Chasing Returns Is Particularly Dangerous for Retirees
Generally, investors tend to increase stock allocations near a market peak and then panic and decrease allocations after a market drop. Vanguard has estimated that the behavioral coaching provided by financial advisors to help their retirees stick with a financial plan could add 1.5% of additional returns for an investor per year on average over time.
Even after advisory fees, the net return earned by the investor could be higher than otherwise. In this regard, sustainable spending numbers derived from an analysis that assumes an investor always stays the course and rebalances regularly to their aggressive asset allocation throughout retirement may be far from reality for most retirees.
What happens to sustainable spending if retirees change their asset allocation at inopportune times? That is, what if retirees increase their stock allocation to chase returns after valuations have risen and then become fearful and lower their stock allocation after valuations have already fallen? Retirees could take any number of arbitrary actions in this regard.
These hypotheticals are much easier to understand with numbers attached to them, so I created an example of an asset allocation strategy in which a retiree maintains a 50% stock allocation when Shiller’s PE10 is between 2/3 and 4/3 of its historical median up to that point in time.
When values exceed the 4/3 threshold, the recent market gains embolden the retiree to increase her stock allocation to 75%. When market valuations drop to less than 2/3 of historical numbers, she panics and switches to a 0% stock allocation. When market valuations return to the middle range, she switches back to a 50% stock allocation.
Testing this on Robert Shiller’s historical data since 1871, this strategy typically lowers sustainable withdrawal rates compared to a fixed 50/50 allocation. For this data set, the fixed 50% stock allocation supported a SAFEMAX of 3.95%. The SAFEMAX fell to 3.06% with the behaviorally driven asset allocation strategy. There were twenty-nine starting years in which the sustainable spending rate fell below 4%. Exhibit 1 provides these historical spending rates.
Maximum Sustainable Withdrawal Rates,
50% Stock Allocation and Market Mistiming Asset Allocation, 30-Year Retirement
Retirement Researcher 2017
Maximum Sustainable Withdrawal Rates
Retirees clearly would have been harmed historically by having their emotions lead them to deviate from their strategic asset allocation. This is an important consideration, because to the extent that individuals do not successfully stick with an asset allocation over time, the hypothetical retiree used to derive the 4% rule is irrelevant to real individual outcomes.
To the extent that advisors can help retirees better approach the ideal outcomes for the hypothetical retiree used in safe withdrawal rate studies, the discussion of portfolio performance falling below a benchmark return should generally not be interpreted as an impact of advisory fees. Without the better outcomes supported by advisory fees, retirees may be left in an even worse position.