Understating Sequence of Return Risk

[samclem]

In bold is the way I would have phrased it--but everyone sees these things differently.

If you are frugal or have a sufficiently large portfolio maybe a TIPS ladder, some rental income, an SPIA and SS will cover your income needs and insulate you from sequence of returns risk. This is a very conservative and old-fashioned way to fund retirement and obviously does not maximize your potential income.....it minimizes [-]risk[/-] volatility. Depending on the investments, it could also increase chances of failure due to inflation (if the SPIA is not adjusted for inflation), and, historically, would have reduced the amount available for spending and/or the amount available to heirs.

 

[nun]

In bold is the way I would have phrased it--but everyone sees these things differently.

Originally Posted by nun View Post
If you are frugal or have a sufficiently large portfolio maybe a TIPS ladder, some rental income, an SPIA and SS will cover your income needs and insulate you from sequence of returns risk. This is a very conservative and old-fashioned way to fund retirement and obviously does not maximize your potential income.....it minimizes [strike]risk[/strike] volatility. Depending on the investments, it could also increase chances of failure due to inflation (if the SPIA is not adjusted for inflation), and, historically, would have reduced the amount available for spending and/or the amount available to heirs.

The inflation component of sequence of return risk is also important and if you go with a liability matching approach you have to account for that. The poor value of SPIAs, especially if they are index linked, is a challenge and a big reason why they are not popular. But if you are a TIAA-CREF customer you will probably have considered them as TIAA-CREF still recommends that at least some income comes from an annuity and offers products that increase payments over the years. But realistically most people will look for other stable income sources with some inflation tracking content.....I-bonds, rent TIPS etc. If they go that route they'll have to settle for low returns for a while.

 

[Danmar]

the argument made by Wade Pfau and others of his profession, that money unspent is an undesirable outcome.

Living beneath our means during retirement is a legitimate way to minimize the risk of bad sequence of returns. We don't all share the same level of risk tolerance, nor do we all experience the same marginal utility for spending.

Well first of all,I would submit that money is never unspent, rather just given to someone else to spend. If this is a conscious choice great, if it is just by chance not so good.

Secondly, it seems less than ideal to spend less so you won't be at risk of having to spend less? But as always to each their own.

 

[daylatedollarshort]

With a liability matching strategy fixed expenses, those not subject to inflation such as a fixed rate mortgage payment, can be matched with fixed income with set maturities, and expenses subject to inflation are matched with inflation adjusted investments. If you are buying an annuity that is not inflation indexed to cover expenses subject to inflation, then that isn't really using a matching strategy.

Stocks have historically outperformed inflation in most decades, but not always, and are not US government guaranteed to keep pace with inflation compared to investments such as TIPS and I-bonds. Of course that guarantee comes at a price. Each retiree has to pick a strategy that works best for their own household and risk tolerance. I have no risk tolerance, I hope to be able to leave money to our favorite charity and we're cheap dates, so we're going with the liability matching.

 

[bmcgonig]

Well first of all,I would submit that money is never unspent, rather just given to someone else to spend. If this is a conscious choice great, if it is just by chance not so good.



Secondly, it seems less than ideal to spend less so you won't be at risk of having to spend less? But as always to each their own.

Not that I agree or disagree, but I think really some people spend less so they won't be at risk of spending MUCH less.


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[Danmar]

Not that I agree or disagree, but I think really some people spend less so they won't be at risk of spending MUCH less.


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I guess it's a question of degree. I don't really get the ultra low SWR'ers. Like under 2% say, unless they have a desire for big legacy/charitable giving. Anyway to each their own.

 

[daylatedollarshort]

I guess it's a question of degree. I don't really get the ultra low SWR'ers. Like under 2% say, unless they have a desire for big legacy/charitable giving. Anyway to each their own.

If spending more than 2% makes you happy go for it. It is your money. You earned it. Enjoy it. But the Millionaire Next Door author found that most MNDs are actually pretty thrifty.

From the Thomas Stanley blog (The Millionaire Next Door):

"When people ask me about the activities of millionaires, I have a short answer. As I wrote in The Millionaire Mind, the typical millionaire is, in three words, "a cheap date!" Yes, a cheap date even among a fraction of the top 1% of the wealth holders in America. Many of the favorite activities of millionaires are not at all costly. It matters not if you are rich or poor, the best things in life are free or close to it."

A Cheap Date

 

[Danmar]

If spending more than 2% makes you happy go for it. It is your money. You earned it. Enjoy it. But the Millionaire Next Door author found that most MNDs are actually pretty thrifty.

From the Thomas Stanley blog (The Millionaire Next Door):

"When people ask me about the activities of millionaires, I have a short answer. As I wrote in The Millionaire Mind, the typical millionaire is, in three words, "a cheap date!" Yes, a cheap date even among a fraction of the top 1% of the wealth holders in America. Many of the favorite activities of millionaires are not at all costly. It matters not if you are rich or poor, the best things in life are free or close to it."

A Cheap Date

It all gets spent sooner or later. Spending under 2% just means you "spend it" by giving it away. If that is what you plan for great. I don't view "cheapness" as a desireable quality in retirement but as I said to each their own. Not sure if I have the "millionaire" mind. Doubt it but I'm pretty happy with the mind I have.

 

[papadad111]

. I don't really get the ultra low SWR'ers. Like under 2% say, unless they have a desire for big legacy/charitable giving. Anyway to each their own.

Not necessarily legacy. More about portfolio survivability ... ties back to sequence of returns. For those needing to fund 4 or 5 decades of retirement, to avoid serious sequence of returns risk requires one not to exceed a 2-2.5% withdraw rate. Given this is an early retiree board, there are many on here in their 40's. Very different from the guys and gals who are retiring "early" at 57. Or 62. Or 65. It's a totally different ballgame not just due to age difference and mortality probabilities but also due to the nature of "guaranteed" retirement income such as pensions, fully funded SS etc versus what is seen for most retirees in their 40's being far more dependent / reliant on Mr market for covering living expenses.

 

[daylatedollarshort]

It all gets spent sooner or later. Spending under 2% just means you "spend it" by giving it away. If that is what you plan for great. I don't view "cheapness" as a desireable quality in retirement but as I said to each their own. Not sure if I have the "millionaire" mind. Doubt it but I'm pretty happy with the mind I have.

What you call cheapness others might call The New American Dream:

"We seek to cultivate a new American dream—one that emphasizes community, ecological sustainability, and a celebration of non-material values."

https://www.newdream.org/

 

[hnzw_rui]

What you call cheapness others might call The New American Dream:

"We seek to cultivate a new American dream—one that emphasizes community, ecological sustainability, and a celebration of non-material values."

https://www.newdream.org/

Here's hoping only a few people subscribe to that ideology. I'm guessing consumerism plays a big part in helping my portfolio grow.

 

[nun]

Two ways to reduce sequence of return risk are to spend less and have a less volatile asset allocation.... Of course having less to spend often a consequence of a less volatile portfolio. This is where the frugal folks have an advantage over those that are seeking to spend down their assets.

 

[Corporateburnout]

It all gets spent sooner or later. Spending under 2% just means you "spend it" by giving it away. If that is what you plan for great. I don't view "cheapness" as a desireable quality in retirement but as I said to each their own. Not sure if I have the "millionaire" mind. Doubt it but I'm pretty happy with the mind I have.

+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.

 

[Danmar]

I'm surprised that some people think 2% is a reasonable SWR. Safe it certainly is but do you really think that is all you can safely spend? Firecalc would imply otherwise? But as always to each their own.

 

[Danmar]

What you call cheapness others might call The New American Dream:

"We seek to cultivate a new American dream—one that emphasizes community, ecological sustainability, and a celebration of non-material values.

Sounds great, where do I send my check?

 

[MichaelB]

Our withdrawal rate is 4%, which I think is a tad high, but it doesn't keep me awake at night. Still, I see nothing wrong with someone spending 2% - 3%, especially if they don't feel it is a sacrifice.

 

[Danmar]

Our withdrawal rate is 4%, which I think is a tad high, but it doesn't keep me awake at night. Still, I see nothing wrong with someone spending 2% - 3%, especially if they don't feel it is a sacrifice.

I don't either but they should understand that they will likely leave quite a bit to someone. Planning for who that would be is important, at least for me.

 

[rodi]

I guess the withdrawal rate is somewhat personal. Some folks have a negative WR due to pensions covering their expenses - so they continue to add to savings. Others are risk intolerant so might have "safer" portfolios with less equity exposure - they want to keep their WR low to insure they'll have enough even if inflation roars into play.

I'm right about 3.5% and have no issues with that. It will actually go down as my small pension and SS come online, and go down again when I launch the kids. I might increase spending... but my life is pretty good at my current spending level.

 

[MichaelB]

I don't either but they should understand that they will likely leave quite a bit to someone. Planning for who that would be is important, at least for me.

I think someone talented enough to accumulate a portfolio that will fund that level of spending understands this perfectly well.

 

[W2R]

I'm surprised that some people think 2% is a reasonable SWR. Safe it certainly is but do you really think that is all you can safely spend? Firecalc would imply otherwise? But as always to each their own.

(Bolded emphasis mine)

Perhaps I misinterpreted the above, but to me it sounds like desperation to spend every last possible cent.

There's a lot to be said for contentment, if one can find it, especially if one can find genuine contentment without spending all that one can safely spend. If someone is truly content at a 2% withdrawal rate, to me that seems like a very nice situation to be in.

But as you say, each to their own.

 

[nun]

+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.

When it comes to comparing spending, percentages aren't much use, we need dollars. Warren Buffet's 2% is a heck of a lot larger in absolute amount than most people's 4%. My annual budget is $38k which is covered by rent and pension so I have a 0% withdrawal. I certainly don't feel as if I pinch pennies, I go on vacations, go to the theatre and cinema 2 or 3 times a week, and eat out with friends at least once a week. I am frugal in some things like I don't have cable TV because I can get what I like to watch free and I do a lot of my own cooking and repairs because I enjoy it.

 

[daylatedollarshort]

When it comes to comparing spending, percentages aren't much use, we need dollars. Warren Buffet's 2% is a heck of a lot larger in absolute amount than most people's 4%. My annual budget is $38k which is covered by rent and pension so I have a 0% withdrawal. I certainly don't feel as if I pinch pennies, I go on vacations, go to the theatre and cinema 2 or 3 times a week, and eat out with friends at least once a week. I am frugal in some things like I don't have cable TV because I can get what I like to watch free and I do a lot of my own cooking and repairs because I enjoy it.

Ditto. We go out to eat a few times a week. We have a nice house in the Bay Area, money to travel (aided by credit card reward point hacks) and newish cars. We just live below our means. Yesterday we went to the zoo in the afternoon and saw a Shakespeare play in an outdoor amphitheater in the evening. Those were free on library passes. There are lots of free and inexpensive things to do in our area. The other week we went to a lecture at the planetarium on cosmic rays and the Ice Cube neutrino observatory. We could spend more but why when we can do things we enjoy without spending a lot and still save money.

 

[Corporateburnout]

When it comes to comparing spending, percentages aren't much use, we need dollars. Warren Buffet's 2% is a heck of a lot larger in absolute amount than most people's 4%. My annual budget is $38k which is covered by rent and pension so I have a 0% withdrawal. I certainly don't feel as if I pinch pennies, I go on vacations, go to the theatre and cinema 2 or 3 times a week, and eat out with friends at least once a week. I am frugal in some things like I don't have cable TV because I can get what I like to watch free and I do a lot of my own cooking and repairs because I enjoy it.

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.

If 38K is enough for you to live happily in retirement and you're able to cover this from pension and rent that's great. Our spending is substantially more than that and is covered from our portfolio until SS kicks in. Although I'm concerned about the sequence of return risk in the first few years of retirement I'm not willing yet to skimp on travel, fine dining, sports teams season tickets, visiting DW family overseas etc. Now if we encounter a few consecutive years of negative returns we may reduce our spending a bit but the plan was developed before we pulled the plug and we have enough safeguard in it. Worst case our kids will not get an inheritance.

But as a couple of people have said before to each their own.

 

[daylatedollarshort]

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.

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

 

[daylatedollarshort]

Sounds great, where do I send my check?

If you really want to know more on the topic, you don't have to spend any money. There are many free resources on the Internet like this youtube video: