Sequence of Return Risk

You'd expect significantly lower vol with 55% fixed interest ! The commodities incl. gold are designed as inflation hedge with low correlation to other portfolio components. Unfortunately lower returns than an all stock portfolio in the long run has to be expected. Personally I give very little weight to how a portfolio like this backtests.

 

@Big Daddy

Here is my understanding.

• Stocks are a high volatility high return asset class, that over the long term out performs inflation by quite a lot allowing you to increase your 'real' wealth.
• Bonds give a long term return above inflation but lower than stocks (and in the current and foreseeable future much lower since inflation is kept in tighter controls these days)
  
• Gold has no income and over the long term go neither up or down after inflation. I also recall reading that it had a 27 year period of zero growth (to go with that zero income).

The more you diversify out of stocks, the lower your volatility and the lower your long term return.

By taking 70% of your money out of stocks and putting them into a combination of low and zero real return asset classes, you are lowering your short term volatility at a great expense of long term return. That is, if you keep it in this proportion for the long term your gains will be incredibly low and will take you decades more to reach the same level of wealth.

So this would work if you could time the market, but this isn't a realistic option without the almanac from back to the future.
If you sold down equities like this in the US in 1991 when the market was at an all time high, you would have missed out on new peaks every single year for the next 9 years and missed out on re-doubling your money. ie if your 500k was invested in the early 80's and grew to 1m and you pulled out, you would see yourself missing it growing to 2m.

So my question with this portfolio is -
1. How do you know when the peak has arrived to switch from equities to this?
2. What would your reaction be if you pulled out and the market continued to rise until it doubled?
3. Would you keep this ratio indefinitely?
4. If not, how can you predict when to switch back to real growth assets?

 

Vanguard - From assets to income: A goals-based approach to retirement spending - Australian edition

https://static.vgcontent.info/crp/i...earch/assets-to-income-wp.pdf?20180815|080000

 

Thanks @Nodrog. I certainly wonder how many previously middle to high income baby boomers are now having to curb their spending when retiring. I have seen a few.

 

Certainly not us. Income continues to increase. In fact when it comes to lifestyle expenditure we spend more now than we did when working. And no we don’t feel guilty about this. My only mandatory rule is that a decent amount of our annual income gets reinvested back into the market. If need be we’d cut back on expenditure if that was under threat. Everyone is different both in their level of wealth and desires but the key point is that one lives within their means.

The Vanguard paper is very biased toward the Total Return approach as usual. I don’t agree with all of it but posted it incase others were interested in this sort of thing. We personally follow the income approach but not the typical stereotyped one that Vanguard always likes to portray.

 

What does below statement mean, extracted from the article attached?????

‘There are known knowns; there are things we know that we know. There are known unknowns; that is to say, there are things that we now know we don’t know. But there are also unknown unknowns — there are things we do not know we don’t know.’


Former United States Secretary of Defence, Donald Rumsfeld

Gee, I am so glad I don't hold many stocks.......or ever plan to hold any annuities! All I understand from this is that nobody has a crystal ball into the future performance of anything, so how can we plan for all those 'knowns' and 'unknowns'...?

 

We know the US has had its longest Bull Run in history (I'm not a week early am I?)

We know it will end, but not when.

We have no idea what will cause the next crash (some people claim to).

 

Johari window.

 

Spot on. The problem of fat-tailed distributions.

 

Thanks, looked it, seems I learn something new every day!

 

Didn't Howard Marks have a memo out back in the day: you can't predict, but you can prepare?!!!

 

RICH, BROKE or DEAD?


The best calculator I have seen for exploring sequence risk on retirement spending. Unlike most others it can incorporate the elephant in the room - probability of dying.


Well worth going to the link and having a play.

Post-Retirement Calculator: Will My Money Survive Early Retirement? Visualizing Longevity Risk - Engaging Data

Unfortunately, like almost everything that is cutting edge in modelling historical data for sequence risk insights - it only uses US data and life tables.

 

Thanks @dunno. Like you say shame that there’s not more tools available with Australian data.

I can’t recall whether I posted this earlier but it doesn’t make for pleasant reading depending on one’s circumstances. @dunno your mission if you choose to accept is to find holes in this analysis:

Safe withdrawal rates for Australian retirees - Morningstar.com.au

 

If the market is overvalued then the true swr (the maximum you can withdraw) should be lower than what the research says because of regency bias (the market has been performing better on average due to recent outperfomance) and the higher likelihood of a reversion to the mean.

 

Thanks.

To be honest it’s been awhile since I read the paper but when @dunno mentioned probability of death I had a vague recollection this may have been taken into account using “Australian” stats.

Fortunately in our situation we make sure we are unlikely to ever need to draw on capital so SWR is of little concern. Strange as it might seem I just like reading about such things to entertain myself.

 

2.5% SWR. Possibly so on a 50:50 stocks:bonds portfolio. A high assset allocation to equities is what makes the difference.

 

Hey Nodrog (general response - not specific to you)

The future is unknown, so your linked article is as defensible as the next opinion I guess.

IMO. 2.5% seems pessimistically low.

I have no problem with 4% as a rule of thumb. It’s what the historical maths points to for countries that haven’t had the crap blown out of them in a war and it is also about the level of natural dividends/buybacks. Rules of thumb aren’t meant to be gospel – they are rules of thumb.

The underlying problem is trying to extract a fixed income from assets with variable cash flows. The real answer is not a better estimate of SWR rates but flexibility in living of the variable cash flow. (living off dividend income is one sensible way of matching spending to the cash flows, just don’t concentrate the portfolio chasing an unnatural dividend return)

One thing I noted in the paper is they use a MER of 1%. In coming up with the 2.5% SWR.

So easy today to build a diversified portfolio for 0.25% max unless you drink the active management cool aide. That bumps the SWR up to 3.25%.

Assuming 1.6M super Cap as level of funds at retirement. 2.5% SWR means you can safely withdraw an inflation adjusted $40,000 per year.

Control your expenses and the equivalent risk SWR becomes 3.25% which means the same 1.6M can safely provide an inflation adjusted $52,000.

EXPENSES MATTER!!!!!! extra $12,000 (30%) per year income increasing with inflation just by controlling your expenses by 0.75%.


Referring back to the Rich, Broke, Dead calculator. I could make the argument that the 4% rule of thumb is too low.

I think a 5%+ SWR could be argued. When you consider broke in Australia would simply mean you fall back onto the pension system. Even at 5% SWR you are much more likely to die with too much money than having to resort to the pension in your later years.



You only get one crack at life – don’t let a bunker and beans level SWR rate scare you into wasting time working longer and saving more than you need.

 

The SWR is how much you should withdraw to reach $0 after a specific number of years in the worst possible scenario. In every other case you still have money left and in some cases more than what you started with. Given the age pension as a safety net and the fact that people spend less after a certain age I am certain it is too low. Maybe the government needs the 20% of society who probably contribute 80% of the growth (Pareto principle) to stay in work to keeping the economy moving, so they push media and the finance industry to communicate a lower rate.

To ensure the moolah doesn't run out, I'd suggest reduced spending during bad times, especially during the early years when the risks are the highest.

 

Thanks @dunno.

Huge day in the yard today. Nakkered.

Great response and I agree. I didn’t want to cloud responses with upfront comments until others much smarter then me like yourself were able to put their view(s) forward.

I keep hearing about all these retirees living into their nineties but maybe I hang out with the wrong crowd but I’ve seen plenty of the opposite. There’s gotta be a balance between living for today vs saving for tomorrow. And as you say we are very fortunate in that if it all turns to **** the pension is there as a backup.

Whether one’s approach is Total Return or dividend focused (not just banks, TLS and a few AReits but a broad based portfolio) I think we have more in common than first meets the eye. That is we’re huge believers in equities. Perhaps we might have different ways ro ride out rough patches (?) but our future is dependent on what I believe is the best asset on the planet, ie shares.

To conclude though I sometimes wonder if given my reality is likely more fortunate than others it’s very easy to offer views on the downside when there is more fat to fall back on. Then again my wife came from as poor a family as you could imagine in Australia and my parents were very ordinary with minimal wealth. So never underestimate what one can achieve. Educate yourself to maximise employment prospects, save well, invest then let the eight wonder on the world, compounding, do it’s magic.

 

Never understood the total return label you assign me or the dividend focused label you assign yourself or why the two should be opposed. It's all just the same investing in equities to me.