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Not all equity funds have the same volatility. Buying high Beta funds may require more bonds to match your overall portfolio volatility goals. That's what makes some newsletters nice. They do it for you.
People seem to think that volatility is a bad thing in investing, something to be avoided and to smooth out. It really isn't, and it is a mistake to put too much emphasis on volatility since that impedes your ability to get a good return. Volatility is fine as long as two conditions are met: (1) the trend of the swings is upward, and (2) you are not caught in a situation of needing to sell equities during a down-swing.
One way to achieve goal #1 is to do broad-market investing since we know that historically, the S&P 500 (and other indices) all trend upward. Individual stocks may not, but you can ameliorate that by broad funds or ETF's.
The way to mitigate #2 is to make sure you have enough liquidity (e.g., cash, cash-equivalents) to last you through a market downturn. So let's say you know you need $50k/year of distributions every year off your portfolio. In general, market downturns turn around in 2-3 years. Say 4 years, or 5 to be safe. So you keep 200-250k in cash and put the rest in equities.
One thing to notice here is the cash allocation is not calculated as a percentage of your portfolio, it is calculated as a fixed amount by what your needs are. Personally, I do not know why financial planners keep advocating the percentage approach.
The second thing to notice is that this strategy is not focused on volatility smoothing at all - it is all about keeping as much of your money in equities as possible (since over the long term that has proven to give the best return) by mitigating the risk of that with a cash reserve. In fact, it is questionable if you need to invest in any bonds at all with this approach. If this were the 1980's with interest rates greater than 10% then heck yes I would be buying bonds, but in this environment, no way.
volatility has little to do with gains. in fact if you saw the research on the chart above there is little to be gained when spending down beyond a 50/50 mix.
the permanent portfolio beat the s&p 500 over 35 years with volatility akin to watching paint dry.
in fact my own fidelity insight growth portfolio beat the s&p 500 with an average of 15% less volatility by a huge margin since 1987.
volatility has doubled on the same portfolio mix since 2000. if someoine was comfortable with a 50/50 mix and could sleep at night with a 15% swing down they were now getting 2x that swing and many bailed out losing money as those swings were more than they signed on for..
volatility and the thought of losing your money whether you actually do or not becomes more stressful in retirement where there are no do overs.
the name of the game for most retirees who need their portfolios to live on is get the income you need ,with a high rate of success with the lowest highest risk vs highest reward they can.
most of those who are spending down from their portfolios do not realize the math changes and it isn't the same as when you are just leaving things untouched.
that is why if you just look at the results above from the actual math, equity levels over 50% seem to make little difference. they just make for more of a white knuckle ride in the drops.
Last edited by mathjak107; 03-23-2014 at 03:22 AM..
one other thing i wanted to add is while we all think by having cash buckets to spend from or a bucket system that isolates us from down markets and liquidating stocks the net effect is a case of the emporers new clothes.
yep, it is smoke and mirrors that make us feel better in our heads but the reality is their is little difference in safety.
the weight of cash and bonds in up turns hurt gains so much that when compared to 100% equities the results came out the same.
according to research done by dr wade pfau and others using a bucket system for cash spending in down turns added nothing to the equation except lowering volatility..
100% equities built up a higher cushion in the up years so even liquidating stocks at a loss in the down years made no difference.
of course this assumes you do not take a major hit in the first 5 years before you gain some cushion.
the best method to date showing the greatest sustainability is what is called the rising glide path.
it was recently discovered by two of the most famous retirement researchers today dr wade pfau and michael kitces.
typically at odds with each other they did a joint project and came up with an amazing discovery.
we have been doing things backwards for decades telling retirees to flee stocks and reduce them.
the safest most succesful method discovered to date is to reduce equities down to 30-35% or so going into retirement. then INCREASE equity exposure by 1% a year through retirement .
that had the absolute best results over every single retirement time frame to date.
it protected you from being crushed in down markets early on yet gave you increasing inflation protection and emergency money on a declining balance as time went on .
Last edited by mathjak107; 03-23-2014 at 03:06 AM..
the rising glide path matches the other tied for first place method which was covering basic expenses with an immediate annuity or SPIA and putting the rest into equities to grow and provide inflation protection.
if you think of an annuity as something that hypothetically can pay out until age 100 or so than you can equate that to an allocation percentage.
at age 70 you can figure you have a 30% allocation left of income so a 70 year old would be in kind of in a 70% equity /30% fixed income scenerio with the equities/annuity.
there was nothing that had a historical lower rate of failure going out as many years .
the rising glide path method is based on that data. so as you age you increase equities by 1% a year up to a max of 70% if you live that long.
in effect you are trying to duplicate those high success rates he equities/annuitys combo had on your own.
it is nice to have that option of not using the annuity if you are not really suitable for one.
folks who buy annuities typically are healthy with longevety in their family . usually they are not good picks for those in less than stellar health and good genes.
in fact statistically that is just who buys them , the mortality credits could be so much higher for those who lived if the masses bought them but somehow once again the market levels out where it should and the bulk of annuity holders do fit that mold i described.
now anyone can duplicate those results which is very good news for those like me with crappy genes.
one other thing i wanted to add is while we all think by having cash buckets to spend from or a bucket system that isolates us from down markets and liquidating stocks the net effect is a case of the emporers new clothes.
yep, it is smoke and mirrors that make us feel better in our heads but the reality is their is little difference in safety.
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it is no surprise this would be true since the reverse is true. if increasing stock allocations had little benefit after 50% then the reverse has to be true and performance would be no different using a bucket system which avoids selling equities when down when high allocations to equities is used..
in fact back testing has shown they are not different and do not yield much different performance results.
the fact you are spending down at the same time gains and losses are coming in make for very different results than you are used to.
according to the update:
" The difference between 100% success for 75/25 and 96% for 50/50 is just that in two years (1965 and 1966) the maximum withdrawal rate fell slightly below 4% with 50/50, but stayed slightly above 4% with 75/25. It is not that big of deal when considering your overall return requirements and tolerance for risk."
for interesting reading the authors of the origonal trinity study took another look at it in 2011 to re-evaluate things.
Mathjak, you are drawing lots of conclusions from calculations that appear to be highly questionable. Take a look at some different Firecalc scenarios. Use a 5 or 6% withdrawal rate and a 25 or 30 year time period and use the investigate tab to see the effect of different different equity allocations. The probability of success will increase steadily to a 100% allocation. I would be very cautious about drawing conclusions solely from this sort of calculator. Try some different calculators with slightly different starting points and you will arrive at vastly different conclusions.
one other thing i wanted to add is while we all think by having cash buckets to spend from or a bucket system that isolates us from down markets and liquidating stocks the net effect is a case of the emporers new clothes.
yep, it is smoke and mirrors that make us feel better in our heads but the reality is their is little difference in safety.
I usually just skim through these investment advice threads, but this comment caught my eye. Weren't you once a strong proponent of the so-called bucket system?
i still am , because it eases our minds . there is no question psychologically it is easier on us , the fact is the end result may be the same.
living through a balanced portfolio in downturns and experiencing 1/2 the drop mentally feels a whole lot better than being down 2x that.
when we dropped 40% in 2008-2009 we had so much already in buckets one and 2 that while uncomfortable we really didn't stree over it much at all.
had i still been 80-100% equities i would have felt very different.
while success rate wise it may not have done a thing compared to the high equity position the toll on my body was a lot less
Last edited by mathjak107; 03-23-2014 at 07:27 AM..
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