Foreword
This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.
Ben Felix, an actual financial advisor, is out with a video about sequence of returns risk, a topic that we covered somewhat in Monte Carlo.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
Sequence of Returns Risk
To put it simply, sequence of returns risk (or sequencing risk) is the risk that a series of bad market returns during the early years of your retirement can dramatically reduce your future purchasing power by diluting the value of your portfolio before it has a chance to grow, resulting in you having to withdraw “more expensive” money in the short term to meet day to day needs.
While Ben is right that historically, a portfolio of 100% stocks statistically works better, and that the other proposed methods of retirement planning (diversification, bucketing, safe withdrawal rate, etc.) tend to results in worse results (i.e. less money to spend) at least based on historical data, there are some points which I think he did not address:
- If you are planning on leaving an inheritance to your heirs, then having more assets left over at death need not be a bad thing — your heirs just get more in their inheritance.
- There is, arguably, a regime change in the financial markets recently compared to the past ~50 years — interest rates have been steadily coming down since the late 1970s to the early 2020s, but has since then broken the trend and started going up. Perhaps this is a blip and interest rates will resume going down, or they may continue going up — nobody really knows. But a diametrical change in interest rates trends can potentially have dramatic effects on how assets perform going forward.
- For retirement planning purposes, you have to make some assumptions about the future in terms of rates of return, spending needs, etc. Given that for some, retirement can be a semi-permanent thing (especially for tech workers, where the probability that you’ll be hired at a salary anywhere close to what you were making pre-retirement is very low), it makes sense to use more conservative estimates to build headroom for your calculations. After you actually retire, you can choose to adjust up your spending budget if your assumptions prove too conservative.
Note that none of the points above invalidates Ben’s arguments — his arguments are still very sound. But his arguments are based on historical data, and while there’s a good chance the arguments will prove true, there is also a non-negligible chance that, well, some things may change.
Whether you want to hedge that (possibly very small) risk, or are willing to chance it, depends on your tolerance for the risk.
Janky Thoughts 