November 13, 2017: Is This A Good Time For Retirees Or Would Be Retirees?

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, December 18, 2017. You can also find the re-balance calendar for 2017 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Is This A Good Time For Retirees Or Would Be Retirees?

With stock markets making new record highs month after month, investors are in a good mood. Naturally, if you ask anyone who is in stock markets and going to retire soon, you probably will get a positive answer. After all, what’s not to like to see your account value gone up so much?

However, if history is any guide, for those we are retiring in or near a stock market peak, it turns out that the time from now on is awful, to say the least.

Empirical data

Retirees or would be retirees who derive income from their investments encounter two problems when markets are near a peak:

Markets might soon go into a bear market or a deep correction that can wipe out 30% to 50% of the wealth. Unfortunately, in a market low, retirees have to continue to withdraw funds from their already shrunk accounts, making it harder to recoup the loss later. Basically, withdrawing from a portfolio at a low level and then grow it vs. withdrawing from a portfolio at a high level and growing this portfolio and, at a later time to encounter a correction can have two very different outcomes. See the live portfolios below.
What’s more, retirees often base on the current value/wealth at a market peak to plan their spending in the future. Such a spending will no doubt have even bigger effect on a portfolio.

We have published some newsletters on this subject before: for example, July 8, 2013: When To Retire And Bear Market Impact On Retirement Income And Spending. In fact, we have continued to monitor those portfolios discussed in that newsletter. Here is a quick recap on the letter:

We use a modified popular 4% withdrawal rule for retirement spending:
Floor and Ceiling Retirement Strategy with 4 Percent Fixed Percentage is one of variable withdrawal strategies in order to maximize withdrawals while at the same time incorporating some provision to reduce withdrawals.

The withdrawal amount is calculated as a percentage of the portfolio total value. The withdrawal amount is allowed to rise or fall with the performance of the portfolio. However, the withdrawal will neither fall below a floor nor rise above a ceiling.

As an example, the initial floor can be set at 3.6% and rise with inflation. And the initial ceiling can be set at 5% and rise with inflation. The withdrawal amount can be set initially at a fixed percentage like 4%. On a $1,000,000 portfolio, the withdrawal will not fall below an inflation-adjusted amount of $36,000. Nor will the withdrawal rise above an inflation-adjusted amount of $50,000.
We then created portfolios that simulate the above withdrawal strategy, assuming their start date as 1/3/2001. Thus, investors continue to withdraw money (at a year end for their annual spending) based on the above strategy. Notice that the portfolios began with $1m dollars initially invested on 1/3/2001. The start date just happened to be near the peak right before the tech bubble induced bear market — to be precise, the peak was in July 2001, so 1/3/2001 was a bit early. By the time to 1/2001, S&P 500 has lost about 10%. So these portfolios actually started in a better situation.

The latest portfolios (as of 12/31/2016)

Portfolio Name	Value (as of 12/31/2016)	Latest Withdraw (as of 12/31/2016)	Total Spent (as of 12/31/2016)
P Floor and Ceiling 4 Percent On Vanguard 500 Equity VFINX	823,526	53,826	755,441
P Floor and Ceiling 4 Percent On VBINX Moderate Portfolio	1,182,742	53,826	755,958
P Floor and Ceiling 4 Percent On Six Core Asset TAA Moderate Portfolio	2,295,725	74,759	1,106,203

Observations:

At the end of 2016, the portfolio that only buys and holds S&P 500 (VFINX) has the least value: $823k vs. $2.2 million dollars of the portfolio that employs Tactical Asset Allocation (TAA) portfolio Six Core Asset ETFs Tactical Asset Allocation Moderate.
Furthermore, even compared with the buy-and-hold moderate portfolio represented by Vanguard balanced index fund VBINX, the tactical portfolio has more than doubled the value.
The full stock/equity S&P 500 investment has still not recouped back the initial $1 million principal (after subtracting spendings over times). On the other hand, the other two portfolios have increased their value over the initial value.
In terms of spending, the TAA portfolio investor has enjoyed much higher spending: accumulated spending $1 million vs. $755k of the other two over the years. The living standard is much higher too: $74k a year vs. 53k a year.

Even if we look at the 10 year relative values since 11/6/2007, the tactical portfolio has done better (assumed all started as 10,000 10 years ago):

This is because the 10 year period starts in the middle of the 2008-2009 bear market which made a real low in March 2009.

The reason that the tactical portfolio can preserve and grow better is because of its avoidance of deep loss in both 2000-2003 and then 2008-2009. In fact, for two portfolios that could have the same 10 year growth without any spending/withdrawing, they can fare very differently when regular spending/withdrawing is carried out. For those who needs to withdraw from a portfolio to spend, an interim deep loss can turn out to be a more prolonged loss that makes a big difference on their living standard (withdrawal amount) and terminal portfolio value (wealth).

To summarize, for a retiree or soon to retire investor, retiring close to a market peak is detrimental to your financial health. This is especially true for those who only rely on strategic asset allocation portfolios, which have been the most popular method lately. In fact, among all of the major Robo advisors such as Betterment, Wealthfront and FutureAdvisor, MyPlanIQ is the only one that advocates employing both tactical and strategic portfolios. We suspect that when the next bear market comes, it will fully show the advantage of our approach.

Current environment

Of course, one may wonder or think that the current bull market still has some leg to go up, given the strong strength stocks have exhibited. As stated before, we have no crystal ball to predict when the markets will finally crater. However, as pointed out numerous times, there are two key points that make us cautious:

The current bull market has been going on since March 2009, about 9.5 years now. Based on Mackenzie, since 1956, the average bull market lasts about 46 months (or about 4 years). But if we expand the horizon from 1926, the average bull market length is about 9 years. Nevertheless, this bull market is the second longest one since 1926.
The valuation of stocks are historically high. In fact, based on Dr. Hussman, current median price/revenue for S&P 500 components is the highest since 1986. Using Shiller CAPE or Buffett’s Total Market Value/GNP (some modified version), he estimates that S&P 500 total return will be negative in the following 10-12 years. This situation is similar to year 2000 or year 2007, only worse. Remember, it took more than 12 years (from 7/2000 peak to 1/2013) for S&P 500 index to get back to its peak in 2000.

Even though it’s likely that stocks might still have 10% or 20% or even 50% to go up, we should be reminded that right now, it’s actually a BAD time to retire.

What to do

An obvious way to counter this is to delay your retirement. Just like retiring near a market peak is bad, the best time to retire is when markets are low!

Regardless, for retirees and soon to retire investors, it’s paramount to manage risk exposure right now. As we always stated in our newsletter, this is not a good time to be over exposed to risk assets such as stocks and real estates (invest trusts).

However, recognizing our deficit of being able to time the stock markets, we don’t simply say one should completely avoid stocks. In fact, the best way is to adopt an active strategy such as MyPlanIQ’s Tactical Asset Allocation(TAA) or a hybrid/blended approach: invest in both TAA and Strategic Asset Allocation (SAA) portfolios. The key here is to be able to preserve capital when a bear market hits while still deriving inflation beating returns.

Market Overview

Last week, stocks retreated a little, still near their record highs. S&P 500 companies have done fairly well in their Q3 earnings report: blended 6.1% growth vs. the originally expected 3.1%. However, the obvious weakness in high yield bonds has been very alarming: the SPDR high yield bond index ETF JNK has fallen below its 200 days moving average.

Of course, the weakness might be attributed to things related to tax reform bills or any other reasons. Nevertheless, in the current highly overvalued environment, a deep correction can happen fast. Again, by no means we are predicting, but being aware of the current situation and managing risk accordingly is the right approach. Stay the course.

For more detailed asset trend scores, please refer to 360° Market Overview.

Now that the Trump administration has been in the office for more than half a year, it has stumbled and encountered many difficulties to implement its promised changes in terms of tax cuts, job stimulation and infrastructure spending. On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in.

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.