Redesigning Portfolios Built For Accumulation To Work In The Decumulation Phase

Craig Israelsen
12/16/20 4 PM EST
CFP® Live CPA IWI
Program Id: 109324523
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Advanced CE Class: Redesigning Portfolios Built For Accumulation To Work In The Decumulation Phase 

The worst time to suffer a stock market loss is a few years before and after retirement. The sequence of returns is a risk professionals know about because it poses a risk you cannot control. However, you do control the risk level of a portfolio when it is most sensitive to losses, and that's a focus of this class.


Transitioning a pre-retirement portfolio optimized for growth to a decumulation-stage portfolio optimized for sustainable income is a challenge that advisors face routinely. The objective of this class is to carefully consider the best strategic options in advising clients on transitioning portfolios from accumulation to decumulation to better control risk posed by a sudden loss in the five years before and after retirement.

Assuming the portfolio is the primary source of retirement income, risk should be reduced as an investor approaches retirement, and in the years immediately after retirement. This logic produces a 10-year window in which the portfolio is designed to avoid a large loss.


Craig Israelsen, Ph.D., teaches on A4A monthly about low-expense investing. For three decades, Craig has helped define best practices in managing portfolios for individuals, publishing his research monthly in Financial Planning magazine. He's taught on A4A for a decade. Craig's also  taught family financial management at universitiesthree decades, and he's currently Executive-in-Residence in the Financial Planning Program at Utah Valley University.

Craig's monthly A4A classes enable low-expense portfolio management in a professional practice. 

After registering, you will receive an email confirmation from This email address is being protected from spambots. You need JavaScript enabled to view it.Check spam folder if you do not receive it.

This webinar is eligible for one hour of CE credit towards the CIMA® and CPWA® certifications, CFP® CE, PACE credit toward the CLU® and ChFC® designations, and live CPA CPE credit.

 

Q&A About Portfolio Design   

1. (James Brewer) Was there a reason that you did not use the 7Twelve?

7Twelve has a lot of moving parts (12 tickers).  I felt the topic was complicated enough so I felt using individual asset allocation funds would suffice.

 

2. (James Bruenn) Rankings of 30 & 31, say, in a group of 25 funds? 

As mentioned, there were 78 asset allocation funds in the analysis.  The slide only showed the top 25 asset allocation funds ranked by lump sum return.  When analyzing the ranking of each of the 78 funds based on periodic investing ($1,000 per year) or annual withdrawals some of the funds that were in the top 25 based on a lump sum investment ended up being ranked below 25 (such as 30 or 31 or whatever).

 

3. (John Crosby) Craig: With a fund that has a high degree of rank i.e. a fund that is ranked 9th that is now ranked 30th in SOR, or % are other factors involved, i,e money managers, expenses?  Its seems to be too much of a change for just fund management, or expenses?

The impact of the sequence of returns really is THE issue when we get away from a lump sum assumption.  The expense ratio of a fund is already baked into the published returns.

 

4. (Robert Gibb) What role do you believe immediate annuities and deferred income annuities play in reducing sequence of return risk and enhancing portfolio longevity?

As it pertains to a distribution portfolio (where money is being withdrawn by the retiree) I believe that there is a good case for the use of an immediate annuity as a buffer against a bad sequence of returns (SOR) in the portfolio.  Having said that, I would suggest that a broadly diversified retirement portfolio is the better overall approach to combat SOR risk.

 

6. (Brent Hamilton) What if the client has a minimum amount needed to live on? What would you do to guarantee their minimum income needs are met?

The question of a guaranteed minimum withdrawal is a good one.  Let’s assume a starting portfolio of $1 million and the client has a minimum need of $50,000.  That represents a 5% withdrawal of the starting balance. 

The graph below demonstrates how a 60/40 portfolio handled a 5% annual withdrawal rate over 70 rolling 25-year periods since 1926.  The average annual withdrawal was $89,030—which is well above the initial $50,000 withdrawal because the portfolio was allowed to grow by only withdrawing a percentage-based amount each year.  The annual withdrawal declined year-over-year 36% of the time, but the average amount of decline was only $2,682.

7. (Brent Hamilton) Jonathan Guyton talked about a system with guard rails on so there was an upper bound for withdrawals & a floor amount?

A percentage-based withdrawal system from a retirement portfolio is essentially a guard rail system that doesn’t take nearly as much thinking to figure out.

 

8. (Ajay Kaisth) Where to target date funds fit into this analysis? Is there a need/advantage to combining target date funds from different fund families?

Yes, that would be my suggestion.  Target date fund providers can differ dramatically in terms of their approach to risk – particularly target date funds that are approaching the stated target date.

 

9. (Jason Lampe) Slide 27. Sometimes it is Instl share class and sometimes A share class. Any reason it's not the same share class throughout?

Good catch Jason.  I considered only the oldest share class of each fund.

 

10. (Sophit Lee) Are the returns for the 21-year period used for the lump sum ranking the same or different from the 21-year period used for the withdrawals?

There is only one set of annual returns for each of the 78 asset allocation funds.  The sequence of returns (SOR) makes no difference in the ending balance of a $10,000 lump sum investment after 21 years.  However, once we move away from the lump sum assumption, the SOR can make a big difference if we assume that money was being invested annually OR money was being withdrawn annually.  We use dollar-based ending values to assess the impact of SOR.

 

11. (David McCary) How would setting 5 years of spending aside in a govt bond bucket to be tapped in down equity market years work?

Yes, that is the essential idea of a broadly diversified portfolio.  That is, a portfolio that has “buckets” that range from aggressive to ultra safe (in terms of equity risk).  I suspect that 2-3 years of safe reserve would be adequate.

 

12. (Douglas Shannep) What were the 3 funds on the last slide?

Vanguard STAR, T. Rowe Price Capital Appreciation, Fidelity Asset Manager 50%.

 

13. (Steve Smith) How did you get funds with ranks lower than 25?

As mentioned, there were 78 asset allocation funds in the analysis.  The slide only showed the top 25 asset allocation funds ranked by lump sum return.  When analyzing the ranking of each of the 78 funds based on periodic investing ($1,000 per year) or annual withdrawals some of the funds that were in the top 25 based on a lump sum investment ended up being ranked below 25 (such as 30 or 31 or whatever).

 

14. (Steve Smith) Did you run the 7Twelve through this test?

Yes, see below.








 

 

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Excellent

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This type of Real World information is crucial for portfolio design. You are right Andy, it's groundbreaking.

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Excellent. One of Craig's Best. Although it was not easy to follow all the numbers, appreciated Craig's effort and critical thinking as well as his summary which was effective,

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