Sequence of Return Risk

O.K.

For me I have already ruled out dividend income setting the withdrawal rate. In real terms the volatility is too great and the draw down duration too long. I want to find a solution that allows me to stay 100% in equities. Real men don’t dampen volatility with cash Sacrifices too much potential upside for downside protection.


Yield is just one part of the total return. There is no doubt that in Australia currently safe withdrawal rate for 100% equity is below current dividend levels. For America, it is probably currently above. When management decides how to allocate discretionary free cash flow from business each year they certainly don’t have my safe withdrawal rate in mind so I don’t think I will subordinate my SWR decision to them.


Some interesting tit bits arose whilst looking at the dividend history. I’ll post up some more charts as I get a chance.

 

Depends on the retirees level of wealth and what their objective is. If their wealth is substantial enough so that cash / bonds will very comfortably meet their retirements needs they may have little interest in concerns such as sacrificing upside potential etc. And factors such as diminishing marginal utility of wealth / income play a role.

 

The cash for volatility dampening comment was tongue in cheek. For nearly everybody it’s a sensible balanced approach. I however am not a very balanced person.

I probably need to give some back ground so my angle on investigating sequence risks makes sense.

I am financially independent and have been so for 15 odd years. I have enough capital outside super to get through to preservation age in 13 years if the future rhymes with history at which stage my plan is to transfer any capital balance to our PAF.

Inside super I have accumulated surplus to what we probably need. I would like to transfer that excess to the PAF now but legally I can’t. I can however make a mental allocation and segregate assets in the SMSF. I’m trying to determine how much I will mentally set aside and segregate for future transfer to the PAF and how much I will allocate to funding our personal retirement. The PAF allocation I will continue to manage in the same way as I always have. With the retirement assets, I want to learn to invest in a manner that caters for me becoming a senile old fool(if I'm not alrerady). I’m happy to allocate enough to retirement to ensure I can afford to maintain 100% exposure to equities and don’t need cash allocation to dampen volatility. I’m thinking somewhere around 3Mil with 13 years left of accumulation is about right for our desired minimum income – but want to investigate sequence risk and how I manage it before making the final allocation decision.

 

That makes sense. My idea was to model it so we punch years till retirement and Cape Shiller into a spreadsheet and be told the appropriate cash (risk-free) allocation and the maximum they should withdraw (which may be above 4% in good years) whilst minimising risk. As with any prediction of the future, it is only statistics, so it may go sour in the case of Black Swan events (the world getting hit by an asteroid the size of the moon).

The cash allocation is to cover near term expenses whilst reducing the risk of capital erosion in correction scenarios. This is why those matrix percentages may be even higher (like 50%) in a real scenario when someone hits retirement after a long bear market (e.g. right now) - at that point in time they are at the greatest risk of losing a big chunk when such a loss would be most disastrous.

I didn't test this with real data, but if someone points me to the location of the TSR for the history of the ASX I can backtest over 10, 20, 30, 40 year periods. I'd need a dataset with: Year, TSR, Inflation, Risk-free rate.

 

Pre tax Dividend yields.



The imputation regime started about 1985 from memory. Has that and the baby boomer generational lump with their desire for dividend income in retirement turned Australian equities (on average) into a yield trap? Where not enough capital has been retained and re-invested into the economy to grow future dividends?

 

The Shiller data is a bit smoother month to month because of how it is compiled – but there is also a longer term lower volatility to US Dividends Amounts distributed. Despite the falling US yield % dividends amounts being paid out by US companies is rising as a result of them retaining past profits and growing their businesses, We are being left behind because of a lack of productive re-investment.

 

Many of the depressing studies quite often assume you lump summed all your wealth into the market the day before it crashed. Whereas in reality wealth is accumulated steadily over time. This is where if possible it might pay for retirees to accumulate surplus cash in good times which can be used to supplement income in bad times and just as importantly reinvest part of this cash into the market in times of gloom.

Of course there are many alternatives such as the traditional rebalancing of bonds / equities etc.

I favour the dividend focused approach as decisions are minimal. No rebalancing and having to decide what to sell etc.

 

Re ASX it depends which part of the market one invests in and hence why I hold LICs who invest outside the mature large cap stocks. In part it's also why I have some International exposure.

 

As strange as it sounds, I was intentionally referring to the inverse Shiller, not AUS, CAPE for retirement here in Australia for the very reason you mention that our PE would suggest too high an SWR and that if the US market goes bear ours will likely follow in sympathy no matter how healthy our CAPE is currently tracking. I did say it was a rough guide!

 

Sounds sensible. Once I've. Worked out how much I'm going to set aside for retirement, I'll have to stop thinking like an active stock picker and learn some passive investment waysto get my allocation set. Getting the mix right will be the challenge. Market concentration of the index's is going to require some real thought in relation to passive etf's, active old school LICs, direct passive holdings etc for the Australian component. And how big should the international component be?

 

I assume your reference to PAF is in relation to private philanthropy?

Given your apparent level of wealth normally it would seem you have little to be concerned about. Your SWR is likely to be so conservative the risk of outliving your investments is very remote. But am I correct in assuming that maximising the PAF allocation is of great importance hence the level of analysis you are undertaking?

 

SPIVA reports make it quite obvious where paying for active management is worthwhile. See page four of following report:

http://au.spindices.com/documents/spiva/spiva-australia-year-end-2016.pdf?force_download=true

Over the longer term Mid / small caps are the standout.

 

Yes, maximising the PAF allocation is important to us. But so also is getting the retirement allocation right. I could just throw so much at the retirement allocation that sequence risk becomes irrelevant, but if I constrain the amount allocated now then I will be forced to learn passive investment and learn it well else risk a bad outcome in retirement. I want that challenge and motivation and the security that can come from the knowledge..

 

Well I'm taking a break from challenging subjects for a short time to enjoy a few home brews on the deck with the head brewer.

I expect those here to have solved this riddle before my return later tonight. Get cracking.

 

That may look like a random mess but look at the lead up to 2008 and then the top performers in 2008. A lot of people probably moved their money into cash after the crash, which was wrong in hindsight.

Build up cash via savings as the risk increases due to the retirement / market. Avoid selling equities (this breaks rule number 1) but it may not be avoidable if the cash allocation is short - there is no law against taking profits.

The risk here is if there is a prolonged bull market where you have cash on the sidelines. Consider the lost growth as the insurance policy against going completely bust in retirement. Note, when it crashes you will be cashed up for bargains.

This idea is probably getting a little too complicated. Maybe it's fine to keep 3 years of cash reserves and trust the market will rise again. However, I don't see the point in keeping this size cash reserve with over 10 years until retirement.

 

You may find the following author of interest. From memory although he is Canadian I think he also analysed the Australian sharemarket in his book and software. His analysis is based on historical sequence of returns rather than less reliable Monte Carlo simulation. He has developed software that appears to be widely used by professionals. I think a trial version of the software is available hopefully including ASX data:

otar retirement calculator

 

Boy this is a good thread. I keep forgetting I'm on propertychat. If things get bad I have these house thingys I can sell, right?

 

This reserve is for retirees not accumulators?

 

The 4% Rule: The Easy Answer to “How Much Do I Need for Retirement?”

Stocks — Part XIII: The 4% rule, withdrawal rates and how much can I spend anyway?

What is Your Retirement Number - The 4% Rule - Go Curry Cracker!

American stuff you've probably all read

 

Yep there's a whole pile of stuff that I've read overtime such as :

The Ultimate Guide to Safe Withdrawal Rates – Part 1: Introduction

One link will lead to another, it's never ending.