Avoid SOR risk? I think not! "SOR" = Sequence of Returns

[audreyh1]

Has the game changed with the relationship between bonds and equities? I thought (many years ago) that the concept was that bonds got better when equities declined, and vice versa. Has the world of ZIRP changed that? Now, bonds look like stuffing money under the mattress,and equities go up and down. If that is the case, then rather than a percentage, it would make sense to hold x number of years in fixed, and the balance in equities. That way you would have a shield over being forced to sell stocks in a down market (at some point, you still need to sell, and when you decide to sell it becomes market timing). This past ten years it has been a situation where the overweight in stocks has improved portfolio performance. Unless bonds begin to appreciate when stocks falter, then all you are doing is averaging the performance of stocks towards 0 (or whatever the yield is on bonds).

They still do. No ZIRP didn’t change that. The swings may not be as dramatic but they are still there. Just look at the sudden and powerful flight to quality in Dec 2018. Some bond funds that had been negative for the year actually turned positive.

 

[Sandman62]

I haven’t gotten through this whole thread yet. But for now, I’ll share that I did reduce to 30/70 a year or two before I retired last year.

My philosophy is that I don’t need to make another $x+y when the $x we already have is plenty. OTOH, $x-y would’ve meant working several more years.

My 2 cents.

 

[pb4uski]

STC in FIRECalc with $1 million, $35k spending, 70% equities, 40 year time horizon:

Here is how your portfolio would have fared in each of the 108 cycles. The lowest and highest portfolio balance at the end of your retirement was $-233,044 to $11,726,566, with an average at the end of $2,795,636. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 40 years. FIRECalc found that 3 cycles failed, for a success rate of 97.2%.

Retiree B under FIRECalc with $825,000 ($1 million with $175k carveout for first 5 years of spending in a CD ladder), $35k spending, 70% equities and 40 year time horizon and withdrawals beginning in 5 years (2024 rather than 2019):

FIRECalc looked at the 108 possible 40 year periods in the available data, starting with a portfolio of $825,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 108 cycles. The lowest and highest portfolio balance at the end of your retirement was $-177,413 to $10,836,920, with an average at the end of $2,686,575. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 40 years. FIRECalc found that 2 cycles failed, for a success rate of 98.1%.

STC has higher upside and higher average balance, but Retiree B has better success rate, which was his reason for grading from 52/48 to 60/40 to begin with.... to me all in, six of one or a half dozen of another, but if it allows Retiree B to sleep better at night then that is great.

 

[pb4uski]

Same as above but with a 4% WR/$200k carveout to try to differentiate the strategies more.

STC:

FIRECalc looked at the 108 possible 40 year periods in the available data, starting with a portfolio of $1,000,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 108 cycles. The lowest and highest portfolio balance at the end of your retirement was $-1,047,806 to $10,718,171, with an average at the end of $2,093,993. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 40 years. FIRECalc found that 17 cycles failed, for a success rate of 84.3%.

Retiree B:

FIRECalc looked at the 108 possible 40 year periods in the available data, starting with a portfolio of $800,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 108 cycles. The lowest and highest portfolio balance at the end of your retirement was $-984,227 to $9,701,433, with an average at the end of $1,969,352. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 40 years. FIRECalc found that 17 cycles failed, for a success rate of 84.3%.

Still pretty similar.

 

[jollystomper]

There is always one thing that gets lost in discussions on here about AA, or SOR or risk in general and that is not everyone is trying to maximize their returns. Some want to preserve with steady returns and are OK with leaving a little on the table.

+1

That is my approach. I am happy with singles, I do not need to swing for the fences. If others choose to, though, that is fine by me.

 

[Chuckanut]

Keep in mind that SOR problems that occur after the early years of retirement may be less serious since the assets don't have to last as long. Thus, we should focus on avoiding SOR problems early in our retirement.

I'll leave 'early' to be defined by each individual.

 

[audreyh1]

Usually the first 15 years is suggested as the danger zone for the retiree. Kitces work was trying to address that specifically.

 

[SecondCor521]

I agree with @Montecfo that doing an SWR and then going more conservative to account for SORR is double-counting.

I assessed my longevity and risk appetite and then calculated my SWR three years ago - 40 years at 90/10 at 4%. That gave me 100% safety in about 5 different retirement calculators. Any historical SORR is already covered at that point. Any future-is-worse-than-the-past SORR is not covered, but was never intended to be by historical tools anyway (which are the gold standard IMNSHO).

 

[RobLJ]

1. I was going to chime in, then saw this: this is pretty close to what we are doing, although I'll average up at SS.

Having retired in 2017 when CAPE10 was >30* I did adopt a muted rising glidepath. I started at 55/45 and plan to follow Age In Stocks until approximately SS time. I haven't settled on my final AA, I'll probably stop at 65/35 - if it is good enough for Wellington it is good enough for me.

On valuations, I was sufficiently scared by US valuations in '97 that I took Fid Contra gains and moved 2/3 to Fid LowPrice. Also housing & valuations in '06 scared me enough to move from 95-5 to 63-25-12. As big a factor was the realization I was almost 50 and was taking on risk that, in the event of a recession, would take a long time to recover. The Great Recession was worse than I expected, of course. I'm pretty much done with market timing, having run out the string of luck--although if I see extreme valuations like '97, I'll do it again.

 

[Doc0]

SOR is related to taking money out of a portfolio when the stocks are in the red. It's a buy high sell low problem. If you look at the graph on the FIREcalc homepage it is 1973 1974 and 1975 SOR. If you retired in 73 you flamed out. In 74 you had money but not growth. In 75 you pulled the golden ring. The solution is to put some money in a separate low risk portfolio something like a 20/80 which happens to be the tangent portfolio most gain for least risk. Leave the rest of the portfolio alone except for re-balancing. If you need 40K/yr stick 120K in the 20/80 and leave the rest at 60/40 or 70/30. When the market is down say 25% (or more than the SD of the portfolio) live off the 20/80 money. This effectively re sequences your portfolio to a better SOR. If you lived 3 years off the 20/80 in a 1973 retirement you would have converted it to a 1975 retirement. You really only need to do this once so no real need to refill the resequence account. The reason is by the time your "next" crash comes along you'll be closer to death and you'll run out of life before the bad SOR has a chance to manifest. 2 things are certain you will experience bad SOR and you will die so by re-sequencing you dramatically mitigate your risk

 

[Clone]

If you look at the graph on the FIREcalc homepage it is 1973 1974 and 1975 SOR. If you retired in 73 you flamed out. In 74 you had money but not growth. In 75 you pulled the golden ring. The solution is to put some money in a separate low risk portfolio something like a 20/80 which happens to be the tangent portfolio most gain for least risk.

I would suggest that the FireClac example has the illusion that the only difference between these three scenarios is the date when the person retired. If we were to review where they were in 1972, you would find that the value of the three portfolios is very different.

The story could be- "If you believe in a magic number, like 25 times your required retirement income, then hitting that number at the end of a bull run (and right before a big crash) is much more dangerous than having that number when you retire at the bottom of the big crash."

 

[Doc0]

I would suggest that the FireClac example has the illusion that the only difference between these three scenarios is the date when the person retired. If we were to review where they were in 1972, you would find that the value of the three portfolios is very different.

The story could be- "If you believe in a magic number, like 25 times your required retirement income, then hitting that number at the end of a bull run (and right before a big crash) is much more dangerous than having that number when you retire at the bottom of the big crash."

You could suggest it but you'd be wrong. The only difference in the portfolios is when you start extracting money, and that is the point of SOR. All three portfolios started with 750K and extracted 35K/yr for 30 years, except 1973 which ran out of money around 19 or 20 years. In 73 you are forced to sell low for the duration. 3 years of early bad SOR. In 74 things are a little better but you still don't recover but at least you make 30 years, 2 early years of bad SOR. In 75 growth has resumed. You suffer only 1 year bad SOR. If you actually review the market quarter by quarter in those years it oscillates all over the place and is not V shaped. It oscillates between negative and very negative. As well those years represented stagflation where prices were spiking because of the oil crisis in the face of a deflationary economy. Just like it takes years to "compound" your portfolio's growth, it takes years for a miscalculation or bad SOR to yield the portfolio's failure. I set up a 30 year spread sheet of SOR and offsetting withdrawal from the risky portfolio and relying on the low risk portfolio did in fact re-index the risky portfolio to a far better outcome. In retirement you have to spend money to live. Buying high during accumulation and being forced to sell low during withdrawal to buy your hamburgers is a sure fire looser resulting in permanent loss of wealth. In a 50% market drop you can expect a 70/30 portfolio to loose 33% of it's value a.k.a. 1M goes to 660K and pulling another 4%/yr out (120K over 3 years) adds to the misery because your 660K is NOT growing. Your cool 1M is now 550K. A 20/80 portfolio would only drop only about 10%, keeping 90% of it's value, since it's mostly bonds so if you started with 120K in the 20/80 you could expect to live for nearly 3 years on that dough while the 70/30 portfolio recovers unmolested. If you further re-balance the 70/30 along the way it will magnify the 70/30 portfolio's recovery because that forces you to buy low by transferring excess bond money into stocks. There's nothing magic about it.

 

[Andre1969]

While the 1973/74/75 scenario gives a good perspective of what a difference a year (or two) makes, I think realistically, for anybody thinking of retiring back then, if you didn't take the plunge in '73, there's a good chance you wouldn't have in '74 or '75 either, because the economy in those two years would have eroded your net worth to the point you'd go into OMY mode for awhile.


Of course, this is just for people who voluntarily pick when to retire...sometimes that choice isn't made for us, with health concerns, layoffs, and other times life gets in the way. And, most people have some other source of income to fall back on...at the very least, SS.


FWIW, my paternal grandfather retired in 1974. However, he did it after working for something like 35 years on the Pennsylvania Railroad, so he got a pretty nice pension. They were also good at saving money (not investing, so much), so they wouldn't have had their money tied up in anything risky enough to lose much value in '74-75.

 

[REWahoo]

You could suggest it but you'd be wrong.

+1

 

[Doc0]

FWIW, my paternal grandfather retired in 1974. However, he did it after working for something like 35 years on the Pennsylvania Railroad, so he got a pretty nice pension. They were also good at saving money (not investing, so much), so they wouldn't have had their money tied up in anything risky enough to lose much value in '74-75.[/QUOTE]

My first year of investing was 1975, same year Vanguard was founded. In those days people did have pensions. IRA's and 401K's were just being legislated into existence. It cost $200 to make a trade and mutual funds charged 3% to 6% up front load fees beside the yearly rip off. A very different scene than today. People like your grandpa couldn't afford the load of investing. Financial services was pitched to a very different clientele than today. In grandpa's day savings accounts and CD's from banks provided the juice, both extremely vulnerable to inflation so a lot of retirees did loose a lot. A 6% CD doesn't fare well against 18% inflation. But the SOR graph none the less is an accurate depiction of the risk associated

 

[Andre1969]

Wow, thanks for that historical perspective, Doc0! It really was a different time.



I think one of the first stock trades I did, back in the late 90's, cost me $24.95 to do it over the phone. One of my co-workers had a stock guy he used, and he gave me the guy's number. When I called him though, he said he charged $50 to do a transaction, and recommended I go with the automated thing over the phone. So, I'll give him some credit, for his honesty, at least!


But to think nowadays, you can go online and do stock trades for something like $4.95 or so.


With the way fees and everything was so stacked against you back in the day, it seems like the system was geared more toward keeping you trapped in a middle-class lifestyle. Give you just enough pension, SS, and other incentives to let you have something, at least, but not much to actually aspire to.


These days, it seems like it's much easier, if you have the drive, ambition, and maybe a bit of luck, to invest, and break free of that...shoot for the stars, for lack of a better word. That might actually be one reason the middle class is shrinking these days. It's not just that people are falling off at the low end and becoming the "working poor", but they're also rising above it, at the high end, and becoming "upper class" or whatever vague term you want to use.

 

[REWahoo]

My first year of investing was 1975, same year Vanguard was founded. In those days people did have pensions. IRA's and 401K's were just being legislated into existence. It cost $200 to make a trade and mutual funds charged 3% to 6% up front load fees beside the yearly rip off. A very different scene than today.

Thank you John Bogle!

 

[Clone]

You could suggest it but you'd be wrong. The only difference in the portfolios is when you start extracting money, and that is the point of SOR. All three portfolios started with 750K and extracted 35K/yr for 30 years, except 1973 which ran out of money around 19 or 20 years.

Averages don't tell you much at all. Retire in the early 1970s, starting with $750,000 and taking out $35,000 each year, and on average you'll do just fine. But that average is meaningless.

Shown here are the year-end balances of three identical portfolios. One starts in 1973 (red), another in 1974 (blue), and the third in 1975 (green). So much for relying on averages!

So I interpreted this as each person started retirement with 750K in their portfolio. You are saying that the chart shows one person who immediately withdraws 35K, the next person waits one year, and the third person waits two years? In other words, the axis on the bottom is 1972 + the number shown, not the year of retirement for each individual?

 

[Lewis Clark]

SOR is related to taking money out of a portfolio when the stocks are in the red. It's a buy high sell low problem. If you look at the graph on the FIREcalc homepage it is 1973 1974 and 1975 SOR. If you retired in 73 you flamed out. In 74 you had money but not growth. In 75 you pulled the golden ring. The solution is to put some money in a separate low risk portfolio something like a 20/80 which happens to be the tangent portfolio most gain for least risk. Leave the rest of the portfolio alone except for re-balancing. If you need 40K/yr stick 120K in the 20/80 and leave the rest at 60/40 or 70/30. When the market is down say 25% (or more than the SD of the portfolio) live off the 20/80 money. This effectively re sequences your portfolio to a better SOR. If you lived 3 years off the 20/80 in a 1973 retirement you would have converted it to a 1975 retirement. You really only need to do this once so no real need to refill the resequence account. The reason is by the time your "next" crash comes along you'll be closer to death and you'll run out of life before the bad SOR has a chance to manifest. 2 things are certain you will experience bad SOR and you will die so by re-sequencing you dramatically mitigate your risk

This sounds good in theory, but the problem comes with the timing of when to replenish your 20/80 portfolio. This could end up just being a disguised form of market timing.

If this is only done once as you suggest, it seems like a form of equity glide path, where we go into retirement with XX% equities in the asset allocation, and let the equity allocation rise over time as we live off the fixed income portion of the assets during the first bear market.

 

[FinancialDave]

The story could be- "If you believe in a magic number, like 25 times your required retirement income, then hitting that number at the end of a bull run (and right before a big crash) is much more dangerous than having that number when you retire at the bottom of the big crash."

You are exactly correct, which year you might have started your retirement in the last 100 years certainly does make a difference and the variance from the best 40 years to the worst 40 years is generally in the millions of dollars so it DOES have everything to do with the SEQUENCE of returns you see during retirement for money you are withdrawing from your account, but mostly for money that requires you to sell shares of your investments.

Selling investments when their price is depressed is what SOR is all about. So in most cases if you are withdrawing via the 4% rule you will end up selling some investments at some point in time if you don't have a substantial cash bucket.

I have done dozens and dozens of simulations using historical market and inflation data and for the same starting position, like I said, depending on which year you start you can either run out of money or are left with millions of dollars after 40 years of withdrawals.

Asset allocation does matter as well, but only to an extent. In most cases anywhere between about 80% equities and 30% equities will usually be acceptable - once again depending on which year you started your retirement.

All that being said "who knows" about the future. That is why I always want to err on the conservative side of the 4% equation.

Dave