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

[ERD50]

Seems I've heard recommendations from some here, that one could/should be conservative in their AA for the first 5 years, because the failing scenarios hit that bad sequence of returns in the early years. You get hit, and it is hard to recover.

That never felt right to me, seemed more like market timing. And so what if that bad stretch hit you after the first 5 years? Wouldn't that be just as bad? Especially because those bad drops are preceded by a run up that would have been missed.

But I wasn't sure how to test the idea. Then I came up with this, using that portfolio analyzer site. Now I know people will say this is cherry-picked data, but I think it stands as an illustration.

So imagine two people ready to retire. They have just seen the market double in the last 5 years, and they both are a bit nervous that it is poised for a drop. Retiree "STC" decides to stay the course with a 70/30 AA, retiree "B" goes to 100% bonds. They both have $1M and will start with a 3.5% WR, adjusted for inflation each year.

The year is 1995. The market rises for another 5 years. Does "B" decide he's missed out on too much, time to join in (just in time to get clobbered!)? Or is he more convinced of future drops, and sticks with 100% bonds? Either way, "B" never catches up to "STC" - though they are at about the same point for a brief period at the bottom of the 2nd drop, FEB 2009.

By end of 2018, STC's portfolio has risen to $2,694,000 while B's portfolio has lost buying power, down a bit to $974,000 (both numbers shown as reduced by inflation).

https://goo.gl/vJtsAL (select "Infl Adj" under graph)

I'm sure different start years would show an advantage for being conservative, but that really just seems to demonstrate market timing to me. Like I said, after a 5 year run up, most of us would be thinking a correction is coming. Sometime. But when?

Portfolio 1
VBMFX Vanguard Total Bond Market Index Inv 100.00%

Portfolio 2
VFINX Vanguard 500 Index Investor ........ 70.00%
VBMFX Vanguard Total Bond Market Index Inv 30.00%


-ERD50

 

[audreyh1]

I don’t think 100% bonds have ever been recommended although I suppose some here might be 100% fixed income.

More typical strategy starting out conservative recommendation is like 30% stocks with a gradual glide path to higher equity exposure (up to 70%) over a long time period. Basically spending down your fixed income during the early retirement years and letting your equities run. https://www.kitces.com/blog/should-...is-a-rising-equity-glidepath-actually-better/

Basically I do whatever it takes to stay invested, and I don’t care about the end score. Just survival before reaching the end. Hedging my bets staying 50/50 seems to work well enough for me, I don’t really care if I am “leaving money on the table” by not having a higher equity allocation.

I also use the % remaining portfolio withdrawal method which tracks recent portfolio performance.

 

[Cut-Throat]

Yup, looks like market timing to me. Use something like VPW, which has you withdraw less, If and when the sequence of returns are bad.... If not, you withdraw more.....

 

[COcheesehead]

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.

Here is an interesting article about historical troughs in the S&P over 5/10 year periods. It might enlighten you on just how long a market can be down. https://seekingalpha.com/article/99066-s-and-p-500-safety-over-5-year-and-10-year-periods?page=2

Edit: Sorry Audreyh1 and I posted at nearly the same time. Wasn’t trying to steal her lines. So I am in agreement with her

 

[COcheesehead]

Yup, looks like market timing to me. Use something like VPW, which has you withdraw less, If and when the sequence of returns are bad.... If not, you withdraw more.....

There’s a good line in the link I posted above. “Market timing is not a good idea...However, standing out of the way of a train wreck, is not market timing.”

 

[Cut-Throat]

There’s a good line in the link I posted above. “Market timing is not a good idea...However, standing out of the way of a train wreck, is not market timing.”

+1

 

[Clone]

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).

 

[ERD50]

There’s a good line in the link I posted above. “Market timing is not a good idea...However, standing out of the way of a train wreck, is not market timing.”

OK. And since they are not the same thing, analogies aren't useful, are they? Market timing (trying to time the train wreck), isn't a good idea.

Or is that what you were trying to say?

-ERD50

 

[Montecfo]

The safe withdrawal rate models contemplate SOR risk. When you seek 95%+ confidence, you are being conservative. So when you decide to consider SOR risk again by conservative AA, you are re-plowing the same field, as I see it.

If you want greater confidence, I suggest you reduce the withdrawal rate.

 

[Cut-Throat]

If you want greater confidence, I suggest you reduce the withdrawal rate.

Yup, and reducing it when the market is tanking is even more effective. Think VPW.

 

[Jerry1]

I don’t think 100% bonds have ever been recommended although I suppose some here might be 100% fixed income.

More typical strategy starting out conservative recommendation is like 30% stocks with a gradual glide path to higher equity exposure (up to 70%) over a long time period. Basically spending down your fixed income during the early retirement years and letting your equities run. https://www.kitces.com/blog/should-...is-a-rising-equity-glidepath-actually-better/

Basically I do whatever it takes to stay invested, and I don’t care about the end score. Just survival before reaching the end. Hedging my bets staying 50/50 seems to work well enough for me, I don’t really care if I am “leaving money on the table” by not having a higher equity allocation.

I also use the % remaining portfolio withdrawal method which tracks recent portfolio performance.

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.

Here is an interesting article about historical troughs in the S&P over 5/10 year periods. It might enlighten you on just how long a market can be down. https://seekingalpha.com/article/99066-s-and-p-500-safety-over-5-year-and-10-year-periods?page=2

Edit: Sorry Audreyh1 and I posted at nearly the same time. Wasn’t trying to steal her lines. So I am in agreement with her

Agree with the above posts. Bolded statements are my emphasis on what I feel are the important points.

 

[Sunset]

OP - too bad you didn't run this with 100% stocks, oh, wait you provided a link, so I added it.

portfolio 1 = 100% stocks
portfolio 2 = 70/30
portfolio 2 = 100% bonds.

 

[Sunset]

I always thought the SORE was like stepping off the curb and getting hit by a bus.

You retire, and immediately the the market drops far and stays down then starts a slow climb back over a few years.
That would be the situation that would hurt 100% stocks pretty hard.

 

[daylatedollarshort]

The matching strategies in the Bogleheads wiki recommends inflation adjusted bonds for the money you must have for retirement. Even at a zero real return over 30 years that gives an investor 3.33% safe withdrawal rate, with the relative safety of U.S Treasury bonds. Add in a ~1% real yield, which is where rates have been lately on TIPS, and that is more than sufficient for our retirement spending needs.

 

[njhowie]

ERD50, are you looking to stir the pot, or is it just a slow/boring evening?

Bottom line, as always, it depends on the investor's risk tolerance and investment objective. No matter how much you attempt to debunk this topic, you are never going to get everyone on your side and agree with you. Nor will you be able to prove the point you are attempting to - because you cannot predict the future. For those who "have enough" and are objective about their financial situation, there is no need whatsoever to have any money in equities at all.

Here's something to contemplate - why does the stock or bond market need to be a part of anyone's wealth (growth) plan in the first place? Has everyone simply been trained like Pavlov's dog that it is how you "do it"? Is it possibly the greatest pyramid scheme going and it's Wall Street's, the financial sector's, and the government's mission to convince ("educate") the masses it's required?

It's wonderful that you have such a high equity allocation and that you're so comfortable with it. It's not for everyone, and no matter how much you attempt to do it, you will never convince everyone that your approach is the best or that somehow you or anyone else is insulated from potential disaster in his/her portfolio.

I'm really drained when it comes to these discussions, and as much as I promised myself I would not respond, here I am. However, I won't put myself through whatever is going to follow, so I'll just ignore/unsubscribe from the thread. I won't even get out the popcorn, not interested in what comes.

Best to all who continue.

 

[audreyh1]

The safe withdrawal rate models contemplate SOR risk. When you seek 95%+ confidence, you are being conservative. So when you decide to consider SOR risk again by conservative AA, you are re-plowing the same field, as I see it.

If you want greater confidence, I suggest you reduce the withdrawal rate.

Asset allocation is part of your SWR selection, it’s not independent. You have to select a given AA to then figure out your SWR for a given portfolio survival statistic goal. I assume most people try out a range of AAs and look at the differences in portfolio survival statistics for a given SWR. Or maybe they’ve decided ahead of time that they are only comfortable with a certain AA and then figure out the SWR they have to accept in order to meet their portfolio survival statistic goal.

 

[RunningBum]

Dropping your equities for the first 5 or 10 years due to SOR worries makes no sense to me either, especially for early retirees. The only logic behind it that makes sense is that for a 30 year or less retirement you only have 20 or 25 years left. But many of us have much longer retirements.

In other threads I tried to say how if I retired at 49 and cut way back on my equities for 10 years, at 59 the strategy would have me back at my full AA, while a new retiree at 59 would be cutting way back. I was told these were not the same situations, but we are still looking at the same retirement span. Nobody ever could explain how they were different, so I don't buy it.

I'm so glad nobody was able to convince me of this questionable strategy when I retired 8 years ago. Obviously a down turn would've hurt me, but as it stands I'm in much, much more solid shape to weather one now. Had I cut my equities back at the start of retirement I'd still be facing SOR risk. I'm not going to debate anyone in favor of cutting equities early unless they can explain how I wouldn't still be exposed now had I done it 8 years ago. To me, that's the crux of the argument.

 

[24601NoMore]

For those who "have enough" and are objective about their financial situation, there is no need whatsoever to have any money in equities at all.

Here's something to contemplate - why does the stock or bond market need to be a part of anyone's wealth (growth) plan in the first place? Has everyone simply been trained like Pavlov's dog that it is how you "do it"? Is it possibly the greatest pyramid scheme going and it's Wall Street's, the financial sector's, and the government's mission to convince ("educate") the masses it's required?

It's wonderful that you have such a high equity allocation and that you're so comfortable with it. It's not for everyone, and no matter how much you attempt to do it, you will never convince everyone that your approach is the best or that somehow you or anyone else is insulated from potential disaster in his/her portfolio.

Amen! Everyone is going to have their own level of comfort when it comes to risk. I'd personally prefer LESS risk with reasonable return and definitely do not feel the need to run the number up as high as I can get it..

When I decided to ER, I projected expenses and income out year by year until we're each 90 (which should far exceed how long either of us will live). As long as my plan covers us with a good deal of certainty through predictable income streams while conservatively estimating inflation and expenses, I don't feel the need to aim for having as big of a pile of $$ at the end of the game as I can get. I know different folks have different goals (including leaving as much as possible to legacy, family, etc) but for me, I'd rather dial back on equities to 40/60 or even 30/70 and SWAN..

ETA - for those who follow Rick Ferri, he said back in 2015 that the "center of gravity" for pre-retirees or retirees is 30/70 and presents a heck of a compelling case in the following article:

https://seekingalpha.com/article/3036636-the-center-of-gravity-for-retirees

 

[24601NoMore]

This data from Vanguard on different AA performance since 1926 may also be of interest. Check out the difference in average annual return, # of years with a loss, best year and worst year for different AAs.

30/70 gets a very reasonable average (7.2%) with far fewer "years with a loss" over 70/30 or even higher equity allocations, with a pretty minor difference in average performance (~2%).

Although "past performance is no guarantee of future results", etc..if I can get anywhere near 7.2% (heck, even 5%) on 30/70, I'm perfectly happy..

 

[ERD50]

I've got some errands to run, will make a quick reply and try to get back to others later....

ERD50, are you looking to stir the pot, or is it just a slow/boring evening? ...

I'm really drained when it comes to these discussions, and as much as I promised myself I would not respond, here I am. However, I won't put myself through whatever is going to follow, so I'll just ignore/unsubscribe from the thread. I won't even get out the popcorn, not interested in what comes.

Best to all who continue.

Wow!

I'm just the curious type. I've seen posts before where people advocate staying conservative in the first few years to avoid the early SOR risk. As I said, that just never made any sense to me, timing wise, and I wanted to test it and get feedback.

I'm not advocating anything, I'm just trying to understand if there is any merit to a conservative start for someone normally comfortable with a higher AA. If you want to take a conservative AA, and you understand the risks and it works for you, you are all set. I don't understand what all the drama is about?

I think you missed the point. It wasn't a 0/100 bonds versus 70/30 test. It was bonds early to avoid SOR, and then a switch to 70/30 after this supposed early-risk passed, as advocated by some. The graph does not show the switch, you can picture that - but clearly, if the lower AA is behind after 5 years, you are in worse shape for any later SOR drop. That was my point.

OP - too bad you didn't run this with 100% stocks, oh, wait you provided a link, so I added it.

portfolio 1 = 100% stocks
portfolio 2 = 70/30
portfolio 2 = 100% bonds.

Hah! I had that exact graph, and figured it would be too confusing, and someone would say "100% Equities! Are you crazy!"

And that's why I gave the link. In addition, after I posted I tried starting years of 1995~1999, in case 1995 was really too specific to this case. I didn't keep detailed notes, but I was generally surprised that '96 and '97 looked pretty similar (and I myself have notes from 1997 that I was very concerned the market was peaked out, and I was ready to do some DTM, but decided to stay the course, and was rewarded with 2 more great years). By 1998 things were more balanced between the two. For 1999 bonds had more positives, but the 2018 endpoint still favored 70/30.

-ERD50

 

[ERD50]

Dropping your equities for the first 5 or 10 years due to SOR worries makes no sense to me either, especially for early retirees.

.... I'm not going to debate anyone in favor of cutting equities early unless they can explain how I wouldn't still be exposed now had I done it 8 years ago. To me, that's the crux of the argument.

You got my point. Thank you!

-ERD50

 

[DayDreaming]

... Now I know people will say this is cherry-picked data, but I think it stands as an illustration...

To further cherry-pick that data, here is the exact same analysis that the OP did, except I changed the starting year from 1995 to 2000. In this case, the 100% bond investor comes out looking pretty good. I think the moral of the story is to not base your plans on cherry-picked data?

 

[ERD50]

To further cherry-pick that data, here is the exact same analysis that the OP did, except I changed the starting year from 1995 to 2000. In this case, the 100% bond investor comes out looking pretty good. I think the moral of the story is to not base your plans on cherry-picked data?

The moral was intended to be - sure, some years it will be better to go conservative early, but it isn't clearly better on average. If we run more scenarios, I suspect that the conservative-early approach will lose most of the time. It just becomes market timing.

-ERD50

 

[donheff]

It seems like cherry picking a bad sequence is helpful for estimating your pucker factor for SOR. I added a 50/50 to the above and would feel much more comfortable right about now with that rather than with 100% equities going into the 2000 double dip period. I also would have been more comfortable with the 2009 50/50 dip. My actual 60/40 was more extreme but still within tolerances.

 

[Dtail]

Dropping your equities for the first 5 or 10 years due to SOR worries makes no sense to me either, especially for early retirees. The only logic behind it that makes sense is that for a 30 year or less retirement you only have 20 or 25 years left. But many of us have much longer retirements.

In other threads I tried to say how if I retired at 49 and cut way back on my equities for 10 years, at 59 the strategy would have me back at my full AA, while a new retiree at 59 would be cutting way back. I was told these were not the same situations, but we are still looking at the same retirement span. Nobody ever could explain how they were different, so I don't buy it.

I'm so glad nobody was able to convince me of this questionable strategy when I retired 8 years ago. Obviously a down turn would've hurt me, but as it stands I'm in much, much more solid shape to weather one now. Had I cut my equities back at the start of retirement I'd still be facing SOR risk. I'm not going to debate anyone in favor of cutting equities early unless they can explain how I wouldn't still be exposed now had I done it 8 years ago. To me, that's the crux of the argument.

Agree with you.
Thus I am not really a fan of a rising equity glide philosophy at the start of retirement. This concept can be at odds of a reversion to the mean concept on the other side of the equation.