As a follow up to the previous post: Here’s the skinny…
Risk Managed Accounts May Subdue Sequence of Returns Risk (Part II)
Risk managed accounts are my first line of attack (my second will be discussed in Part III) against the sequence of returns risk for investors withdrawing retirement income from their accounts.
In Part I, we analyzed a scenario in which investors had a nest egg of $1,000,000 and were attempting to take annual withdrawals beginning at $60,000 and increasing each year by 3% adjusting for inflation. The problem was, depending upon the sequence of their returns, (1) one ran out of money, (2) another had a declining balance, and (3) the third maintained their $1,000,000 nest egg after withdrawals. Mathematically these are all accurate and true. That’s the unusual challenge with sequence of returns risk – it depends on the luck of the draw.
So, do we just throw up our arms and pray the sequence of returns works in our favor? Of course not.
The looming retirement planning question is “How may we prepare in real life?” Can we do anything to combat this risk besides simply withdrawing less money? Well, let’s address the ultimate stress-test… Let’s hypothetically look at what would have occurred to investors in the midst of the 2008-09 financial crisis.
We will compare and contrast relevant numerics for the S&P 500 Index alongside a risk managed account from USA Financial Portformulas, using the Sector Bull-Bear Strategy.
Here’s what performance and accumulation look like if we simply assume that both the S&P 500 and the Sector Bull-Bear Strategy have $1,000,000 invested and are allowed to accumulate with no withdrawals from 2004 through 2016:
I’ll attach a PDF brochure for the Sector Bull-Bear Strategy if you would like to know more details specifically about how the model functions. Suffice it to say here, the Sector Bull-Bear is a formulaic trending risk managed model that uses specific criteria to select amongst 11 sector ETFs for the S&P 500 via “sector trigger scores,” but then also calculates an overall “master sector trigger” to formulaically dictate when the model will shift entirely out of equities to a conservative bond/gold ETF blend.
The chart above illustrates the S&P 500 (the GREY line) versus the net fee performance of the Sector Bull-Bear (the BLUE line) from the beginning of 2004 through 2016. Take particular note of how the Sector Bull-Bear would have responded during the 2008-09 financial crisis by automatically shifting out of equities – revealing the popularity of using risk management.
But remember, we are discussing the perils of the sequence of returns risk and the difficulties it creates when distributing retirement income withdrawals from a portfolio.
So next, we will extract withdrawals just as we discussed in Part I of this write-up.
In the chart below, we will use the identical investment of $1,000,000 and identical performance from the chart above. However, now we will assume that the investor begins to immediately withdraw $60,000 per year, via monthly income checks, increasing each year by 3% to adjust for inflation.
In this chart, the GREY line still represents the S&P 500 with ZERO withdrawals, just so you have a point of reference. But our real focus is now on the green and orange lines. The GREEN line represents the S&P 500 less the withdrawals (again, beginning withdrawals at $60,000/year paid monthly and increasing 3% annually for inflation). Notice the severity of the decline during the 2008-09 financial crisis and the fact that by 2016 the GREEN line is running consistently below the initial investment of $1,000,000.
The ORANGE line represents the Sector Bull-Bear less the same withdrawals (again, beginning withdrawals at $60,000/year paid monthly and increasing 3% annually for inflation). Once more, focus your attention on the reaction of the ORANGE line during the 2008-09 financial crisis. Also, follow the ORANGE line movement through 2016 as it remains significantly above the initial investment of $1,000,000 through the duration. This is the value of using risk management to combat the sequence of returns risk!
Unfortunately, all I ever read about the “acceptable retirement withdrawal rate” and/or the “sequence of returns risk” is that one must reduce their retirement income. It’s as if everyone forgot what investment planning was all about. Risk management is why we exist! Anyone can simply identify a 60/40 portfolio allocation and reduce income payments from 6% down to 3%; there’s no need for a financial advisor in a relationship based on that math.
But financial advisors exist to deliver value to their investors. And risk management is one of the primary ways that such value may be delivered… Especially to an investor in need of withdrawing retirement income.
That’s the Skinny,
Mike Walters, CEO
