Does Sequence of Returns Invalidate Modern Portfolio Theory?

[Justin Bilyj]

Retirement rules of thumb like the 4% rule are at odds with other opinions saying the theory doesn't take into consideration stock price fluctuations. If you have a bad sequence of returns in the beginning years of retirement, your portfolio is $%@#$@#.
I have heard some say, "just lower the withdrawal rate to 2-3%" and that will pass the montel carlo simulations, but is there a better way to structure retirement plans? I have heard of tactical asset allocation, I know Jason Wenk is a huge proponent of that theory and has a running blog on his experiences with that theory.
Can anyone comment on a good withdrawal rate or their opinion on sequence of returns?

Just looking to drum up a good conversation about retirement planning and how to prepare for market risk in retirement years.

 

[beachbum2012]

Remember, the 4% rule is based on the research of William Bengen's Safemax where he looked at 30-year periods from 1925 onward having a 50/50 stock/bond asset allocation. Looking at various 30-year periods he saw that even in the worst performing 30-year period, a retiree could still withdraw 4% inflation-adjusted each year and still not run out of money in this 30-year period.

Some ways to mitigate sequence of returns risk is to be flexible in withdrawal amounts, rather than a set 4% inflation adjusted. If the portfolio ever drops below certain thresholds in retirement, then you can lower the % withdrawn that year. That way, you can withdraw less in years where the market is down. Another way is to take some of the portfolio out of the market and put it in fixed or indexed annuities. They can be immediate or deferred. A 3rd way is to do what you talked about in your other post, and that is to spend down the nest egg in order to delay the SS income claiming age as long as possible, which increases your guaranteed income on an inflation-adjusted basis for the life both you and your lower-earning spouse.

 

[Justin Bilyj]

But he only went back to 1930, and the market is way different now....

 

[beachbum2012]

Yep, I agree, it is very different now; not only market volatility but ridiculously low interest rates and bond yields too. Google "Wade Pfau" and "4%" rule or "Safemax", etc. He's done a lot of research on including these other newer variables into the mix like how do these non-existent bond yields affect things, or how would the 4% rule apply to say 20th century Japan, or what is the safe withdrawal rate for someone who retired in 2000, etc.

My biggest problem with the 4% rule is that it's assuming the investor is going to participate 1:1 with market gains. However, most mutual funds under-perform their benchmark as does the average investor return. So where a 50/50 mix of SPYders and intermediate U.S. gov't bonds might give you a safe 4% withdrawal rate over a 30-year period, that rate might be far too high if a broker/dealer puts that same retiree in sub-par investments.