Author Topic: What if your portfolio extremely exceeded your expectations?  (Read 1654 times)

heybro

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What if your portfolio extremely exceeded your expectations?
« on: January 21, 2020, 03:38:19 AM »
You've got a rough idea of what your returns should be like.  You may have run simulations to determine probable highs and lows.  You've considered various return scenarios and you've been careful to withdrawal no more than 4%.

What if the stock market completely over-delivered beyond your expectations?  Is there a certain dollar amount that would cause you to switch everything in to cash (or a majority in to cash) and say "you've definitely won the game."  Or, would the fear of inflation still make you keep it in stocks.

Or, would you simply just adjust your asset allocation a little bit more to cash.

Or, would you simply stick to your original asset allocation plan?

habanero

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #1 on: January 21, 2020, 04:55:46 AM »
In most developed markets (US, EUR, GBP etc) you can by inflation-linked long-dated government bonds which effectively will shield you from inflation if you are certain the notional value is more than large enough that you don't really need any real returns for the rest of your life.

30y (or 29y remaining) US Inflation-protected bond currently has a real yield of ~0,45%. The mechanics of these bonds is that the principal increases with inflation and then pay some coupon (which given the increased notional increases with inflation).
« Last Edit: January 21, 2020, 05:09:37 AM by habaneroNorway »

jeroly

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #2 on: January 21, 2020, 05:15:10 AM »
In most developed markets (US, EUR, GBP etc) you can by inflation-linked long-dated government bonds which effectively will shield you from inflation if you are certain the notional value is more than large enough that you don't really need any real returns for the rest of your life.
+1.

With the excess capital above whatís needed to fund future expenses (i.e., future life expectancy in years x annual post-FIRE expenses + end-of-life needs such as healthcare or required minimum estate value) you can get very aggressive with your investments in an attempt to maximize your legacy.

Example: 
You need $50k/year in FIRE.
You are 40.
You want to plan for living until 100. 
You expect end-of-life healthcare costs of $300k.
You want to leave at least $1,000,000 to each of your two children.
If you have more than 60x50,000+300,000+2,000,000=$5,300,000 you can put that all in TIPs and put whatever is left over into tech, Bitcoin, private equity, or whatever you want to gamble on... or just keep it in TSM funds.

habanero

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #3 on: January 21, 2020, 05:24:00 AM »
The mentioned 29y TIPS (Treasury Inflation-Protected Security) pays a coupon of 0,5% semiannually so 1% annually. However, given what you have to pay for the bond to your broker you end up with a real yield of ~0,45% annually.

So to live off a large enough stash with no equity market risk or inflation risk, TIPS is the weapon of choice, not cash and not regular government bonds (which will tank if inflation skyrockets)

Retire-Canada

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #4 on: January 21, 2020, 06:50:54 AM »
Or, would you simply just adjust your asset allocation a little bit more to cash.

Or, would you simply stick to your original asset allocation plan?

Say my portfolio started at $1M with a $40K annual withdrawal and after 5 years it was $2M after accounting for inflation...I would take a portion of those gains...say $500K out and do something "safer" with it. I'm not trying to get as rich as possible, but I'm not going to buy $2M of gold and bury it in the yard either.

nereo

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #5 on: January 21, 2020, 07:18:43 AM »
Two points:
1) a good Investor Policy Statement (IPS) will consider what to do with excessive gains during retirement, as this scenario is quite common for people who bother to extensively plan their finances.

2) One should not increase their spending simply because their portfolio has [momentarily] gone up (a version of the hedonistic treadmill).  Using the '4% rule' one takes 4% of their *starting* portfolio balance, adjusted for inflation - not 4% of what they currently have.  This allows for the ups and downs of the market.

...but to echo the other posters, if my portfolio  grew substantially larger I would put some of the excess into a bond ladder, following guidelines outlined in IPS. Playing defense to some degree is smart after you have "won the game"

habanero

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #6 on: January 21, 2020, 07:36:49 AM »

Using the '4% rule' one takes 4% of their *starting* portfolio balance, adjusted for inflation - not 4% of what they currently have.  This allows for the ups and downs of the market.

This doesn't really make sense. That's the same as saying someone who has higher annual spending cannot use the 4% rule if they reach their higher number through market gains. The rule has to hold for any portfolio balance at any point in time regardless of how that balance got to where it is, otherwise it isn't a rule as is interpreted.

If market goes up big time, the retired has increased the probability of success if spending is kept constant. He can increase spending, but probability of success will go down to where it was earlier.
« Last Edit: January 21, 2020, 07:45:16 AM by habaneroNorway »

reeshau

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #7 on: January 21, 2020, 08:21:43 AM »

Using the '4% rule' one takes 4% of their *starting* portfolio balance, adjusted for inflation - not 4% of what they currently have.  This allows for the ups and downs of the market.

This doesn't really make sense. That's the same as saying someone who has higher annual spending cannot use the 4% rule if they reach their higher number through market gains. The rule has to hold for any portfolio balance at any point in time regardless of how that balance got to where it is, otherwise it isn't a rule as is interpreted.

If market goes up big time, the retired has increased the probability of success if spending is kept constant. He can increase spending, but probability of success will go down to where it was earlier.

@nereo  is correct in explaining the 4% rule as stated by William Bengen.  If your portfolio goes up, that is in essence insurance against a sudden drop--it will not impact your withdrawals.  By his (very simplistic) simulation, you keep calm and carry on.

@habaneroNorway is also right:  you can do whatever you want.  But, don't rely on Bengen's rule (or the subsequent Trinity Study) for comfort--you are out on your own, and now have your own behavioral model to figure out.  Being specific, increasing your withdrawal rate to 4% of a higher amount of wealth is indeed starting over:  so, you have signed up again for sequence of returns risk in your first years.  (assuming the increase is much more than inflation)  I think most people would not want to subject themselves to this voluntarily a second time.

The other aspect is what do you do if the account goes up *again*?  Someone in this case in the last decade may have taken several steps up, and be at significant risk if the next decade under performs averages in reversion to the mean.


nereo

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #8 on: January 21, 2020, 09:42:17 AM »

Using the '4% rule' one takes 4% of their *starting* portfolio balance, adjusted for inflation - not 4% of what they currently have.  This allows for the ups and downs of the market.

This doesn't really make sense. That's the same as saying someone who has higher annual spending cannot use the 4% rule if they reach their higher number through market gains. The rule has to hold for any portfolio balance at any point in time regardless of how that balance got to where it is, otherwise it isn't a rule as is interpreted.

If market goes up big time, the retired has increased the probability of success if spending is kept constant. He can increase spending, but probability of success will go down to where it was earlier.

As reeshau explained, I am using the "4% rule" (note the quotation marks) as outlined in the trinity study and used extensively as a starting point on this forum adn elsewhere (including the defaults of many popular calculators like FireSIM and cFireCalc).  If you increase your WR every time your portfolio goes up you will experience more failures unless you decrease it whenever it goes down. 

Speaking of which, this strategy (and what you seem to be describing) is a typically called a Variable Withdraw Rate (VWR) and mathematically cannot ever fail. However, it has the 'weakness' that a retiree will not know how much money is available to him or her in future years, which makes financial planning difficult and is more stressful for many.


BECABECA

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #9 on: January 21, 2020, 11:25:54 AM »
Thereís no dollar amount that will make me switch all to cash. I am trying to maximize my end of life dollar amount for legacy charitable donations, so I will just keep my same asset allocation to achieve that. But I will increase my annual donations if my stash is still outperforming after the first 5 years of retirement (past the biggest SORR worry years).

PDXTabs

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #10 on: January 21, 2020, 11:28:33 AM »
What if the stock market completely over-delivered beyond your expectations?

I would probably buy more flats in European cities that I love (to one day be willed to my children).

habanero

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #11 on: January 21, 2020, 11:47:27 AM »
If you increase your WR every time your portfolio goes up you will experience more failures unless you decrease it whenever it goes down. 

I don't disagree on that (obviously), but my point was that the "4%" can be applied from any starting point, but if you increase spending after good market performance - even if only increased once and stabilize at this new higher level of spending you can still apply the 4% rule, but with a new starting point and new sequence of return risk the first years and so on. You are basically in exactly the same position as someone else, with spending equal to your new higher level, who just reached his 4% number.


vand

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #12 on: January 21, 2020, 12:34:08 PM »
The answer is to rebalance. While research seems to conclude that no single rebalancing period dominates, you should still have an idea of what your rebalancing thresholds are.  For example, if you hold a garden variety 60/40 portfolio you can choose to either set your rebalancing boundaries at 70/30 or 50/50, or once a year.

Very few years does the stock market actually return anything like its long term average; mostly it "overperforms" with the occasional periods of drastic underperformance via a bear market coming along once in a while to keep everything in balance.




jeroly

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #13 on: January 21, 2020, 12:41:10 PM »
Very few years does the stock market actually return anything like its long term average; mostly it "overperforms" with the occasional periods of drastic underperformance via a bear market coming along once in a while to keep everything in balance.
To underline this point:

I looked at the market's annual returns from the last 149 years.
109 years showed gains, 40 had losses.
The median gain in the 109 profitable years was 18.4% (19.2% average).
The median loss in the 40 losing years was -9.2% (-12.1% average).

The CAGR overall was 9.9%.

GuitarStv

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #14 on: January 21, 2020, 12:54:16 PM »
If my portfolio does better, then I can make larger donations to charities that I like.  I'll be fine with the withdrawals I've targeted.

MissNancyPryor

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #15 on: January 21, 2020, 02:56:38 PM »
So if I am really living off 3% but the 4% is the SWR by well understood theory, I could reasonably assign that 1% annually to other things like a bond index or unscheduled/higher end play or charity.  I might not withdraw it but I could track it and have it understood as my "extra" that could be withdrawn later.

I think it will take a few years of feeling confident in FIRE before I will feel like that 4% is really OK, it is early days for me.   

trollwithamustache

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #16 on: January 21, 2020, 04:44:25 PM »
you can always leave the excess $$ in cash and let the cash accumulate into X years of cash. At some point the market will disappoint you, its what it does. And those years you run down the cash and don't touch your pummeled investments.

secondcor521

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #17 on: January 21, 2020, 06:42:38 PM »
I divide my portfolio logically into two piles:  the pile I will spend during my life, and the pile I won't.

For the pile I will spend, I guess at my life expectancy to get a planning horizon - currently I'm 50 and plan to 90, so 40 years.  Then I run FIREcalc to find what AA is historically safest over that time frame - last I looked that is 90/10.  I then take 25x my current spending run rate and allocate that amount that way.

The rest that I won't spend will by definition go to my kids.  Although I could get hit by a bus tomorrow, the odds are that they'll inherit from me at least 20 years from now.  That pile is 100% stocks because of the time frame likely involved.

So to the extent my portfolio exceeds my expectations, my kids will be better off.  I've been trying to spend more, but I'm not very good at it.  I'm currently at a 0.64% net withdrawal rate, and that's including Christmas expenses which are a high-expense time of year for me.

use2betrix

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #18 on: January 21, 2020, 06:52:49 PM »
Well - if it exploded so much that it got to the 0% rule instead of the 4% rule, that could be worthwhile. You could then possibly pull it all, wait for the next hard market downturn, and dump a good chunk back in.

Thatís probably what I would consider.

bacchi

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #19 on: January 21, 2020, 07:18:27 PM »
Isn't this similar to McClung's rebalancing plan? When the equity portion grows to more than 120%, divert what's over 120% into bonds. This is a forced rebalancing into bonds when times are good and prevents selling equities when times are bad.


Radagast

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #20 on: January 21, 2020, 07:43:44 PM »
What if the stock market completely over-delivered beyond your expectations?  Is there a certain dollar amount that would cause you to switch everything in to cash (or a majority in to cash) and say "you've definitely won the game."  Or, would the fear of inflation still make you keep it in stocks.
There is no point where I would switch everything to cash. Ultimately I regard cash to be about as risky as stocks, and bonds more so. Anything in isolation is a terrible idea (although if I could choose just one, Total World Stock Index would be it). If there was a crazy run up, for example if US stocks double in the next 5 years sending the CAPE10 above 50, I might increase my diversification into other things, but would not likely consider having less than 50% of the total in (global allocation) stocks.

FIRE 20/20

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Re: What if your portfolio extremely exceeded your expectations?
« Reply #21 on: January 21, 2020, 08:05:36 PM »
If you increase your WR every time your portfolio goes up you will experience more failures unless you decrease it whenever it goes down. 

I don't disagree on that (obviously), but my point was that the "4%" can be applied from any starting point, but if you increase spending after good market performance - even if only increased once and stabilize at this new higher level of spending you can still apply the 4% rule, but with a new starting point and new sequence of return risk the first years and so on. You are basically in exactly the same position as someone else, with spending equal to your new higher level, who just reached his 4% number.

This is true, but I worry that it some who read it may be misled even if you fully understand it.  If you do what I understand you're saying, then you all but guarantee you will find one of the failure points.  4% doesn't guarantee success - in somewhere around 5% of cases it fails if no reductions in spending or additional income are added.  If I retire with $1M and withdraw $40k and then find I have $1.2M in a year or two and adjust to withdraw $48k without regard to inflation and keep adjusting in the future, eventually I'll "start" in one of the failure years like 1966/7.  Your success rate drops from about 95% or whatever Trinity found and will eventually hit 0% if you give it enough time.  Of course cuts and additional income should fix it, but you could have really tough years in there.

Another way to think about this is that if people follow the normal 4% rule, in roughly 19 out of every 20 years everyone is successful with no adjustments.  In 1 out of 20, everyone gets unlucky and needs to adjust a bit.  If you keep renewing by adjusting your spending up to 4% each year your stash grows more than expected then you'll eventually hit an anti-jackpot and find yourself in a failure year. It's like repeatedly playing Russian roulette, although the consequences aren't as sudden.  Even if your odds are 1/6 if you keep playing you'll eventually find the bullet. 
Part of the reason the 4% rule is so safe is that most of the time, 5-10 years in your wdr is really low and you don't adjust, so when the bad times hit you have plenty to ride out those bad years.  This approach reduces that.