (and dividends and interest) and re-balance. If the market goes down a lot, I will actually be purchasing equities.
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Old 03-29-2018, 08:13 AM   #7
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Quote:
Originally Posted by cooch96 View Post
i believe the 4% rule survived the lost decade. Sequence of return will always impact a portfolio; I would hope a retiree would know that before using the 4% rule.

I’m sorry. I don’t think I understand your question. But based on the lost decade, hindsight suggests the smart thing would’ve been to stay the course.
We're only 18 years into a retirement starting in 2000. Do you know for sure it has survived?

I ran a quick spreadsheet, starting at 40K withdrawal, rising by inflation, with 50/50 stock/bond returns. You'd be at $1.1M and change now. Kind of recovered ($1M in 2000 would be worth nearly $1.5M now) but you are now withdrawing $58,829. Most success graphs show a nice increase in wealth in the early years, often reducing in the later years as you continue increasing your withdrawals to keep up with inflation. You'd probably still make it, but it's not a sure thing, especially since many think the market is poised for another correction.
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Old 03-29-2018, 08:16 AM   #8
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Originally Posted by Mdlerth View Post

Seriously, cooch96 is right. There is a SOR risk always out there. If you made provision for it as part of your allocation strategy from the beginning then you'll be fine.
On one hand you are saying that cooch is right, you can just follow the 4% rule. On the other hand, you are saying you have to make provision for it. Which is it: stay the course, or make provision? And what would that provision be, and when do you do something? That's the question the OP is asking.
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Old 03-29-2018, 08:45 AM   #9
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Quote:
Originally Posted by MrLoco View Post
.

When does the light bulb go off and the retiree says" Hey I need to reduce my withdrawal rate....take more from bonds/cash......reduce expenses , etc."

Does this occur after 1 qtr? Six months? The full year? I would hate to wait until the end of the year of 2002 when the S&P 500 tanked for 22% already. How does one distinguish between a "drop" in the market and the start of a true bear market which is where sequence of return becomes an issue?

Curious what others think.
I think for most of us that retired in 2008 the light bulb went off pretty quickly as the market kept on dropping . I lost over 30% and immediately reduced expenses . The thing that I learned from that period is to have enough in cash to weather a few years .
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Old 03-29-2018, 08:54 AM   #10
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Originally Posted by MrLoco View Post

Now , we have a scenario akin to the start of the "lost decade" , the first 3 years of the 2000's where the S&P 500 had losses of 9, 12, and 22%.
Are you meaning that we are potentially entering a lost decade or are you just running hypotheticals here?
If you think we're at the start of a lost decade I'm curious how you might know that. (a question, not a challenge)
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Old 03-29-2018, 08:55 AM   #11
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Old 03-29-2018, 09:06 AM   #12
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Quote:
Originally Posted by MrLoco View Post
Sequence of return risk is probably the number one factor which worries me about the "health" of my retirement portfolio. My question is : when does one know or realize that sequence of return risk is taking place?

For example. Take a retiree with a $1,000,000 portfolio with 50% invested in the S&P 500 and 50% in interm. bonds. Further assume this is all in a taxable account and the retiree is withdrawing 4% annually ( total return with dividends at 2% and withdrawal from earnings at 2%).

Now , we have a scenario akin to the start of the "lost decade" , the first 3 years of the 2000's where the S&P 500 had losses of 9, 12, and 22%.

When does the light bulb go off and the retiree says" Hey I need to reduce my withdrawal rate....take more from bonds/cash......reduce expenses , etc."

Does this occur after 1 qtr? Six months? The full year? I would hate to wait until the end of the year of 2002 when the S&P 500 tanked for 22% already. How does one distinguish between a "drop" in the market and the start of a true bear market which is where sequence of return becomes an issue?

Curious what others think.
Since I use % remaining portfolio, I automatically reduce income after a bad year. If my portfolio drops 20%, by definition my income drops 20%. If the portfolio is slow to recover, my income also recovers slowly.

In terms of mid year adjustments - I withdraw a full year of income at the start of each year, so I don’t worry about what the market is doing during the year or try to predict anything, and I make no spending adjustments. If I have to take an income cut the next Jan, so be it.

Over the years I’ve accumulated quite a stash of unspent funds as our spending has not kept up with our portfolio growth, so we should be able to weather income cuts due to the portfolio dropping - at least for a good while.
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Old 03-29-2018, 09:13 AM   #13
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Quote:
Originally Posted by MrLoco View Post
...
When does the light bulb go off and the retiree says" Hey I need to reduce my withdrawal rate....take more from bonds/cash......reduce expenses , etc."

Does this occur after 1 qtr? Six months? The full year? I would hate to wait until the end of the year of 2002 when the S&P 500 tanked for 22% already. How does one distinguish between a "drop" in the market and the start of a true bear market which is where sequence of return becomes an issue?

Curious what others think.
The short answer is to design your withdrawals and portfolio to withstand the worst sequence historically. VPW is your friend in this but many do not feel comfortable (or motivated) to run this and look at spreadsheet results.

You cannot really "see it coming" should a bad sequence emerge. It is a little like hiking on a trail and only being able to see 50 yards ahead. You don't know if you will be gaining or losing altitude in the next mile. Let alone the next 5 miles. And there is no map.

In one of the worst sequences starting in 1966, the low point was reached in 1975.
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Old 03-29-2018, 09:19 AM   #14
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SOR risk is a big factor for me, since I'm aiming to retire at 45 and am not quite as "belt and suspenders" as the average poster here. IIRC, the big failures with the 4% rule were during the stagflation period of the early 70s, and SOR risk is focused on your first decade in retirement, so, if there's a significant bear market right after I retire, I'll:

1. Start comparing the market's behavior (and inflation) to the early 70s - it's not a perfect method, but it should give me a ballpark idea of where I'm at. This would only work for a year's worth of data or more, so it's not a quick signal.

2. Re-assess how far expenses can be trimmed - our FIRE has a significant cushion for travel, etc., so there's some reduction available there. And DH and I both grew up frugally, so we know we can eat more cheaply too.

3. If it's in the first couple of years, pick up a 6-month contract gig. They're pretty common in my industry and location and a couple years out of the job market won't make me unemployable. DH is in a similar boat.

Our careers involve a lot of risk management, so we're comfortable with the limitations of data - what it can and can't tell you, how much uncertainty still exists no matter how many numbers we crunch. What's that saying about being agile and hostile?

Re: the question on a year 2000 retiree being OK right now, I think Kitces has a post on his site about how they're doing that talks about it.

eta: found it: https://www.kitces.com/blog/how-has-...ancial-crisis/
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Old 03-29-2018, 09:22 AM   #15
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Like so much with investing, you don't know. So, you plan in advance.

My spending remains constant(4% or so) and independent of market fluctuations. I spend from bonds (and dividends and interest) and re-balance. If the market goes down a lot, I will actually be purchasing equities.
+1

I intend to spend per plan for the next three years (rolling) independent of market fluctuations and have a more aggressive AA if the markets become significantly less expensive. That said, I'm sure a 40% or more drop in the equity markets would cause me to tap the spending brakes, but more likely my later years spending plan. I can handle a lost decade, but longer than that would be cause for concern.
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Old 03-29-2018, 10:26 AM   #16
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I think the timeframe that started with 2000 might be one of those few that's destined for failure. At least, for me. I put a bunch of data into a spreadsheet awhile back, using my actual gains and losses for each year, and also the actual rate of inflation for each year. If I had started off with $1M on 12/31/1999, a 4% withdrawal rate would have me at $287,553 at the end of 2017. While I wouldn't be out of money, at that rate what's left wouldn't last much longer.

A 3% withdrawal rate would have me at $817,293. I think even that would have me a little leery. Although, for a 30 year retirement, at this point there would only be 12 years left, so that might work out. But for, say, a 40 year or more timespan, I might be a bit apprehensive.

As for that 2000-2002 timeframe, If I was retired, I probably would have started scaling back on my spending over the summer of 2001. As I recall, 2000 actually wasn't all that bad for the most part, and I only ended up down about 5.4%. The early part of 2001 actually seemed optimistic, and I hit a new all-time peak in May of that year...of course, I was (and am) still adding investments, and not having to draw anything out yet. But, as things cooled down over the summer, I would've begun to worry. And then, the 9/11 tragedy hit. I ended up down about 30.4% that year. And I went on to lose another 23.1% in 2002.
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Old 03-29-2018, 11:04 AM   #17
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Quote:
Originally Posted by RunningBum View Post
On one hand you are saying that cooch is right, you can just follow the 4% rule. On the other hand, you are saying you have to make provision for it. Which is it: stay the course, or make provision? And what would that provision be, and when do you do something? That's the question the OP is asking.
I must not have penned my thoughts clearly. What I intended to convey was that the provision is made at the outset by selecting an allocation. That's all. OP doesn't need to do anything beyond sticking to the chosen AA.

It's what I will be doing when I retire. Perhaps I'm completely misguided and will crash and burn after a dozen years, but at least I'm going to be walking my talk.

I've read hundreds of threads on this site exploring this issue. They chart historical data, Monte Carlos, etc. SOR risk is baked into them all. After digesting those I've come to the conclusion that staying aligned with a selected allocation is the wisest course. It almost doesn't matter what that AA is: 80/20, 30/70, whatever. There is an enormous range within which the probability of retirement success using that 4% WR is very high.

I won't be offended if you draw different conclusions from your own research.
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Old 03-29-2018, 12:24 PM   #18
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I must not have penned my thoughts clearly. What I intended to convey was that the provision is made at the outset by selecting an allocation. That's all. OP doesn't need to do anything beyond sticking to the chosen AA.

It's what I will be doing when I retire. Perhaps I'm completely misguided and will crash and burn after a dozen years, but at least I'm going to be walking my talk.

I've read hundreds of threads on this site exploring this issue. They chart historical data, Monte Carlos, etc. SOR risk is baked into them all. After digesting those I've come to the conclusion that staying aligned with a selected allocation is the wisest course. It almost doesn't matter what that AA is: 80/20, 30/70, whatever. There is an enormous range within which the probability of retirement success using that 4% WR is very high.

I won't be offended if you draw different conclusions from your own research.
Thanks for clarifying.

If I'm not mistaken, the 4% system is generally said to have a 95% success rate (for 30 years, but that's another issue I won't get into). Not 100%. So there is also a 5% failure rate "baked in" to these studies. Guess when those failures are most likely to happen? In poor sequence of return situations is my guess. So yes, SOR is baked in, as a very possible failure. Not as a "don't worry about it, it always works out" baked in thing. That's what I take issue with.

Stay the course? Right into one of those 5% failures? Then what? Nobody is going to be sympathetic that your plan should have worked 95% of the time.

The OP (I think) is asking how you tell if you are in one of those failure cases, and what and when you do something about it. Blindly following a plan that has a 1 in 20 chance of failing, especially when you see it off to a bad start, doesn't seem wise to me. If you look at all those graphs in Firecalc, I'll bet you anything if you include only the ones start similarly to 2000-2002, they have nowhere close to a 95% success rate. I'm sure they aren't all failures, but you probably wouldn't be too comfortable with the odds.
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Old 03-29-2018, 12:32 PM   #19
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flux capacitor issues

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Originally Posted by Mdlerth View Post
It's easy to recognize a long term market drop in its early stages.

Just rev your DeLorean up to 88 miles per hour...

Seriously, cooch96 is right. There is a SOR risk always out there. If you made provision for it as part of your allocation strategy from the beginning then you'll be fine.
but if you’re having issues with your flux capacitor it might be more difficult


that’s why you need to build in a buffer, punching out when you’ve “just hit your number” isn’t the best way to go. we’ve had a CD ladder, plus a buffer, (another buffer) and are close enough to applying for SS at FRA to be the next buffer Those that are trying to get out in very early years (40’s and the like) need to be mindful of the SOR more than those who can engage other sources
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Old 03-29-2018, 12:36 PM   #20
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