Volatility: The Enemy of Long Term Retirement Planning.

October 26, 2017

"Volatility" refers to the propensity of  a stock or index's market growth rate to diverge up or down from its average growth rate over time. Assume for discussion that the SP 500 has an average growth rate of 10% with a standard deviation of 15%.  Standard deviation is a principally a portfolio measurement; it is both added and subtracted from the 10% average return to determine a likely outcome range. In this example, an investor can anticipate performance  ranging in any single year between -5% and +25% at least 2/3  of the time.  Thirty percent of the time performance falls between -20% and +40% or two standard deviations. 


High Volatility gives short term traders the motivation to trade.  However, for late-term investors and income beneficiaries, higher volatility always lowers long-term returns, adds short-term market risk  and amplifies

sequence risk. The higher the standard deviation of the portfolio, the greater the impact.  


This is an important risk area, one that income beneficiaries need to assess, especially when planning for distributions.  Commonly, investors find that conservative fixed income investments alone do not produce adequate interest to fund future needs and, therefor, growth equities are used to boost returns. Often equities comprise a 100% allocation of portfolios requiring distributions for decades. 


Simultaneous with higher equities exposure are the higher returns that have rationalized withdrawal amounts as high 8%/yr in my experience. More often than I can count, I have encountered investors erroneously believing that a portfolio growing at an average 10%/yr will support 6-8% fixed distributions and fees and still grow 2-4% annually.  Unfortunately, the only time this works is with a 10% fixed return, something the market has never given.  Volatility upends this reasoning.


One can spend interest and dividends but not the appreciation locked up in a share of stock; that is the problem with using growth stocks to support distributions.  The only ways to unlock the value are to use margin or sell the shares for a profit or loss. When portfolios  liquidate shares to support distributions those shares are gone permanently.  If liquidations occur during early market dips more shares need to be liquidated throughout the market recovery at a loss to satisfy fixed distributions. Once a portfolio declines 15%-20%, market recovery alone will never restore principal so long as distributions continue. Over time the erosion in shares takes a toll and distributions become unsustainable.


The risks are real but outcomes vary depending on market cycles and active management.  Most important is monitoring your shares and balances.  If you started at age 67 with a $1 million and three years later you have $900,000 remaining after $50K/yr (5%) in annual withdrawals, its time to react.   At $900,000 distributions rise to 5.5%/yr. and to 6.25%/yr if the portfolio declines to $800,000 accelerating depletion.   Conversely, should the portfolio appreciate, it's time to build reserves and restructure your portfolio to preserve those gains. 


 In the extreme cases I've witnessed, Investors were left destitute after between 8 and 12 years of withdrawals, which they expected to last 20+ years and leave an estate.  Markets fell back and by the time the market recovered, these Investors had automatically liquidated over half their portfolio to fund distributions.  It was simply too late to recover and provide distributions.  The markets recovered but their portfolios did not. 


My simplest advice is to stop liquidating your stocks, suspend or substantially reduce distributions to allow recovery to occur.  To that end you should have liquid reserves sufficient to fully fund or supplement reduced distributions for a year or two. And no automatic withdrawal plans! 


















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Frederick W Rosenberg JD


27 Village Green Ct
South Orange, NJ 07079

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