Sequence of Return Risk

Decision Rules and Maximum Initial Withdrawal Rates

by Jonathan T. Guyton, CFP and William J. Klinger

 

Do people review their sequence of returns risk? I quit my main job a bit over two years ago, and had SORR in the back of my mind. Things have worked out well - despite living off some of the portfolio income I've ended up with portfolio growth around 24% over that period. In other words, the first two years of "drawdown" have been kind. Do people update their SORR risk assumptions based on the early years of FIRE, or just lower the SWR based on the portfolio growth and start again?

Its probably moot, as I've now began contracting, and am accumulating surplus earned income again. The increased portfolio income has meant we are doing more discretionary things, but the underlying budget hasn't changed much.

 

Someone who retired in 2000, withdrawing 4% p.a. from a portfolio only invested in the S&P 500, would be down to only 24% of their original portfolio amount.

A good reminder that when it comes to having enough to retire:

• SWR and year of retirement are the two most important variables of success
• Probably a bad idea to be 100% invested in equities
• Probably a bad idea to only be invested in a single market (e.g. only US or Australia)

Source and more discussion on these numbers: Retired in 2000? Congratulations on surviving another year (with charts!!!)

 

Just to add on...

- Probably a bad idea to never check how your investments are going in retirement.
- Probably a bad idea to never make adjustments in your spending if the market turns to ****.
- Probably a bad idea to never consider making some extra income in the future if need be.
- Probably a bad idea to assume any plan is bulletproof, or guaranteed.

 

Pardon but what does “SWR” stand for? All I could think of was standing wave ratio?

 

Safe withdrawal rate

 

couple of good articles here from Movement Capital

One Portfolio Risk To Rule Them All

The Hidden Risk FIRE Investors Miss

 

Some good points.

Must admit I’m not a fan of writing (on any topic) which only points to problems, as opposed to offer ideas.

And the possible workarounds have been described as more risks (holding cash, spending less etc). Which technically yeah okay, it’s another thing to consider.

But I find that mentality a bit tiring and negative. Or perhaps it just doesn’t gel with my overly relaxed “we’ll figure it out” optimistic type of nature lol.

 

Those are some fantastic graphs.
If I am not mistaken, the difference between having a balance of $0 after 30 years and doubling your starting balance is only a difference of .6% withdrawal rate based on 1965 as the starting point. Wow.

 

As a wise old investor once said, "No one, know's nothing' it's a continual battle between the bull and bears and on any given day one's up and the other's down



Or you could have enough accumulated that minor battles don't affect the outcome of the war

 

However much one knows the theory and the need to stay the course, it’s a different matter in practice. Retired 3 months ago, straight into the headwind of a bear market.

Spouse is threatening to send me back to work. Although maybe that’s got nothing to do with sequence of returns.

 

Given that sensible long term investing is being drowned out on PC at this time I’ve stopped reading most other threads. So for something different I’ve come back to this interesting post by @dunno. I’m interested in your thoughts @dunno and anyone else wanting to comment.

Over the years most of what is recommended for those with SMSFs in pension mode is to keep at least two years of pension payments in cash to avoid selling shares in bad markets. @dunno even when you end up being able to commence your SMSF pensions it appears that you would invest all cash distributions / contributions immediately then draw down capital to meet pension payments? Hence am I correct in assuming there would be NO Cash Buffer held?

Now the following here is specific to our circumstances but depending on one’s SWR it could be applicable to others. Firstly the SMSF pension payments are mostly surplus to our living expense needs as personal holdings cover that. Secondly as discussed elsewhere and thanks to @dunno the conclusion was that for most it would be sensible to switch the SMSF member to pension mode when possible for a considerable time given the tax benefits. Thirdly we’ve typically followed the standard advice of keeping a cash buffer of at least two years pension payments.

Given the above the question being is a cash buffer needed? As the SMSF pension is not required to fund living expenses it can simply be reinvested in personal names. Hence if shares in the SMSF were sold at a loss in that structure to meet pension payments because they are reinvested immediately in personal names in effect overall there is no loss. The shares have simply been moved from one tax environment to another. Long term exposure to the market is maintained.

One negative in a bad market where no cash buffer is held could potentially be some shares prematurely needing to be moved out of the SMSF into a higher taxed environment ie personal names. But that needs to be compared with the longer term loss of growth in the SMSF by holding cash earning next to nothing.

Thoughts please?

 

Hi @Nodrog

No cash buffer for me – we already live of investments and the tax implications of turning 60 won’t change the thinking, just some more shuffling.

My cash allocation is 1%. When there is excess, I invest, when there is a deficit, I build it back up. Obviously, there is some pragmatism in managing cash flows with dividends coming in (and potentially active investment realisations) and monthly allocations to spending going out. Even some tax optimisation at times.

The 1% just sits in a cash management account. It is really just for transactional liquidity.

I don’t want more than 1% from an investment allocation perspective as I am not worried about volatility.

I couldn’t think of anything worse in a passive plan than fretting about a cash buffer, emergency account or glide path etc and having to think about the rules of when to use, run down, rebuild, consequences of exhaustion blah blah blah…… The guts of the illusion that you can benefit from a cash buffer in reality comes down to a timing belief. If you don’t run it down and rebuild it AT THE RIGHT TIME, it’s no different to a static allocation.

​

I’m with you on this one – So much stuff supposedly proven by short term occurrences is just plain dangerously wrong. My desire to push back which given the way humans work would be futile, so I will simply be avoiding PC for quite a while I suspect.

“If you can keep your mind when all around you are losing there’s”

Time for some perspective. C19 is no bigger than events that have proceeded it. Human spirit and endeavour will prevail.




This is the first decent market fear that I have been through since the move from active to passive. Its pure bliss………. Getting on with life whilst a simple passive plan that accounts for all historical precedents (plus a margin of safety) looks after the finances is so much nicer than 08/09 was for me as an active investor.

On the virus side I’m guilty of being a bit conservative. I don’t think anything stops this now until heard immunity occurs like the Spanish flu. I have no desire for anybody in the family to get sick at the peak whilst the health system is stretched.
This site is a good explanation of the exponential math involved in virous spread. Can't say I feel Australia is in front of the eight ball.
Coronavirus: Why You Must Act Now

Our boat is packed with 3+ months of supplies. We had planned a trip to the islands north of West Papua (isolated heaven on earth) leaving mid-April to coincide with favourable weather for the trip – Looks like Tassie might just have had its first local transmission – think we might go early.

Stay well people.

 

Thank you again @duuno. I can see bit by bit the layers peeling away as my habits / beliefs of many years give way to acceptance of alternative / better ways to invest. With that comes increasing greater simplicity and peace of mind.

 

Thanks again also @dunno for giving calming,clear reminders in the midst of this current storm, will save your post for reference in times ahead. Have a fantastic trip.

 

@dunno Might be a silly question, but why 1%? Does this represent something meaningful in real terms? Just curious really.

 

You’ll find plenty on bogleheads going to water and questioning their beliefs. Stick to your fixed asset allocation and minimize attempts to time as much as possible. It’s your North Star.

 

It's probalby there for day-to-day transactions, the rest invested to maximise equity premium exposure. I'm sure dunno would have a 0% cash allocation if he could transact with stocks.

 

As per @mtat response. Its just arbitrary for transactional purpose. Zero doesn't work, 2% is more than necessary.

Thanks, but only got as far as Refuge Cove at Wilson Prom before turning back. Leaving Aus waters become a question mark in our minds. Tassie has also implemented border controls on top of Aus border controls starting tonight, some comfort in that. Will monitor the rapidly developing phase of this situation now from home. Back on the boat though if we get uncontrolled community spread down here. ​

 

Reflections on the passive plan now that It is getting stress tested.

Just getting some thoughts down for my benefit, but I’ll post it here in case somebody get something from it even though it’s probably very disjointed form another person’s perspective. At least I be able to look back one day and see what I was think in real time.

The relative isolation from information on the boat is awesome.
Some information needs to be let through.
How do you filter necessary from garbage?
Updating the control spreadsheet last night caused the first “fear” emotion since starting passive journey.

Downturn has just reached point where next month’s spending amount will require a decrease on this month if market remains the same. To this point monthly SOR figure has been at ceiling rate reflected buoyant market. From here to the floor rate, monthly withdrawals will fall in line with market. Spending floor will be reached if market gets to around XAO 3,500. We are just around average market conditions in big picture – just repriced quickly. Don’t anchor…. Don’t anchor.

Long term - benefits of better re-investment need to stay front of mind during eruptions of short-term emotion.

It’s not until reaching floor withdrawals that the plan comes under any pressure from A SOR perspective. Remember the floor withdrawal was calculated allowing for greater than 1970’s occurrence from the floor level. That’s around XAO 1400…… In the emotional fear moments – remember to settle the f down princess and look at the big picture. The plan deals with a hell of a lot more than it takes to trigger your emotions.

The floor spending is still way more than we need. A reducing spending budget will be good for the kids to experience.

Asset Allocation front.

Volatility of having around 60% direct stocks now re-enforces goal to get that down to 30% by 2030.

A lot of companies are technically insolvent in this environment. Most things about picking stocks that I know is out the window. Its now a probability game of who will receive enough support to make it to the other side. Socialism and capitalism need to join hands to get through – I am out of my depth in this environment. So I will quicken the pace of converting direct to ETF’s where needed so that new funds are only added to ETF’s. Not selling directs – happy to chance the companies held directly that were viable and profitable pre- Corona won’t be let go to the wall. But new purchases currently require maximum diversification as I have no idea what’s going on.

Capitalisation indexes are cheap enough to halt future purchase of value factor. Opportunity to convert value to capitalisation if it occurs will be sometime down the track.

A lot of default is going to occur from the developed world’s attempts to fight Corona.

How will that default be worn? My best guess with the bridge to the other side talk is the default will be worn by us all as future inflation. The size of that future inflation will depend weather or not personal housing debt has to be bailed as unemployment grows.

A lot more people will die in undeveloped countries, but they will be through it faster – what opportunities will it throw up for them?

Do any of the developed countries really f it up and take a major step back in PPP terms – the currencies are going to be fascinating.

A bit of global equality equalising won’t be a bad thing.

Population growth is unsustainable – this pandemic as sick as it sounds helps. Better than a major war.

Don’t die…… pay attention to everybody that means something to you – just in case your taking things for granted that you shouldn’t be.

Enjoy living and learning through a moment that will feature in the future when people contemplate SORR. A chance to get some of the detail that is mostly lost when look at historical examples. Most important point to self, as you learn from this time, evolution of the plan is fine – if you start thinking revolution to something completely different – walk away and check your emotions. Things are moving fast but similar has been seen before and incorporated already into the plan. Expect things to get a lot lot worse – hey if it doesn’t that a pleasant surprise and if it does you have rehearsed so emotions won’t be so overwhelming.

Probably many more thoughts in their infancy somewhere in my head but that’s about all that falling out at the keyboard now.