longinvest wrote: ↑Wed Jul 24, 2019 10:04 am
I like to take a broader view. I think that the magnitude of portfolio withdrawal fluctuations should be considered in context of the size of
total retirement income including Social Security (possibly delayed), pension (if any), and (if necessary)
inflation-indexed SPIA* relative to the retiree's financial
needs for a
comfortable retirement.
*
Single Premium Immediate Annuity.
Note that the baseline, here, isn't a bare-bones retirement but a comfortable one!
Let's pick the example of a retiree who owns her home free and clear who could live comfortably on $80,000 (including taxes and expenses). By comfortable, I mean expenses that include travel and other fun things.
The retiree has just turned 65. She worked from age 25 to 64. Her salary started at $11,532 in 1979 ($40,687 in today's dollars) and gradually increased to $115,560 in 2018 ($117,878 in today's dollars). She has decided to delay Social Security until age 70 to receive $3,334/month (in today's dollars) and has accumulated a $1,500,000 portfolio through investing and inheritance. She has no work pension.
She is used to living below her means and could live on less than $80,000 (including taxes), if it comes to it, but it wouldn't be as comfortable.
With a 60/40 stocks/bonds portfolio, the
VPW Accumulation And Retirement Worksheet tells us that she could withdraw
$105,661 from the portfolio in 2019 (taking into account the future $40,008 annual income from Social Security). A
-50% stocks loss would lower this to
$83,176, still above her comfortable retirement needs.
With a 30/70 stocks/bonds portfolio, she could withdraw
$97,864 from the portfolio in 2019 and a
-50% stocks loss would lower this to
$87,932.
The difference, in 2019, is
($105,661 - $97,864) = $7,797 (including taxes), which could allow for quite some additional fun while she is younger and still healthy. That's 8% more than with a 30/70 stocks/bonds portfolio.
The difference after a
-50% stocks loss would be
($83,176 - $87,932) = -$4,756 (including taxes). That's
-5% less than with a 30/70 stocks/bonds portfolio. As I wrote earlier, it's still within the comfortable retirement zone.
Let's also investigate the
doomsday scenario of a
-75% stocks loss (e.g. two 50% stocks losses). With a 60/40 stocks/bonds portfolio (reduced to $735,000) total retirement income would be
$67,436. With a 30/70 stocks/bonds portfolio (reduced to $1,083,750) total retirement income would be
$79,490. There's no surprise, here. The 30/70 stocks/bonds portfolio is more resilient to doomsday scenarios, yet, the 60/40 stocks/bonds portfolio still delivers sufficient retirement income, even though it's
-15% below full comfort level. Remember that we're in a
Great Depression (1930s) kind of situation, here. The rest of society is suffering.
All assets are risky. Stocks are significantly more volatile than bonds, but bonds have their own risks. A good argument could be made that the
world bond stock portfolio is probably one of the most resilient portfolios in the long term. It currently sits at approximately 57/43 stocks/bonds according to the
Bill Sharpe's preferred portfolio thread. A retiree
could easily prefer this portfolio over one concentrated into the bonds asset class. I personally have a liking for Vanguard's LifeStrategy Moderate Growth Fund (VSMGX) which provides a
good enough approximation of this
stock-and-bond market portfolio with a moderate
home bias.**
**
A moderate home bias is justified for investors, across the world, by the additional frictions of international investing.
Instead of using a 30/70 stocks/bonds portfolio to reduce income fluctuations (if she wanted to reduce them), our retiree could use part of her portfolio to buy an
inflation-indexed SPIA. With a 30/70 stocks/bonds allocation, her $1,500,000 portfolio would have $450,000 allocated to stocks. If she wanted to keep $450,000 in stocks
with a 60/40 stocks/bonds allocation, she could retain a $750,000 portfolio and use the other $750,000 to buy an
inflation-indexed SPIA which should pay her approximately $2,553/month. She would be reducing her liquidity by 50% but significantly increasing he guaranteed lifelong income. Her 2019 income would be
$98,582 and a
-50% stocks loss would reduce this to
$87,340. The a doomsday
-75% stocks loss would result into a
$79,740 income; still comfortable.
One could easily argue that it's more efficient to annuitize and keep a market-like portfolio than adopting an allocation concentrated into bonds. Yet, our retiree could prefer to keep both the additional liquidity and higher income in 2019 with a 60/40 portfolio and wait until age 80 to annuitize part of her portfolio to dampen the financial risk of living beyond age 100.
"
There is more than one road to Dublin." -- Taylor Larimore