Understating Sequence of Return Risk

[nun]

I think we already know from your signature that your WR is 0% and you've already told us that the sequence of return is not an issue for you so your situation does not apply to the "sequence of return risk" discussion.

As the topic is "understating sequence of return risk" surely a strategy that minimizes (or even removes) that risk is relevant to the discussion.

 

[papadad111]

I guess I'm missing something because I thought what nun advocates is pretty close to what Bill Bernstein and other financial pundits have said to do to avoid sequence of returns risk from ruining your retirement: having your essential expenses covered by income from SS, pensions and non-risky asset classes:

"Bernstein defines a risk-free portfolio as one adequate for a basic retirement—a so-called liability-matching portfolio. With a liability-matching portfolio, you earmark certain assets to pay for your basic retirement expenses, or liabilities. “Anything in excess of that can be invested in risky assets,” said Bernstein. “For some folks, that’s going to mean a 100% fixed-income portfolio, and for wealthier clients, something far more aggressive.”

How to avoid sequence-of-return risk - MarketWatch

and

"A lot of people had won the game before the crisis happened: They had pretty much saved enough for retirement, and they were continuing to take risk by investing in equities. When you've won the game, why keep playing it? "

"You want to end up with a portfolio that matches your liabilities, meaning the amount you'll need to spend in retirement. The rule of thumb I came up with, based on annuity payouts and spending patterns late in life, is that you should save 20 to 25 times your residual living expenses -- that is, the yearly shortfall you have to make up after Social Security and any pension. This portfolio should be in safe assets: Treasury Inflation-Protected Securities, annuities, or even short-term bonds. Anything above that, you can invest in risky assets. That's your risk portfolio. If you dream about taking an around-the-world trip, and the risk portfolio does well, you can use it for that. If the risk portfolio doesn't do well, at least you're not pushing a shopping cart under an overpass."

https://www.bogleheads.org/forum/viewtopic.php?t=125285

What bearnstein totally misses in his definition of risk is inflation risk

My guess is that his so called safe assets can be decimated by inflation and historical inflation risk is just as much a threat to portfolio as sequence of returns risk .

For real early retirees inflation may be even more risky than sequence of returns.

Either way, result is that you either have less money due to market loss or less spending power due to inflation.

Maybe I'll relax about it in a decade or so.... But hard to do that as an early retiree with 25 years till SS and no other pension to backstop me. Relying on mr market and dividends.

It's scary to see portfolio drop by 10 percent in a couple months -- comprising 5+ years of income. Poof. But being far into cash or bonds or safe annuities is foolish not knowing what inflation is going to do either.

It's a gamble.

 

[daylatedollarshort]

But being far into cash or bonds or safe annuities is foolish not knowing what inflation is going to do either.

It's a gamble.

I think the wiki at Bogleheads covers the inflation protection aspect better:
https://www.bogleheads.org/wiki/Matching_strategy

Zvi Bodie recommends sticking mainly with TIPS ladders and I-Bonds for essential retirement expenses not covered by other sources like SS or COLA pensions:
MintLife Blog | Personal Finance News & Advice | Risk Less and Prosper: An Interview With Zvi Bodie

Even at a zero real return over 30 years a retiree could have a 3.33% SWR, and current TIPS real return rates are higher than zero. The ten years are at inflation + .63% as of this writing.

 

[kcowan]

+1.

We worked and saved not to clip coupons and pinch pennies in retirement. If that's some people's idea of a happy retirement more power to them. We enjoy dinning out a few times a week, attend the theater and sporting events and travel. We are willing to tighten our belts in a bad market but not to totally deprive ourselves of our enjoyment.

Yes we feel comfortable as long as our nest egg will sustain us during our lives. We don't scrimp but we do the things that appeal to us, never denying what we want. Granted our tastes have not changed dramatically, just our time available to pursue them. But we are also 12 years in and things are still fine. I guess that comes from having a buffer.

 

[mathjak107]

I think the wiki at Bogleheads covers the inflation protection aspect better:
https://www.bogleheads.org/wiki/Matching_strategy

Zvi Bodie recommends sticking mainly with TIPS ladders and I-Bonds for essential retirement expenses not covered by other sources like SS or COLA pensions:
MintLife Blog | Personal Finance News & Advice | Risk Less and Prosper: An Interview With Zvi Bodie

Even at a zero real return over 30 years a retiree could have a 3.33% SWR, and current TIPS real return rates are higher than zero. The ten years are at inflation + .63% as of this writing.

the flaw in bernsteins plan is he assumes your personal rate of inflation tracks the cpi and that is hardly ever the case .

having all inflation adjusting pretty much betting on TIPS does not mean it will not fall short of your own cost of living which can be very different from a price index on a basket of stuff .

 

[Danmar]

I think we got a little sidetracked (I am guilty) by focusing on spending and legacy levels. Sequence of return risk doesn't really affect those with low WR's (say under 3%) very much. For those with ultra low WR's (say under 2%) not at all. If you are in this camp you are set. Congrats.

For those who planned their retirements with WR's in the normal 3-4% range Sequence of Return Risk is much more of a concern especially in the early withdrawal years. This risk can be mitigated by AA (a more conservative asset mix) and possibly by an income approach to investing (my unproven hypothesis). Also, by annuitizing a portion of your portfolio or otherwise cover your basic living expenses with pensions.

Jim Otar has written a book which discusses this issue extensively and gives a solution if things go bad, ie annuitize further before it is too late.

 

[utrecht]

I believe the thread actually started off talking about sequence of returns even in the accumulation phase, which I think of all the things we worry about here, is one of the very least worry some things there are.

 

[Danmar]

As the topic is "understating sequence of return risk" surely a strategy that minimizes (or even removes) that risk is relevant to the discussion.

Perhaps, except that your "solution" is not acceptable to many(most?) here who have likely built their whole retirement plan on a SWR of 3-4%. Would be pretty tough for most of us to amend our lifestyle plans this late in the game. Unless of course our expenses are covered by pensions,etc, but then there isn't an issue for us in that event.

 

[nun]

I believe the thread actually started off talking about sequence of returns even in the accumulation phase, which I think of all the things we worry about here, is one of the very least worry some things there are.

Sequence of return risk in accumulation is something that can also be reduced by a less volatile asset allocation. TIAA-CREF customers often use a fixed deferred annuity in their portfolio to give guaranteed return. Also we might look into the Ziv Bodie TIPS approach, but maybe the easiest approach is a target date fund that adjusts the asset allocation as retirement approaches.

 

[utrecht]

Sequence of return risk in accumulation is something that can also be reduced by a less volatile asset allocation. TIAA-CREF customers often use a fixed deferred annuity in their portfolio to give guaranteed return. Also we might look into the Ziv Bodie TIPS approach, but maybe the easiest approach is a target date fund that adjusts the asset allocation as retirement approaches.

Of course, but now you are giving away higher potential for return which is what you want during accumulation. This is an exaggeration, but you could just use CDs during accumulations and have no sequence of return risk, but that would be dumb. A person should not be worrying about sequence of returns risk when accumulating. They should be worried about building a large portfolio so they can worry about it running out later when they retire. If they dont build a large enough portfolio in the first place, thy wont have to worry about sequence of returns in retirement because they will still be working.

 

[daylatedollarshort]

One resource I would suggest to get into a different mindset about spending, withdrawal rates and stocks would be the Millionaire Next Door series of books by the late Thomas Stanley, especially his last book called Stop Acting Rich. He does stress that most millionaires in his studies do not have a large portion of their assets in publicly traded stocks, because they like assets they can control and they cannot control the stock market. I think if one is risk adverse yet dependent on returns not guaranteed or controllable or in today's investing environment even likely going forward (per Robert Shiller), sequence of returns is always going to be a concern throughout retirement.

Short synopsis here:

Stop Acting Rich: Preface, Part I

 

[nun]

Of course, but now you are giving away higher potential for return which is what you want during accumulation. This is an exaggeration, but you could just use CDs during accumulations and have no sequence of return risk, but that would be dumb. A person should not be worrying about sequence of returns risk when accumulating. They should be worried about building a large portfolio so they can worry about it running out later when they retire. If they dont build a large enough portfolio in the first place, thy wont have to worry about sequence of returns in retirement because they will still be working.

We are in a space with multiple variables and choices and very few of them are known. I've always taken the approach that I want a large enough portfolio to retire, not potentially the largest one. So I always planned to get retirement income from stable sources. It started by maximizing SS benefits, paying into a fixed deferred annuity, buying a rental property and setting up an equity and bond portfolio. If I had put everything into equities I might well have had a larger portfolio, but I prefer to have more of a liability matching portfolio, I didn't know it was called that back in 1987, but it was my approach. I also took inflation into account as obviously my SS is index linked, I can increase my rental income as costs increase and I planned to use TIAAs graduated annuity payment option before I was lucky enough to get a small COLAed pension. But for most people Id suggest a target date fund so they reduce volatility as time goes on.

 

[jkern]

the flaw in bernsteins plan is he assumes your personal rate of inflation tracks the cpi and that is hardly ever the case .

having all inflation adjusting pretty much betting on TIPS does not mean it will not fall short of your own cost of living which can be very different from a price index on a basket of stuff .

I totally agree with you. I've periodically tracked my personal rate of inflation and compared it to the CPI, and it has always been higher.