## Sequence of returns risk while accumulating

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randomguy
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Tue Feb 20, 2018 3:55 pm
Sorry, that was \$1,000 invested annually. It would make a small difference by looking at monthly contributions, but not much.
I always find these numbers a bit deceptive when you try and use them in the real world. Lets compare 2 people at 1k/year.
1988-2007 74k
1989-2008 55k

That is a pretty big difference.

1988-2017 181k
1989-2017 161k

Given 1 less year in the market (call it like 8%) and those numbers are pretty close. In the real world is the difference huge (25%+) or is it pretty small (~5%). In the real world I think for most people they end up with the smaller difference most of the time as it is rare to have event that takes you out of the game (i.e. dying:)). In the end we just end up seeing a lot of the effects of volatility of the last year (the difference between being +20% for the year or -20%). Now there are definitely periods with good/bad returns. I jus think these charts tend to exxagerate things. The 1999 and 2002 person are going to be a lot closer than charts like this indicated.

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willthrill81
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### Re: Sequence of returns risk while accumulating

randomguy wrote:
Wed Feb 21, 2018 12:57 am
willthrill81 wrote:
Tue Feb 20, 2018 3:55 pm
Sorry, that was \$1,000 invested annually. It would make a small difference by looking at monthly contributions, but not much.
I always find these numbers a bit deceptive when you try and use them in the real world. Lets compare 2 people at 1k/year.
1988-2007 74k
1989-2008 55k

That is a pretty big difference.

1988-2017 181k
1989-2017 161k

Given 1 less year in the market (call it like 8%) and those numbers are pretty close. In the real world is the difference huge (25%+) or is it pretty small (~5%). In the real world I think for most people they end up with the smaller difference most of the time as it is rare to have event that takes you out of the game (i.e. dying:)). In the end we just end up seeing a lot of the effects of volatility of the last year (the difference between being +20% for the year or -20%). Now there are definitely periods with good/bad returns. I jus think these charts tend to exxagerate things. The 1999 and 2002 person are going to be a lot closer than charts like this indicated.
I don't really understand your point here. You seem to be saying that SRR isn't a big issue "in the real world," but then you state that volatility in the late stages of accumulation can make a big difference (which I entirely agree with).

I'm not sure how an analysis of a historical event "exaggerates things." Some were complaining that Monte Carlo analysis was used in the OP, but it seems that you're saying that historical analysis isn't good enough either.

My point was merely to illustrate that SRR is not limited to retirees; it's a real problem for accumulators with very real consequences.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Oicuryy
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### Re: Sequence of returns risk while accumulating

Money is fungible | Abbreviations and Acronyms

KlangFool
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### Re: Sequence of returns risk while accumulating

OP,

As far as I can tell, in order to avoid of SRR while accumulating

A) Save as much as possible and as early as possible.

B) Adjust your AA to be more conservative as it gets bigger or big enough

Do I get this right?

As far as working longer and so on, those are beyond most folks' control. Only (A) and (B) are possible.

KlangFool

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willthrill81
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### Re: Sequence of returns risk while accumulating

KlangFool wrote:
Wed Feb 21, 2018 4:19 pm
OP,

As far as I can tell, in order to avoid of SRR while accumulating

A) Save as much as possible and as early as possible.

B) Adjust your AA to be more conservative as it gets bigger or big enough

Do I get this right?

As far as working longer and so on, those are beyond most folks' control. Only (A) and (B) are possible.

KlangFool
Yes, save as much as possible can help to minimize the negative effects of SRR. Saving as early as possible can help to reduce the actual incidence of SRR. And yes, shifting to a more conservative AA as you get closer to your goal, whether that be in time or money, helps to minimize the effects of SRR.

As far as working longer, that might be within your control, but it might not too. Many are forced into retirement, but certainly not all are.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

dbr
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### Re: Sequence of returns risk while accumulating

A lot of people seem to be fetched up on this obsession with sequence of return when in fact there are combinations of factors that determine the outcome, including in the first place what the average return was/will be. I am not sure the idea of what a "sequence of returns risk" is is completely clear in this discussion. I think the concept is more an issue when it comes to understanding how to plan for retirement without making naive and incomplete assumptions, such as the expected return will actually materialize exactly in each and every year. It isn't really a risk as such different from the general fact that the returns one will receive in each year of retirement are variable and may turn out to be good for the investor or bad for the investor.

triceratop
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### Re: Sequence of returns risk while accumulating

Some early work in this area, of mitigating sequence of returns risk: A different approach to asset allocation by market timer.

The results were interesting. Obviously no guarantees.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

overthought
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### Re: Sequence of returns risk while accumulating

KlangFool wrote:
Tue Feb 20, 2018 9:25 am
4) Most folks rent the house (A) one level below the house (B) that they are willing to buy. Then, they use the cost of renting (B) to justify their purchase of (B). So, for most folks, the calculation is a fraud. They were never to rent (B) under any circumstances. They only use renting (B) to justify their increase in housing expense.

So, it is between 400K townhouse (A) versus 600K SFH(B).

5) In my case, I bought the same house (A) that I am willing to rent. And, the PITI is 20% to 30% lower than renting. Hence, I did not increase my housing expense by renting.
This is something I've heard repeatedly but which does not jive with my own experience at all... starving student with kids, LCOL area, bought an 1800 sqft 3BR house because monthly PITI was ~\$1000 while renting even 900 sqft 2BR in so-so complex was \$1200 or more. Later in life, HCOL area, bought an 1800 sqft 3BR house with PITI ~\$2000 because renting 1200 sqft 3BR would have been closer to \$4000. More recently, MCOL area, bought a 3000 sqft 5BR house with PITI ~\$2000 because renting a 1500 sqft 3BR would have been closer to \$2000.

I totally understand that 1BR condo is a very different beast than a 5000 sqft McMansion, esp. for single or couple... but I've been in the 3BR-with-kids market virtually my entire housing career and in *every* case I've ever seen, the monthly cost of renting even a significantly worse dwelling has been significantly *higher* than buying. The only reasons not to buy were (a) holding the house less than 3 years so closing costs and transfer tax kill the fun; or (b) couldn't afford the down payment, bad credit, etc. that prevent getting the loan in the first place.

Did I just get lucky with a really skewed sample, or does something else explain this discrepancy?

randomguy
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### Re: Sequence of returns risk while accumulating

overthought wrote:
Wed Feb 21, 2018 8:00 pm
KlangFool wrote:
Tue Feb 20, 2018 9:25 am
4) Most folks rent the house (A) one level below the house (B) that they are willing to buy. Then, they use the cost of renting (B) to justify their purchase of (B). So, for most folks, the calculation is a fraud. They were never to rent (B) under any circumstances. They only use renting (B) to justify their increase in housing expense.

So, it is between 400K townhouse (A) versus 600K SFH(B).

5) In my case, I bought the same house (A) that I am willing to rent. And, the PITI is 20% to 30% lower than renting. Hence, I did not increase my housing expense by renting.
This is something I've heard repeatedly but which does not jive with my own experience at all... starving student with kids, LCOL area, bought an 1800 sqft 3BR house because monthly PITI was ~\$1000 while renting even 900 sqft 2BR in so-so complex was \$1200 or more. Later in life, HCOL area, bought an 1800 sqft 3BR house with PITI ~\$2000 because renting 1200 sqft 3BR would have been closer to \$4000. More recently, MCOL area, bought a 3000 sqft 5BR house with PITI ~\$2000 because renting a 1500 sqft 3BR would have been closer to \$2000.

I totally understand that 1BR condo is a very different beast than a 5000 sqft McMansion, esp. for single or couple... but I've been in the 3BR-with-kids market virtually my entire housing career and in *every* case I've ever seen, the monthly cost of renting even a significantly worse dwelling has been significantly *higher* than buying. The only reasons not to buy were (a) holding the house less than 3 years so closing costs and transfer tax kill the fun; or (b) couldn't afford the down payment, bad credit, etc. that prevent getting the loan in the first place.

Did I just get lucky with a really skewed sample, or does something else explain this discrepancy?
It is location specific. Some areas renting is much cheaper. Other buying is much cheaper. I would say there is a trend of LCOL versus HCOL.

KlangFool
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### Re: Sequence of returns risk while accumulating

overthought wrote:
Wed Feb 21, 2018 8:00 pm
KlangFool wrote:
Tue Feb 20, 2018 9:25 am
4) Most folks rent the house (A) one level below the house (B) that they are willing to buy. Then, they use the cost of renting (B) to justify their purchase of (B). So, for most folks, the calculation is a fraud. They were never to rent (B) under any circumstances. They only use renting (B) to justify their increase in housing expense.

So, it is between 400K townhouse (A) versus 600K SFH(B).

5) In my case, I bought the same house (A) that I am willing to rent. And, the PITI is 20% to 30% lower than renting. Hence, I did not increase my housing expense by renting.
This is something I've heard repeatedly but which does not jive with my own experience at all... starving student with kids, LCOL area, bought an 1800 sqft 3BR house because monthly PITI was ~\$1000 while renting even 900 sqft 2BR in so-so complex was \$1200 or more. Later in life, HCOL area, bought an 1800 sqft 3BR house with PITI ~\$2000 because renting 1200 sqft 3BR would have been closer to \$4000. More recently, MCOL area, bought a 3000 sqft 5BR house with PITI ~\$2000 because renting a 1500 sqft 3BR would have been closer to \$2000.

I totally understand that 1BR condo is a very different beast than a 5000 sqft McMansion, esp. for single or couple... but I've been in the 3BR-with-kids market virtually my entire housing career and in *every* case I've ever seen, the monthly cost of renting even a significantly worse dwelling has been significantly *higher* than buying. The only reasons not to buy were (a) holding the house less than 3 years so closing costs and transfer tax kill the fun; or (b) couldn't afford the down payment, bad credit, etc. that prevent getting the loan in the first place.

Did I just get lucky with a really skewed sample, or does something else explain this discrepancy?
overthought,

<<Did I just get lucky with a really skewed sample,>>

You had lived in a very unusual real estate market.

KlangFool

randomguy
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Wed Feb 21, 2018 12:00 pm

I don't really understand your point here. You seem to be saying that SRR isn't a big issue "in the real world," but then you state that volatility in the late stages of accumulation can make a big difference (which I entirely agree with).

I'm not sure how an analysis of a historical event "exaggerates things." Some were complaining that Monte Carlo analysis was used in the OP, but it seems that you're saying that historical analysis isn't good enough either.

My point was merely to illustrate that SRR is not limited to retirees; it's a real problem for accumulators with very real consequences.
There are big difference in account values but those differences don't effect spending ability a lot of the time. Simple example. Take 2 people both with 1 million dollars and markets with the same valuations, interest rate environments, and so on 1 year before retirement.
Person A. Account goes up to 1.2 million. They retire. Over the next year the account value drops to 1 million
Person B. Account drops to 1 million. They retire. Over the next year the account value rises to 1 million

They had a 50% difference in account values at retirement. Do you think over the next 29 years of retirement that person A can take out a dramatically different amount of money than person B? The issue is that looking at 1 point in time rarely tells whole the story. In 2009 there were articles about how long bonds had beat then stock market over the past 30+ years. That was 100% true. It also ignores the reality that stocks beat those bonds for all but like 3 months of that 30 year period. If you needed money at any time other than those couple months, you would have done much better with stocks.

Lets look at are real world example. 60/40 1k/1k year
1988-2007 74k
2008-2016 take out 3k/year 74k->93k

compared with

1989-2008 55k
2009-2017 take out 3k/year 55k-> 91k
So 9 years into retirement and they are in about the same spot. Now obviously the 1988 person is about to have another nice year to who knows what the 1989 person is going to face. Large starting balance differences. So far minimal spending differences.

Sequence (and absolute returns) matters. But it isn't remotely clear by how much. It isn't like we have many 60-70 year sample to look at and things like Monte Carlo are just flawed for cases like this as they don't factor in things like valuations .

randomguy
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### Re: Sequence of returns risk while accumulating

KlangFool wrote:
Wed Feb 21, 2018 8:07 pm

overthought,

<<Did I just get lucky with a really skewed sample,>>

You had lived in a very unusual real estate market.

KlangFool
Are you sure that his isn't the more normal one (well by land area and not population)? I have never seen a study of this but my impression that buying being cheaper than renting for the same house is true for huge chunks of the country. People don't buy cause they don't have the credit/downpayment/income/desire to be there long term. You have to pay a premium to not have the obligation of a mortgage. And buyers tend to ignore things like maintenance:) These tend to be areas that have CAP rates on rental properties that I have never seen in my life:) For fun you can find some TH/Condo complex with units both for rent and sale and see how much the price differs if you want to do an apples to apples comparison.

KlangFool
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### Re: Sequence of returns risk while accumulating

randomguy wrote:
Wed Feb 21, 2018 9:02 pm
KlangFool wrote:
Wed Feb 21, 2018 8:07 pm

overthought,

<<Did I just get lucky with a really skewed sample,>>

You had lived in a very unusual real estate market.

KlangFool
Are you sure that his isn't the more normal one (well by land area and not population)? I have never seen a study of this but my impression that buying being cheaper than renting for the same house is true for huge chunks of the country. People don't buy cause they don't have the credit/downpayment/income/desire to be there long term. You have to pay a premium to not have the obligation of a mortgage. And buyers tend to ignore things like maintenance:) These tend to be areas that have CAP rates on rental properties that I have never seen in my life:) For fun you can find some TH/Condo complex with units both for rent and sale and see how much the price differs if you want to do an apples to apples comparison.
randomguy,

This is a personal finance forum. Why worry about statistic?

<<my impression that buying being cheaper than renting for the same house>>

Do you rent the same house as what you are prepared to buy?

The only relevant question is at the individual level. Either we, as an individual, trick ourselves into spending more when we buy a house or we don't. If we don't, we are safe. If not, we need to watch out for this bias.

Among my peers, this does not hold true. Hence, they are "House Poor".

KlangFool

randomguy
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### Re: Sequence of returns risk while accumulating

KlangFool wrote:
Wed Feb 21, 2018 9:13 pm

randomguy,

This is a personal finance forum. Why worry about statistic?

<<my impression that buying being cheaper than renting for the same house>>

Do you rent the same house as what you are prepared to buy?

The only relevant question is at the individual level. Either we, as an individual, trick ourselves into spending more when we buy a house or we don't. If we don't, we are safe. If not, we need to watch out for this bias.

Among my peers, this does not hold true. Hence, they are "House Poor".

KlangFool
Because statistics expose personal biases. You think renting is cheaper than buying because your personal experience. But I have only heard you ever mention 1 metro area. Extrapolating from that to the rest of the country is a stretch. You (and I) have no clue if it generalizes and how. My experience is that buying houses in LCOL areas is cheaper than renting worse places (i.e. buying a 3/2 is cheaper than renting an townhouse) at a high level (i.e. mortgage/taxes versus rent) by a significant amount. But I also realize I am looking at a sample size of 2. But it is enough for me to think that the OP situation isn't remotely unusual. I have a feeling it is norm for a significant part of the country. Buying should be cheaper than renting in areas that don't much appreciation but I have no knowledge of how much reality matches theory other than the couple samples I experienced.

And yes I have rented houses and then tried to buy similar things (both 1200-1400 sq ft 3/2s in a 5 mile radius all built in the 60s all in the 700-800k range. I made 7 offers. None were accepted). Rent versus buy was a wash. Renting was going to be cheaper short term by about 500/month but odds are (and I was right looking back 15 years) that long term buying would have been cheaper (the places are now all 1.4-1.6 million and rent is thousands more than what the mortgage payment would have been. Obviously I am a poor real estate investor:)). The choice of rent versus buy though wasn't a financial one. It was a personal one based on changes in life circumstances. And yes I am also aware of how much my experience affects my views on this matter:)

I think you are confusing a symptom (buying the big house) with the cause (i.e. they will spend whatever they have. If it wasn't a house, they would be taking a trip to europe and so on.). It is an important distinction. Being house poor tends to be temporary (even small raises rapidly get you out of the house poor situation over 5-10 years) while spending tends to be pretty permanent (i.e. that 10k raise doesn't go towards savings. It goes towards a boat.). If your a spender, there are far worse things to spend money on than a house. They tend to hold their value better than lets say a boat or european vacation:)

KlangFool
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### Re: Sequence of returns risk while accumulating

randomguy wrote:
Wed Feb 21, 2018 10:00 pm

Being house poor tends to be temporary (even small raises rapidly get you out of the house poor situation over 5-10 years) while spending tends to be pretty permanent (i.e. that 10k raise doesn't go towards savings. It goes towards a boat.). If your a spender, there are far worse things to spend money on than a house. They tend to hold their value better than lets say a boat or european vacation:)
randomguy,

<< Being house poor tends to be temporary (even small raises rapidly get you out of the house poor situation over 5-10 years) >>

Really? We would have to quantify this in term of the house price and income level. Are you talking about the household income of 150K and house price of 600K? Or something else?

KlangFool

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willthrill81
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### Re: Sequence of returns risk while accumulating

KlangFool wrote:
Wed Feb 21, 2018 10:16 pm
randomguy wrote:
Wed Feb 21, 2018 10:00 pm

Being house poor tends to be temporary (even small raises rapidly get you out of the house poor situation over 5-10 years) while spending tends to be pretty permanent (i.e. that 10k raise doesn't go towards savings. It goes towards a boat.). If your a spender, there are far worse things to spend money on than a house. They tend to hold their value better than lets say a boat or european vacation:)
randomguy,

<< Being house poor tends to be temporary (even small raises rapidly get you out of the house poor situation over 5-10 years) >>

Really? We would have to quantify this in term of the house price and income level. Are you talking about the household income of 150K and house price of 600K? Or something else?

KlangFool
A 2% annual raise (Fed targeted inflation rate) over 10 years boosts one's gross income by almost 22%, which could be enough to alleviate the 'house poor' status somewhat. Whether that is enough to still enable you to achieve your goals is another matter.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Topic Author
willthrill81
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### Re: Sequence of returns risk while accumulating

Given some recent posts suggesting that sequence of returns risk is only an issue for retirees, I believe that this thread may need reviving.

Also, given some prior concerns about the Monte Carlo analysis in the OP, I thought that I would illustrate how SRR over the last decade of an investor's accumulation phase can impact their portfolio.

In the below numbers, the investor started with \$10,000 in each instance and contributed \$1,000 annually. Their portfolio was a fixed 60% TSM / 40% TBM (for 1980-1989, intermediate-term Treasuries were used instead of TBM). The number listed is their inflation-adjusted terminal portfolio value.

1980-1989: \$40,038
1990-1999: \$44,830
2000-2009: \$21,108
2010-2019: \$30,542

Obviously, SRR had a dramatic impact in these scenarios, leaving 2000-2009 accumulators with less than half as much as 1990-1999 retirees.

I occasionally hear financial planners talk about getting historically average returns during the last decade of accumulation, but the data are clear that that is far from guaranteed to happen.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Random Walker
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Tue Feb 20, 2018 5:04 pm
Over this time frame, the average return accounted for 64% (.8^2) of the variance in final portfolio value, definitely a big factor. The other 36% is due to the particular sequence of returns. The same is true of accumulation.
This shows there are two issues that can both be addressed with one solution. The first issue is average return and standard deviation. If one can maintain portfolio mean expected return but decrease expected portfolio SD by diversifying across investments, the volatility drag is lessened. Also, through diversification the sequence of returns risk can be lessened.

Dave

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willthrill81
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### Re: Sequence of returns risk while accumulating

Random Walker wrote:
Fri Jun 14, 2019 4:44 pm
willthrill81 wrote:
Tue Feb 20, 2018 5:04 pm
Over this time frame, the average return accounted for 64% (.8^2) of the variance in final portfolio value, definitely a big factor. The other 36% is due to the particular sequence of returns. The same is true of accumulation.
This shows there are two issues that can both be addressed with one solution. The first issue is average return and standard deviation. If one can maintain portfolio mean expected return but decrease expected portfolio SD by diversifying across investments, the volatility drag is lessened. Also, through diversification the sequence of returns risk can be lessened.

Dave
Certainly. Beyond the standard diversification of owning broad index funds for both stocks and bonds, do you have any examples you care to share of such diversification consistently reducing sequence of returns risk?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Random Walker
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Fri Jun 14, 2019 5:02 pm
Random Walker wrote:
Fri Jun 14, 2019 4:44 pm
willthrill81 wrote:
Tue Feb 20, 2018 5:04 pm
Over this time frame, the average return accounted for 64% (.8^2) of the variance in final portfolio value, definitely a big factor. The other 36% is due to the particular sequence of returns. The same is true of accumulation.
This shows there are two issues that can both be addressed with one solution. The first issue is average return and standard deviation. If one can maintain portfolio mean expected return but decrease expected portfolio SD by diversifying across investments, the volatility drag is lessened. Also, through diversification the sequence of returns risk can be lessened.

Dave
Certainly. Beyond the standard diversification of owning broad index funds for both stocks and bonds, do you have any examples you care to share of such diversification consistently reducing sequence of returns risk?
International diversification, heavy tilt to SV, increase safe bond allocation, add other factors such as CS momentum, Profitability/quality. Can add TS Momentum. Can add the alternatives reinsurance, alternative lending, variance risk premia, AQR style premia.

Dave

Topic Author
willthrill81
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### Re: Sequence of returns risk while accumulating

Random Walker wrote:
Fri Jun 14, 2019 6:11 pm
willthrill81 wrote:
Fri Jun 14, 2019 5:02 pm
Random Walker wrote:
Fri Jun 14, 2019 4:44 pm
willthrill81 wrote:
Tue Feb 20, 2018 5:04 pm
Over this time frame, the average return accounted for 64% (.8^2) of the variance in final portfolio value, definitely a big factor. The other 36% is due to the particular sequence of returns. The same is true of accumulation.
This shows there are two issues that can both be addressed with one solution. The first issue is average return and standard deviation. If one can maintain portfolio mean expected return but decrease expected portfolio SD by diversifying across investments, the volatility drag is lessened. Also, through diversification the sequence of returns risk can be lessened.

Dave
Certainly. Beyond the standard diversification of owning broad index funds for both stocks and bonds, do you have any examples you care to share of such diversification consistently reducing sequence of returns risk?
International diversification, heavy tilt to SV, increase safe bond allocation, add other factors such as CS momentum, Profitability/quality. Can add TS Momentum. Can add the alternatives reinsurance, alternative lending, variance risk premia, AQR style premia.

Dave
Many of those options in the last set have not been available long enough to the retail investor to get a really good idea as to how much they can reduce sequence of returns risk, but several have done so in the past (e.g. international, SCV, bonds, TS momentum). SCV really helped in 2000-2002, and TS momentum helped both then as well as 2008-2009.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

vineviz
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Fri Jun 14, 2019 12:06 pm
In the below numbers, the investor started with \$10,000 in each instance and contributed \$1,000 annually. Their portfolio was a fixed 60% TSM / 40% TBM (for 1980-1989, intermediate-term Treasuries were used instead of TBM). The number listed is their inflation-adjusted terminal portfolio value.

1980-1989: \$40,038
1990-1999: \$44,830
2000-2009: \$21,108
2010-2019: \$30,542

Obviously, SRR had a dramatic impact in these scenarios, leaving 2000-2009 accumulators with less than half as much as 1990-1999 retirees.
I don't think that what you've observed is actually sequence of return risk so much as just plain return risk.

"Sequence of return risk" is generally used to describe the sensitivity of an investment success to the order in which a set of returns occur, not to the overall average level of those returns.

In other words, sequence of return risk would describe the difference between getting -30%, -20%, -10%, 10%, 20%, 30% in retirement instead of 10%, 20%, 30%, -30%, -20%, -10%.

Under accumulation, the difference in outcomes between those series isn't zero but it is much smaller than the difference in outcomes in decumulation.

But the important thing is that both series have the same expected return: it's only the sequence of the returns that differs.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

dbr
Posts: 29138
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### Re: Sequence of returns risk while accumulating

vineviz wrote:
Fri Jun 14, 2019 9:07 pm
willthrill81 wrote:
Fri Jun 14, 2019 12:06 pm
In the below numbers, the investor started with \$10,000 in each instance and contributed \$1,000 annually. Their portfolio was a fixed 60% TSM / 40% TBM (for 1980-1989, intermediate-term Treasuries were used instead of TBM). The number listed is their inflation-adjusted terminal portfolio value.

1980-1989: \$40,038
1990-1999: \$44,830
2000-2009: \$21,108
2010-2019: \$30,542

Obviously, SRR had a dramatic impact in these scenarios, leaving 2000-2009 accumulators with less than half as much as 1990-1999 retirees.
I don't think that what you've observed is actually sequence of return risk so much as just plain return risk.

"Sequence of return risk" is generally used to describe the sensitivity of an investment success to the order in which a set of returns occur, not to the overall average level of those returns.

In other words, sequence of return risk would describe the difference between getting -30%, -20%, -10%, 10%, 20%, 30% in retirement instead of 10%, 20%, 30%, -30%, -20%, -10%.

Under accumulation, the difference in outcomes between those series isn't zero but it is much smaller than the difference in outcomes in decumulation.

But the important thing is that both series have the same expected return: it's only the sequence of the returns that differs.
It sounds like there is confusion between secular variation in average return and sequence of return issues as you describe well above. This is an issue I think many poster completely ignore or do not understand.

However Willthrill also wrote "Over this time frame, the average return accounted for 64% (.8^2) of the variance in final portfolio value, definitely a big factor. The other 36% is due to the particular sequence of returns. The same is true of accumulation." which sounds precisely like taking proper account of both factors. I may not be paying sufficiently precise attention to all the postings to be sure and therefore note my comments about anyone's comments may be provisional.

Topic Author
willthrill81
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### Re: Sequence of returns risk while accumulating

vineviz wrote:
Fri Jun 14, 2019 9:07 pm
willthrill81 wrote:
Fri Jun 14, 2019 12:06 pm
In the below numbers, the investor started with \$10,000 in each instance and contributed \$1,000 annually. Their portfolio was a fixed 60% TSM / 40% TBM (for 1980-1989, intermediate-term Treasuries were used instead of TBM). The number listed is their inflation-adjusted terminal portfolio value.

1980-1989: \$40,038
1990-1999: \$44,830
2000-2009: \$21,108
2010-2019: \$30,542

Obviously, SRR had a dramatic impact in these scenarios, leaving 2000-2009 accumulators with less than half as much as 1990-1999 retirees.
I don't think that what you've observed is actually sequence of return risk so much as just plain return risk.

"Sequence of return risk" is generally used to describe the sensitivity of an investment success to the order in which a set of returns occur, not to the overall average level of those returns.

In other words, sequence of return risk would describe the difference between getting -30%, -20%, -10%, 10%, 20%, 30% in retirement instead of 10%, 20%, 30%, -30%, -20%, -10%.

Under accumulation, the difference in outcomes between those series isn't zero but it is much smaller than the difference in outcomes in decumulation.

But the important thing is that both series have the same expected return: it's only the sequence of the returns that differs.
Your point is well taken. That being said, SRR is obviously not confined to specific years; the 2000-2009 decade was rough for retirees as well as those in the last decade of accumulation compared to the prior two decades. But for those who still had significant time left in the accumulation phase, the opposite was true (i.e. it was a good period for them to buy stocks at good valuations).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

MathIsMyWayr
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### Re: Sequence of returns risk while accumulating

Sequence of return risk during an accumulation phase is just a mathematical exercise, but is irrelevant in real life. You have to save as much, as often and as long as you can at a proper AA no matter what. On the other hand, SSR in the withdrawal phase is an actionable item. There are many strategies against SRR floating around such as bucket methods, x numbers of years in safe investments, etc. If you implement something similar in the accumulation phase, isn't it any different from market timing?

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willthrill81
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### Re: Sequence of returns risk while accumulating

MathIsMyWayr wrote:
Fri Jun 14, 2019 10:03 pm
Sequence of return risk during an accumulation phase is just a mathematical exercise, but is irrelevant in real life.
That's demonstrably false; my guess is that you haven't read the OP. If SRR is a risk for retirees, then logically it must be a risk for those in the accumulation phase. The big risk as an accumulator is that you will get good returns early in that phase when you don't have much invested and poor returns late in the accumulation phase when you do.

Consider the following two hypothetical retirees. They both have \$600k in their 60/40 portfolio, contribute \$20k annually, and need an inflation-adjusted \$1 million to meet their retirement goal. One started in 1990 and had reached the \$1 million mark by mid-1995. The other started in 2000 and reached the \$1 million mark in 2012. The one beginning in 2000 had to both keep making contributions and potentially delay retirement for seven more years than the one beginning in 1990.

The bucket approach you refer to as potentially helping reduce SRR in retirement has actually been shown to not be effective; it may actually be counter-productive to reducing SRR.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

klaus14
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Fri Jun 14, 2019 10:16 pm
MathIsMyWayr wrote:
Fri Jun 14, 2019 10:03 pm
Sequence of return risk during an accumulation phase is just a mathematical exercise, but is irrelevant in real life.
That's demonstrably false; my guess is that you haven't read the OP. If SRR is a risk for retirees, then logically it must be a risk for those in the accumulation phase. The big risk as an accumulator is that you will get good returns early in that phase when you don't have much invested and poor returns late in the accumulation phase when you do.

Consider the following two hypothetical retirees. They both have \$600k in their 60/40 portfolio, contribute \$20k annually, and need an inflation-adjusted \$1 million to meet their retirement goal. One started in 1990 and had reached the \$1 million mark by mid-1995. The other started in 2000 and reached the \$1 million mark in 2012. The one beginning in 2000 had to both keep making contributions and potentially delay retirement for seven more years than the one beginning in 1990.

The bucket approach you refer to as potentially helping reduce SRR in retirement has actually been shown to not be effective; it may actually be counter-productive to reducing SRR.
Still, for most people delaying retirement is easier than cancelling retirement and going back to work.
Yes SRR is significant risk for accumulators, but not nearly as significant as retirees.

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willthrill81
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### Re: Sequence of returns risk while accumulating

klaus14 wrote:
Fri Jun 14, 2019 10:29 pm
willthrill81 wrote:
Fri Jun 14, 2019 10:16 pm
MathIsMyWayr wrote:
Fri Jun 14, 2019 10:03 pm
Sequence of return risk during an accumulation phase is just a mathematical exercise, but is irrelevant in real life.
That's demonstrably false; my guess is that you haven't read the OP. If SRR is a risk for retirees, then logically it must be a risk for those in the accumulation phase. The big risk as an accumulator is that you will get good returns early in that phase when you don't have much invested and poor returns late in the accumulation phase when you do.

Consider the following two hypothetical retirees. They both have \$600k in their 60/40 portfolio, contribute \$20k annually, and need an inflation-adjusted \$1 million to meet their retirement goal. One started in 1990 and had reached the \$1 million mark by mid-1995. The other started in 2000 and reached the \$1 million mark in 2012. The one beginning in 2000 had to both keep making contributions and potentially delay retirement for seven more years than the one beginning in 1990.

The bucket approach you refer to as potentially helping reduce SRR in retirement has actually been shown to not be effective; it may actually be counter-productive to reducing SRR.
Still, for most people delaying retirement is easier than cancelling retirement and going back to work.
Yes SRR is significant risk for accumulators, but not nearly as significant as retirees.
True, but it's a real risk to both. Delaying retirement for seven years, per my example above, could be pretty bad.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

klaus14
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Fri Jun 14, 2019 10:36 pm
True, but it's a real risk to both. Delaying retirement for seven years, per my example above, could be pretty bad.
Yes. we are on the same page here. I think as you get near your retirement age, you should actively try to reduce volatility of overall portfolio. Bond Tent is one method to do that.

MathIsMyWayr
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### Re: Sequence of returns risk while accumulating

willthrill81 wrote:
Fri Jun 14, 2019 10:16 pm
MathIsMyWayr wrote:
Fri Jun 14, 2019 10:03 pm
Sequence of return risk during an accumulation phase is just a mathematical exercise, but is irrelevant in real life.
That's demonstrably false; my guess is that you haven't read the OP. If SRR is a risk for retirees, then logically it must be a risk for those in the accumulation phase. The big risk as an accumulator is that you will get good returns early in that phase when you don't have much invested and poor returns late in the accumulation phase when you do.

Consider the following two hypothetical retirees. They both have \$600k in their 60/40 portfolio, contribute \$20k annually, and need an inflation-adjusted \$1 million to meet their retirement goal. One started in 1990 and had reached the \$1 million mark by mid-1995. The other started in 2000 and reached the \$1 million mark in 2012. The one beginning in 2000 had to both keep making contributions and potentially delay retirement for seven more years than the one beginning in 1990.
I am not questioning the math. Making simple math correct is trivial, but the big question is what the result of the math means to an investor saving for retirement. You cannot choose when to start saving. Math tells one is lucky and the other is not.

Topic Author
willthrill81
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### Re: Sequence of returns risk while accumulating

MathIsMyWayr wrote:
Fri Jun 14, 2019 10:55 pm
willthrill81 wrote:
Fri Jun 14, 2019 10:16 pm
MathIsMyWayr wrote:
Fri Jun 14, 2019 10:03 pm
Sequence of return risk during an accumulation phase is just a mathematical exercise, but is irrelevant in real life.
That's demonstrably false; my guess is that you haven't read the OP. If SRR is a risk for retirees, then logically it must be a risk for those in the accumulation phase. The big risk as an accumulator is that you will get good returns early in that phase when you don't have much invested and poor returns late in the accumulation phase when you do.

Consider the following two hypothetical retirees. They both have \$600k in their 60/40 portfolio, contribute \$20k annually, and need an inflation-adjusted \$1 million to meet their retirement goal. One started in 1990 and had reached the \$1 million mark by mid-1995. The other started in 2000 and reached the \$1 million mark in 2012. The one beginning in 2000 had to both keep making contributions and potentially delay retirement for seven more years than the one beginning in 1990.
I am not questioning the math. Making simple math correct is trivial, but the big question is what the result of the math means to an investor saving for retirement. You cannot choose when to start saving. Math tells one is lucky and the other is not.
Whether one got lucky or the other got the short end of the risk spectrum, the point is that SRR is real for accumulators and retirees.

You cannot choose when to start saving, but it doesn't mean that you are necessarily a passive recipient of SRR. Just like there are steps that can be taken to reduce SRR as a retiree, so there are steps that accumulators can take as well.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

klrjaa
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### Re: Sequence of returns risk while accumulating

@ mathismyway….An interesting and relevant take on path dependency where savings rate changes as this is a much more likely scenario over one's saving lifetime. The ending wealth is massively different. Reducing volatility during accumulation phase is critical. So the answer to your big question is....it's matters a ton https://investresolve.com/blog/sequence ... r-savings/

MathIsMyWayr
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### Re: Sequence of returns risk while accumulating

klrjaa wrote:
Sat Jun 15, 2019 7:19 am
@ mathismyway….An interesting and relevant take on path dependency where savings rate changes as this is a much more likely scenario over one's saving lifetime. The ending wealth is massively different. Reducing volatility during accumulation phase is critical. So the answer to your big question is....it's matters a ton https://investresolve.com/blog/sequence ... r-savings/
SRR takes place because there are two kinds of arithmetic operations involved, multiplications and subtractions during the withdrawal phase, and multiplications and additions during the accumulation phase. Unfortunately multiplication and subtraction (or addition) do not commute with each other. Subtraction is just an addition of the negative of the original number and share the same property as addition. As a quick example, let's consider a two year investment with market gains of -10% and +10%.
• (-10%, +10%): you will have ((1-10%) + 1)*(1+10%)=2.09
• (+10%, -10%): ((1+10%)+1)*(1-10%)=1.89
I meant it is irrelevant besides "to save as much, as often and as long as you can at a proper AA no matter what." "SRR" is the basis of the commonly accepted investment recommendation of choosing gliding path "Reduce risk as you approach the horizon."

An interesting conclusion of the link:
By actively managing portfolio risk and dynamically assembling diversified portfolios of global assets twice per month, our AAA process is engineered to minimize risks associated with sequence of returns.

Topic Author
willthrill81
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### Re: Sequence of returns risk while accumulating

MathIsMyWayr wrote:
Sat Jun 15, 2019 8:07 am
An interesting conclusion of the link:
By actively managing portfolio risk and dynamically assembling diversified portfolios of global assets twice per month, our AAA process is engineered to minimize risks associated with sequence of returns.
Considering what those folks do in their business, their statement fits that very well. But it is obviously not necessary to take on an 'active' approach to investing in order to reduce SRR. You're correct that ramping up one's allocation to fixed income as one approaches retirement is one way to do this, but that can also exacerbate the issue. What if, for instance, stock returns are very good that last decade, but you've reduced your stock allocation to the point that you don't benefit much from them?

Personally, I view the best 'passive' approach to this issue to be planning to reach financial independence well before you plan on actually retiring. For instance, I'm planning on being FI by age 55, but if it takes me another 5-10 years to get there, I'll be alright. If someone is planning on retiring at age 67 and must delay it by another decade, they may be in serious trouble.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings