Sequence of Returns Risk, or, If the Bottom Drops When I Can Least Afford It

Retirements were put on hold back in 2007 when the markets tanked as the housing bubble burst. Worse off were those retirees in the first years of post-employment; their investments were in use but they had little time to continue maturing. What could these investors have done to avoid what had happened to them?

This hazard is called the “sequence of returns risk,” where the order in which investments record annual gains and losses can have a massive effect on accumulated wealth. There exist a couple of practices we can take that can mitigate this risk. Those near-retirees who made the news back then were all but certainly not exercising either of them.

Our choices help shape our financial future. Deciding them can feel like looking into the void for some. For many workers, it’s a source of anxiety, even fear. They often delay making decisions or acting upon them, which are costly mistakes. If thinking through the particulars of asset allocation or if retirement investing as a whole are off-putting, the best move is to make an appointment with a professional investment advisor.

Now for those two practices.

First, adjusting risk asset allocation (stocks) according to age. Younger investors, particularly professionals with a strong likelihood of decades of increasing income ahead of them, can shoulder much financial risk. That means an all-stock allocation at least until the mid-forties because there’s likely more income ahead of them. Older investors have fewer years to recover from market tumbles, so they should be more conservative in their approach.

Some investors accomplish this progression from higher to lower risk by rebalancing their portfolio annually using the one-hundred-minus-my-age rule of thumb, or 110-age, or for the more aggressive, 130-age. That means a 60% stock allocation at age 40 for a cautious investor or a 90% allocation for the more aggressive.

Alternatively, target-date retirement funds are tailor-made for this practice. By picking a fund targeted for a date closest to a prospective retirement date and depositing to it regularly and automatically, an investor can be assured of proper risk allocation according to age. By the time a worker is approaching her prospective retirement date, most of the assets will be bonds and cash-like. These funds are a terrific choice for workers who don’t want to dive into the details of investing.

The particular rule or fund in use is less important than the application itself—the stock allocation shrinks as the investor approaches retirement. Sudden declines in the stock market become less consequential, even as an age when the consequences would be more dire approaches.

Those investors who had to postpone retirement back in 2007 were too deeply into stocks with just a year or two of employment left, often with little or no bond or cash cushion. A bond cushion buffers a loss in stocks because bonds rarely decline much when stocks are falling. They usually appreciate as stock investors bail out and head for safety.

A cash cushion allows a retired investor to ignore stock losses nearly altogether since she can always draw on that cushion for income rather than stock holdings.

Therein lies the second and, perhaps, more critical practice of having a cash-like holding in the portfolio once I’m within five years of leaving full-time employment.

Investment advice is replete with examples of big-name investors who maintain substantial cash reserves. Warren Buffet is one; I’ve read accounts of his holding cash above 30% of Berkshire Hathaway’s assets. Berkshire’s assets aren’t a retirement portfolio, but the principle is the same. Whether the money is in reserve for investment opportunities after a market tumble or is held for income, having it on-hand means never being caught short.

As an example, I rebalanced my retirement portfolio to a much lower stock allocation when market indices, such as the S&P 500, recently came back to near-even for 2020. In the process, I moved a minor portion of the assets into a short-term US Treasury bond fund, which, due to its duration, acts much like a money market fund. By my post-retirement calculations, it now holds about two years-worth of needed investment income. I’ll carry that allocation into retirement in a few years.

Should the market stall and decline in my last year of work, I can keep my exit date. Should the market decline in the following few years, it’s safe to continue drawing from my portfolio. I have only to switch the source from stocks to cash-like funds in either case.

There are significant inherent risks to relying on the public markets rather than a pension for retirement income. Those risks can be effectively managed with a bit of reading and careful thought, or a relationship with an investment advisor. The resulting peace of mind is also a valuable asset.

Rechecking My Investment Strategy

I’ve made a few investment mistakes in my life that were only revealed when the market took a tumble. It’s arguably time to look back and assess what effect past lessons learned had this time around—arguable because I don’t believe we’re near the end of the current market turmoil.

Our portfolio has always been centered on index funds. Still, I began investing outside my original strategy during the dot-com boom. The old saying about everyone being a genius in a bull market is correct. It was hard not to do well in the nineties, but the real test of investment wisdom came when the bottom fell out.

All at once, institutional investors figured out that companies with no bottom line didn’t make for suitable long-term investments. They bailed out of these stocks, and amateur stock-pickers got slaughtered. I learned then about the value of broad diversification; some equity sectors did better than others, and bonds held value or appreciated as investors fled to safety and stability.

These individual stocks were a minority of our portfolio, but the losses were painful. We moved what remained of our tech stock holdings into a couple of managed equity funds and left stock-picking behind.

Eight years later, the realization of what was about to happen led me to mild panic and a rebalancing out of the bulk of our equity holdings, just before the housing bust occurred. The conventional wisdom holds that timing the market is a losing proposition. I was lucky to get out when I did, but even more lucky getting back in at nearly the right time. Even so, I missed the first 30% of the recovery.

I easily could have waited out the recovery on the sideline, though, unwilling to re-take the risk that I’d successfully unloaded. How much wealth gain would I have missed then? That’s the trouble with timing—it’s a two-step process, and you have to get them both right. Luck shouldn’t be a deciding factor in successful investing.

I learned that jumping out too early or getting back in too late could have undone the good work of a well-diversified portfolio. I realized that I’m in the market for a reason and that I set an allocation for a reason. Either those reasons are valid, and I should stick with my strategy, or they’re invalid, and I should try something else. Jumping back and forth only adds risk.

I incorporated what I learned each time, so when the recent sharp decline hit, I remained convinced we’d keep the portfolio intact, come what may. I kept a fairly aggressive 75%-stock allocation in place until just this past week.

We suffered a decline over the last quarter, but nowhere near the drop in the broader market. Our diversified bond buffer worked as intended.

I’ve been in the habit of periodically rebalancing our portfolio to the allocations I’d set for it as it drifts out-of-balance over time. I stepped up that practice to once per month as market values eroded, essentially buying into now-cheaper equity shares with bond shares that were holding their value. Doing so helped, but not to a great extent. This was a very short period to test rebalancing theory, so I’ll continue the practice regardless.

So what did I learn throughout this turmoil? Nothing is exciting about holding investments that don’t move much when the stock market is on an upward tear. Still, they pay their way by reducing portfolio volatility and providing resources to purchase beaten-down shares when the market comes tumbling down. There’s always a tumble looming. The jury is still out on increased rebalancing.

In short, staying the course has profited me. The V-shaped bounce back up in equity prices helped exemplify all of this quicker than I expected—most recessions take longer for the markets to clear. This one is unusual in our lifetimes. Lately, most significant declines are so.

The Future

If I knew what the next year or so holds for the pandemic, or the stock market, or life in general, I wouldn’t be writing about it. It’s the uncertainty that’s intriguing. A few things seem clear, and I’ll prognosticate beyond.

Some US states are showing a sharp uptick in COVID-19 cases since the grand re-opening. It’s almost as if the virus is making us all suckers. This raises the specter of a re-closing before the fall flu season.

The travel, hospitality, and restaurant industries are all going to suffer significant job losses soon, regardless. Many re-opened businesses will not survive. Restaurants only succeed with packed houses. Ditto bars. Airlines make money only when their seats are near-full. Hotels are much the same. Many of these businesses report low demand. How many will remain past the fall of 2021? Fewer, I think.

I believe we’ll see a significant re-testing of the lows in the US stock market as a result, so I’ve recently re-allocated our portfolio to 50%-stock. That’s relatively conservative for me, but I feel a more defensive posture is the right way to face what comes next.

I’ll continue rebalancing monthly, regardless. That practice has proven its worth. Some caveats to that are the cost of rebalancing—trading commissions and fees, and mutual fund restrictions on frequent trading.

When the day comes that we have a COVID-19 vaccine, I’ll go back to a higher stock allocation. Recall that the past decade’s run-up was predicated on Fed intervention in the markets after the housing bust. The same type of response, only much higher in degree, is going on right now. Imagine how that will spur the market down the road.

In Parting

Nothing I write should drive your investment decisions. This is an effort to organize my thoughts and consider next steps. Do your own homework. Investing can be a rewarding duty, but only through education and discipline. If that’s not your cup of tea, finding a professional investment advisor is a smart move.

George Floyd’s Autopsy and the Structural Gaslighting of America

I wondered how George Floyd’s privately contracted autopsy finding could differ so completely from the initial public autopsy result. Turns out, it didn’t. We’d been gaslighted by the Minneapolis Police Department:

On May 29, the country was told that the autopsy of George Floyd “revealed no physical findings that support a diagnosis of traumatic asphyxiation,” and that “potential intoxicants” and preexisting cardiovascular disease “likely contributed to his death.” This requires clarification. Importantly, these commonly quoted phrases did not come from a physician, but were taken from a charging document that utilized politicized interpretations of medical information. As doctors, we wish to highlight for the public that this framing of the circumstances surrounding Floyd’s death was at best, a misinterpretation, and at worst, a deliberate obfuscation.

(Ann Crawford-Roberts, Sonya Shadravan, Jennifer Tsai, Nicolás E. Barceló, Allie Gips, Michael Mensah, Nichole Roxas, Alina Kung, Anna Darby, Naya Misa, Isabella Morton, Alice Shen writing in Scientific American.)

The truth, as usual, followed later:

By Monday, June 1, in the context of widespread political pressure, the public received two reports: the preliminary autopsy report commissioned by Floyd’s family by private doctors, and—shortly thereafter—a summary of the preliminary autopsy from the Hennepin County Medical Examiner’s Office. Both reports stated that the cause of Floyd’s death was homicide: death at the hands of another.

As the authors further explain, such dishonesty is often used to cover for the crimes and misdeeds of racist police officers. This is the sort of officially sanctioned practice that must be eradicated.

Racism under color of public safety is systemic racism.

#GeorgeFloyd #autopsy

Applebaum: History Will Judge the Complicit

I’ve struggled for three years to understand the people who continue supporting Donald Trump despite ample reason not to.

Thoughtful conservative politics I get—though I’d like to see more of their high-mindedness directed at what to do about intractable social problems rather than what not to do. The plight of left-behind communities stranded without industry I understand—though it’s a harsh irony that these often-white communities are able to drive the election of a naked populist with their multi-decade grievance while black communities continue struggling despite their multi-century grievance. But anti-intellectualism, rejection of long-standing American institutions, and ignorance of the rule of law I do not understand. Each of these delusions is necessary to maintaining support for this man.

Anne Applebaum has authored a masterful assessment of the go-along sentiments driving Trump’s enablers. I highly recommend taking the time to read it.

I don’t know what the future brings for America. Understanding what brought us Trump and why many continue to support him is a first step at figuring that out.

Lowrey: Defund the Police. Um…

Annie Lowrey, writing for The Atlantic:

America badly needs to rethink its priorities for the whole criminal-justice system, with Floyd’s death drawing urgent, national attention to the necessity for police reform. Activists, civil-rights organizations, academics, policy analysts, and politicians have drawn up a sprawling slate of policies that might help end police brutality, eliminate racist policing, improve trust between cops and the communities they work in, and lower crime levels.

A more radical option, one scrawled on cardboard signs and tagged on buildings and flooding social media, is to defund the cops.

Lowrey’s discussion of defunding police forces isn’t a call for dissolving them, but rather divesting them of the activities that lead to over-policing, over-incarceration, and the deaths of innocents. Defunding is not the way to go; the other options already on the table, also mentioned, are. We should do all of those things.

The rest of the article embodies an unflattering comparison of America’s priorities to those in our similarly-situated allies. Our culture, as exemplified by where we spend our money, is out of whack. The good news is that we can repair it.

#policing #criminalJustice #incarceration

The Final Word

A friend passed along a simple recipe composed of four ingredients last week. I shook a couple over the weekend and found another keeper for my cocktails shortlist.

The drink is The Final Word, based on gin and incorporating a new ingredient for me, green Chartreuse. I’m no stranger to gin cocktails; it’s become my favorite base spirit. It helps that gin goes with darn near everything, but it’s also refreshing on the palate, making it the base of many warm-weather pleasers.

IMG 3082

A sip of green Chartreuse puts me in the mind of absinthe, not only for its vivid color but also for its complexity of flavor.

 This liqueur is made by aging over a hundred herbs, plants, and flowers in neutral spirit, then bottled at a sturdy 110-proof. Where absinthe is light on the palate, Chartreuse is heavy, but not cloyingly so.

According to its Wikipedia entry, Chartreuse is one of the few liqueurs that continue aging in the bottle, which is good because I’ll probably have this one around for a while.

The recipe is simple: equal parts London Dry gin—a juniper-forward spirit works best—plus green Chartreuse, maraschino liqueur, and fresh lime juice. Shake with large cubes and double-strain into a chilled glass. Double-straining removes small ice shards from the finished cocktail. A chilled glass, well, that looks pretty and keeps your drink as cold as possible for as long as possible.

I recommend The Final Word to anyone who enjoys gin-based cocktails, herbal concoctions, and anise.

#cocktails #ginDrinks #theFinalWord

The Market is Not Our Friend

In stock market news today:

Screen Shot 2020 05 18 at 11 50 29 AM

The market cares not about people. It is not our friend.

The market is an organic expression of investor sentiment about the future useful for growing wealth. People angered by its apparent disregard of the suffering underlying its gyrations misunderstand this essential fact.

#COVID19 #pandemic #unemployment

Fallows: Flying Will Never Be the Same

James Fallows, writing on what the future of air travel might look like for The Atlantic:

Check-in and security. Anyone who has traveled through China in the 15-plus years since the SARS outbreak is familiar with the large temperature-check gates that inbound and outbound passengers must walk through. Some of them look like bigger versions of the metal-detector gates that are standard-issue in many U.S. buildings. … The gates alert quarantine officers to the presence of anyone who seems to have a fever, enabling individual follow-up examination by thermometer. Virtually no U.S. airports ran passengers through such equipment a year ago, and virtually all of them are likely to do so a year from now.

Our awareness of one another and the germ dangers posed in public spaces has become more acute lately. We should expect public health safety efforts to reach beyond anti-terror measures after 9/11 as more people emerge from self-quarantine into public living.

Imagine, though, the don’t-tread-on-me crowd facing such a portal before a flight. They can’t be troubled or imposed upon to wear a mask for our common good today. Such masks are common in Asian countries where the SARS epidemic killed over 750 patients among 8,000 cases, paling in comparison to COVID-19’s numbers. A fringe of Americans have almost always put their individual liberties ahead of the greater good—contradictions such as world war and natural disaster are the exception for them, not the rule. The future will be a tough place for these folks’ sensibilities.

The Broader Perspective

Of greater concern is the long-term expansion of the underclass. While many small business owners—the largest employment segment—are clamoring to resume operations, my hunch is that we’ll see little increased demand for their products and services until there exists a vaccine. The longer we remain at home the more we learn to make-do without them. Large employers, such as the airlines, will be hard-pressed to employ anything like their current government-supported payrolls. In short, unemployment is going to be a major problem in the American economy throughout 2021 and into 2022, at least.

There will be an ugly recognition on Wall Street when institutional investors give in to this reality. A spike in COVID-19 cases in this areas “re-opening” should trigger it.

The COVID-19 pandemic has given wise business executives an opportunity to clean-sheet redesign their businesses from the ground up. Everything from who and how many they employ to how they operate should be re-considered.

Think on this: What will you, as a consumer, do without down the road now that you’ve successfully suffered it the last couple of months? How does it change our economy and culture if millions share your sentiments?

#COVID19 #publicHealth #airTravel #employment

The Sucker Factor

The trouble with associating a political agenda with a disease possessing a two week incubation time is that, by the time any so-motivated activity yields evidence of error, that error amounts to tragedy.

Looking on the bright side, we’ll get a good read on the agenda vs. relative intellect—aka the sucker factor—in two weeks.

Crashing Markets and the Urge to Do Something

Markets declined at a historic pace last month. Did you look at the rapid decline in your investments—your means of retirement subsistence—and feel a flutter of panic? Confidence and contentment are natural when markets are advancing; not so much as paper losses mount.

Financial experts tell us to remain calm and stay the course when that happens. The arrangements we’ve made, they say, are as prudent and useful in bad times as good. Splitting up investments across multiple asset classes, company sizes, and tax efficiencies is a smart practice. As has been noted elsewhere, a broad allocation can feel like running uphill with a weighted vest on, but it sure feels good in a downhill slide.

Still, we are, in the quiet of our thoughts, alone and prone to second-guessing the choices we’ve made, or might fail to make. What if the markets, having surged back this far, are about to take another significant fall? Should I step off the roller coaster here, closer to the peak?

At the same time, doing nothing feels like a choice, too, and not a particularly good one. I’m a smart investor—or a lucky one, at least—I should be doing something now.

Such thoughts have been the downfall of many investors. Those exiting their investments after declines and remaining out for fear of losing more lock in their losses as markets move higher.

I could rest easy if I invested in a target-date fund whose primary feature is set-it-and-forget-it. Professional management keeps the fund’s internal allocation appropriately balanced for the target retirement date regardless of market conditions. I have only to restrain myself from bolting the market altogether.

I have more on my mind if, on the other hand, I’ve decided to self-allocate my investments across asset classes.

Here’s a handy bit of make-work to occupy myself with something beneficial while markets remain in turmoil: Rebalancing my allocation back to what I’d previously set. If I’m not in the habit of periodically doing this, now’s a great time to begin.

If I had set, say, a 75-percent stock, 25-percent bond allocation, and further, split the stock assets evenly between large-cap and mid/small-cap, and split my bonds between the Aggregate index and a junk bond fund, that allocation is all over the place today. Stocks are down but large-caps not so much. Bonds fell at the outset of the plunge, but investment-grade issues have rebounded. The various valuations probably don’t reflect the care I once took.

Here’s where a spreadsheet or an investment company’s allocation tool comes in handy. My 25-percent bond allocation could amount to well over 30% of my portfolio today. I’ll take a look at my allocation values using current balances and shuffle money back and forth to bring each back in line. And I’ll have purchased additional stock fund shares at discount prices that’ll appreciate well as markets recover.

This activity isn’t only make-work, however. As has been noted elsewhere, periodic rebalancing leads to better overall investment performance. My frequency of rebalancing is mostly a function of how much attention I’m willing to give it and how much it’ll cost to execute the trades. Sales within a tax-advantaged retirement account are, of course, without capital gains taxation, so causing taxable events isn’t a consideration. Investment companies generally don’t charge for transfers among funds, though they may restrict re-investment after transferring out of some of them. Many brokers are charging nothing for trading now, so even rebalancing among individual stock shares might be without cost.

Take a quiet afternoon to look through the links above and research how your investment company handles asset transfers. You might be surprised at how easy and cost-free the practice of rebalancing is, and how satisfied having done something beneficial for your financial prospects leaves you.

#retirementInvesting #rebalancing #markets #stocks #bonds