Freaking Out over Sequence of Returns Risk

[brucethebroker]

The correct option if you can't stand the risk is to move to a place where you can easily live on her pension. There's TONS of those places in the USA.

+1. Or at the very least, consider that a back up plan.

If you had to could you:
1. Downsize to a smaller/cheaper home/apt.
2. Get down to one vehicle.
3. Give up luxuries (vacations, eating out, expensive clothes) for a year or two.
4. Put off planned home improvements for a year or two.
etc.
Not do you WANT to live like that, but could you?

We consider such options the worst case scenario. We could do it, and would if needed. Knowing that helps to sleep better.

 

[mathjak107]

calculators like firecalc only hold true if you don't get whacked early on up front in an extended down turn .

we really have not had that happen as most severe down turns seem to end soon enough like 2008 that they become moot points .

but it can happen and having that extended down turn early on can be like a trader having a string of losses day 1 . they can be quite painful when spending down prior to a good up cycle..

two ways to really protect against that . a rising glide path in to stocks .

you cut allocations going in to retirement early on to about 30% or so and add 2% a year more to stocks getting to your ultimate allocation and then stopping the increase .

or an immediate annuity , so you have a base income that is not sensitive to markets .

 

[MichaelB]

calculators like firecalc only hold true if you don't get whacked early on up front in an extended down turn .

FIRECalc models based on actual historical market cycles, and that does include periods of extended downturns.

 

[mathjak107]

nope , nothing extended at the very beginning before an up cycle . even the unlucky great depression retiree recovered in dollar terms in under 5 years .

many periods had downturns early on , but not extended . v-shapped is very different than u-shapped . we have not had a bad u-shaped one early on .

anything longer than 5 years can have pretty long term effects on outcomes . in 2000 bonds ran with the ball and saved them .

today these low rates and high valuations can produce a different story .

 

[MichaelB]

nope , nothing extended at the very beginning before an up cycle . even the unlucky great depression retiree recovered in dollar terms in under 5 years .

most periods had downturns early on but not extended . v-shapped is very different than u-shapped

I'm not sure if I understand your point. FIRECalc simulations include all historical market performance. So, if you are saying that it doesn't include market cycles that never happened, we agree.

There is no portfolio that can withstand all theoretical future market conditions and circumstances.

 

[mathjak107]

correct , we have yet to have an early on extended down turn . it is not the drop like the 2008 retiree had , it is the fact even a modest down turn that extends out in time can be very damaging .

after a decent up cycle that no longer is an issue , but if it happens out of the gate that can be a problem . even the great depression retiree was whole again within 5 years in dollar terms

 

[MichaelB]

There have been market crashes, but in each one the market recovered in the immediate following years. There have also been extended periods of low performance, but they did not begin with market crashes. There has never been a sharp market decline followed by an extended period of poor performance.

That does not mean it cannot happen, but it does mean it is a low probability event, based on history. The fact that we have fiscal and monetary policy tools that influence the behavior of economies and markets probably has something to do with that.

If the OP is concerned about sequence of return risk, the asset allocation should reflect that.

 

[audreyh1]

That does not mean it cannot happen, but it does mean it is a low probability event, based on history. The fact that we have fiscal and monetary policy tools that influence the behavior of economies and markets probably has something to do with that.

If the OP is concerned about sequence of return risk, the asset allocation should reflect that.

And FIRECALC also includes periods prior to modern fiscal and monetary policy tools such as a few decades before 1920.

 

[exnavynuke]

Firecalc etc also don't model if the US government collapses, or if WWIII wipes out 90% of major cities, or if rampant hyperinflation makes the dollar virtually useless, or any number of nightmare scenarios that "possibly, could, maybe, potentially" happen.

The likelihood of any "never before seen" nightmare scenario, however, is low enough that most reasonable people discount such things in their planning.

 

[bmcgonig]

Best way too get rid of sequence of returns risk is to only take a percentage of remaining portfolio to spend. If you can do that the problem is solved.

A rising equity glide path starting with low stock allocation, also helps.

Having a HELOC or a reverse mortgage to draw on in down years so that you don't have to sell is also a way to avoid it.

Firecalc doesn't include any periods where interest rates were so low and stock PEs so high as the present so we are in a somewhat uncharted territory.

 

[NW-Bound]

Firecalc etc also don't model if the US government collapses, or if WWIII wipes out 90% of major cities, or if rampant hyperinflation makes the dollar virtually useless, or any number of nightmare scenarios that "possibly, could, maybe, potentially" happen.

The likelihood of any "never before seen" nightmare scenario, however, is low enough that most reasonable people discount such things in their planning.

Those risks are hard to quantify, and one cannot do much about these scenarios anyway.

The OP plans to retire at 55. Here's something that has been quantified. And it is also hard to deal with.

The risk of death in the next 10 years for a 55-year old is 71 in 1000 for one who never smokes. That's 1 in 14. For a smoker, it rises to 178 in 1000, or 1 in 5.6.

Source: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3298961/figure/fig2/

 

[marko]

We also have $60K in emergency savings that with her pension, should last us 2 years in a down market if we tighten the belt.

Is that two year cushion enough?

I'm asking you all what strategies you may have implemented to mitigate this risk. And if we are indeed doing all we can do, how do you deal with this uncertainty that keeps me up at night. .

The way I look at it, the Great Recession of 2008 lasted less than a year (according to pundits "the worst financial debacle of our lifetime"). Most of us got back what we 'lost' in about 18 months. If that was the worst, keeping that in mind helps me sleep at night.

 

[mathjak107]

And FIRECALC also includes periods prior to modern fiscal and monetary policy tools such as a few decades before 1920.

i thought i would be the poster child for poor sequencing pay cuts . the day after i retired china cut their currency value and markets plunged . year 2 was no better . now we seem to be recovered

 

[mathjak107]

Best way too get rid of sequence of returns risk is to only take a percentage of remaining portfolio to spend. If you can do that the problem is solved.

A rising equity glide path starting with low stock allocation, also helps.

Having a HELOC or a reverse mortgage to draw on in down years so that you don't have to sell is also a way to avoid it.

Firecalc doesn't include any periods where interest rates were so low and stock PEs so high as the present so we are in a somewhat uncharted territory.

last thing i would want is mandatory loan payments in a down turn . in 2008 many helocs were closed so they were not much help when you wanted it .

 

[bmcgonig]

last thing i would want is mandatory loan payments in a down turn . in 2008 many helocs were closed so they were not much help when you wanted it .

Very true. Reverse mortgage is better in that respect.

 

[marko]

the day after i retired china cut their currency value and markets plunged . year 2 was no better . now we seem to be recovered

Right. You can narrow your focus down to a single set of weeks or months and needlessly panic.

The phrase "Over time" is your friend.

 

[mathjak107]

with the outcome of an entire retirement period influenced by just the first 5 years and fully determined in the first 15 years there is not a whole lot of time in some circumstances early on.

you can have the best 2nd half ever but if the first 15 years are poor the retirement is toast . that is what happened in every worst case scenario . the first 15 years did them in .

while 15 years is a long period of time , 5 years is not and the first 5 years outcome carry's a big influence .

so that is why folks are concerned about sequence's in the early years .

 

[bmcgonig]

last thing i would want is mandatory loan payments in a down turn . in 2008 many helocs were closed so they were not much help when you wanted it .

Your mandatory payment would be minimal. Let's say the stock market was down so you were ok selling bonds but not stocks. So you borrow 40k (half the OP expenses). You can probably get away with paying only interest on this so your payment would be approx 4% of that i.e., 1600.

Not a big deal. If it were then borrow an extra 1600.

 

[mathjak107]

still nothing i would count on . over on the MMM forum are quite a few who had their planned lines of credit closed by the banks in the last downturn .

 

[bmcgonig]

still nothing i would count on . over on the MMM forum are quite a few who had their planned lines of credit closed by the banks in the last downturn .

Then get a reverse mortgage.

 

[mathjak107]

i prefer neither . just my own planning with my own money or an spia if i was concerned about early sequence risk . reverse mortgages come with their own set of issues .

 

[bmcgonig]

i prefer neither . just my own planning with my own money or an spia if i was concerned about early sequence risk .

That's fine too. I'm just pointing out to the OP that there are some solutions to the sequence of returns problem and not to "freak out"

 

[mathjak107]

i agree , and pretty much the biggest sequence risk only apply's before the first up cycle you experience. generally you are okay once you have that cushion . then the normal safe withdrawal rate data can apply .

you need to average about a 2% real return over the first 15 years for 4% inflation adjusting to hold . so just monitor things if need be .

the important thing is if you use equities and take on sequence risk you need a fair amount of discretionary income to cut back on if need be . if the budget for the same draw is mostly non discretionary there may be little to cut back .

we live in queens in nyc and set a budget that is about 1/2 discretionary . we could have moved to manhattan on our same budget but the ratio of non discretionary vs discretionary would change to a level i would consider unsatisfactory if cuts were needed .

 

[nun]

It looks like by your mid 60s you will have all your expenses covered by pension, annuity and SS so your portfolio only has to fund the income gap between age 55 and say 65. That gap looks like $20k to $30k and you have over a $1MM portfolio so you should be able to do that with just dividends or even a CD ladder with zero risk. I think you are all set.

 

[audreyh1]

Best way too get rid of sequence of returns risk is to only take a percentage of remaining portfolio to spend. If you can do that the problem is solved.

That is true - however your real income may shrink to ~40% of where you started before recovering, so you have to think long and hard about how you might survive such a scenario.

If your spending projections are heavily padded with lots of discretionary spending, you might be OK. If your spending is mostly fixed, you don't have the flexibility.

Personally I keep unspent funds in short-term investments not subject to market volatility (in addition to having a lot of discretionary expenses).