Wednesday, February 11, 2015

Negative Sequence of Return - Dollar Cost Averaging works against you during retirement

Understanding that silent portfolio killer: Sequence of return risk - Professional Adviser IFAonline

However, as more people go into drawdown, the real risk lurking in the corner is that most investors (and dare I say advisers) may not pay enough attention to that most silent of portfolio killers: the negative sequence of return.

Advisers and their clients risk being blindsided by this silent danger. Many advisers have adopted cashflow modelling as a guide in making decisions on what would represent a 'safe' withdrawal from
clients' portfolios, but I hate to be the one who breaks it to all the cashflow modelling evangelists out there: the very nature of current cashflow modelling tools used by UK planners means they are far too rudimentary and offer very little beyond time and value of money calculations.

These modelling tools are deterministic, which treat returns as linear (i.e. average annualised returns) and ignore their real-life randomness. This underplays the dangers of negative sequence-of-return,
and risks misleading clients.


Pound-Cost-Ravaging.Final-copy.pdf





The Retirement Killer: Volatility

Alas, there are no risk free 10% returns. Zero risk assets yield about zero real return. In order to get anything over a zero return you must accept some level of risk. But, any volatility in the portfolio
during withdrawals introduces the possibility of portfolio failure. So, you must minimize the risk in the portfolio to its lowest possible level to achieve an acceptable return.

After 30 years of simulation at various risk levels, only 1% of trials fail at 10% Standard Deviation, but 23% fail at a Standard Deviation of 20%. Failure rates soar with the higher volatility!

The Retirement Killer - Volatility Failure Illustration

The simulation reveals a clear link between volatility and survival of the portfolio at any given time horizon. So that anything we can do to reduce portfolio volatility (given the same rate of return and
withdrawal rates) will significantly enhance the chance that a retiree’s nest egg will survive.


the-bca-cab-bac-abc-of-sequencing-risk.pdf

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