A sequence of return risk always exists so long as there are withdrawals. If there are no withdrawals, it doesn't matter whether the market starts off down and then goes up, or starts off well and then declines, so long as it winds up in the same place.
That leads to the (rhetorical) question: why use a
50/
50 mix rather than simply a diversified equity portfolio? One reason is real though not especially rational - emotional discomfort in seeing numbers drop (for all the non-Vulcan investors out there :-)). Another reason is pragmatic. Withdrawals when the market is down eat away at a larger percentage of the portfolio; keeping a bond (or cash) allocation
mitigates that risk.
To be clear. We're all talking about mitigating sequence risk. We just have different views on the best way to do that. There's an
interesting column by Kitces, where he shows that using asset allocation is mathematically equivalent to using buckets with rebalancing. In other words, the
50/
50 portfolio is the same mitigation strategy as drawing from bonds/cash in down markets
so long as one rebalances periodically.
I think one can do better with, say, an 88/12 (cash) bucket strategy
without rebalancing. Except for the dotcom bubble (that took 31 months from peak to trough), markets have generally bounced back in three years. At least most of the way. After waiting it out one can replenish the cash bucket from equities. So I'm comfortable keeping a three year cushion. Starting now, or starting anytime. Right now though, I'd use cash for that cushion because bonds add risk and don't add much to returns.
The reason why I continue to return to the threshold question about when declines matter, is that corrections are both frequent and erratic. Like the saying that indexes predicted nine out of the last five recessions (
Samuelson), one may be out of the market most of the time if one is constantly concerned about the inevitable next correction/bear. (Look at how many years people have been saying that the bond market is about to decline - we're coming up on a decade now.)
If a retiree (inferred from the "no income" hypothesis) has $1M and needs $40K/year, staying completely out of the market isn't unreasonable. A 6
5 year old male can get an annuity paying $40K/year, with 3% annual adjustments, for about $840K. He can have fun with the rest - invest, travel, build a legacy, save for unexpected expenses. Annuities are another way to mitigate risk, as Pfau discusses in his Forbes column cited previously.
Unlike the 9
5% success rate you mentioned, the annuity provides a 100% success rate (assuming that the AA rated insurance company doesn't fold).
I agree with you in being concerned about a
5% chance of failure. It's not like you get 20 lifetimes and get to discard one of them. You've only got one shot at this, and you don't want to be the 1 in 20 who goes broke.
Perhaps I've misread posts, but a response I've read seemed to say to me, "well, these
5% outliers aren't real, but just artifacts of the way the simulators work." You're never going to see in real life, for example, three years in a row of 20% declines, even if they do show up in random simulations.
I take that not as reassurance, but reason for concern that the simulators have fundamental flaws in their design. So while I might agree that the
5% won't actually happen, I'm less sanguine about the accuracy of the other 9
5% of predictions.
