How Are Retirees Doing Since 2008?

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By Ronald Surz :

Sequence of return risk peaks in the " Risk Zone " that spans the transition from working life into retirement, namely the five years before and after retirement. Losses sustained in the Risk Zone can devastate lifestyles even if markets subsequently recover, or so the theory goes. Most investors sustained significant losses in 2008. The typical 2010 target date fund (( TDF )) lost 30% in 2008. The TDF industry has sloughed off those losses, bragging that they have since been recovered and then some, so no harm no foul. But sequence of return risk implies that, despite the recovery, retiree lifestyles could remain irreparably damaged. Let's take a look.

Defending against sequence of return risk

In The First 'To-And-Through' Target Date Fund I describe a Defensive TDF glide path that is designed to protect against sequence of return risk. I'll expand on that idea here to incorporate alternative risk preferences. The following graph shows 3 V-shaped glide paths designed to defend in the Risk Zone, each with a different level of protection. It also shows the asset allocation in retirement for the typical TDF; it's 45/40/15 stocks/bonds/cash.

In theory, retirees on the Defensive glide path should be smiling today because they did not sustain the 30% loss experienced by those in TDFs. Those on the Moderate path should be in about the same place as their colleagues in TDFs, and Aggressive investors should be worst off.

Where are 2008's retirees today?

There is no sequence of return risk without withdrawals. In the absence of withdrawals, we can rearrange return sequences in any way we want and the compound cumulative return is unchanged. Ending wealth is the same regardless of the order in which returns are earned. But if we are withdrawing money, as we are in retirement, the sequence of returns matters a lot. Losses in earlier years can be devastating, while the same losses in later years don't matter much.

Accordingly, we've assumed that retirees have been using the 4% Rule for withdrawing savings in the 9.5 years since 2008. In the following chart we look at 4 different retirees who each had $1 million at the start of 2008.

Let's start with the investor in the typical TDF, shown as the thick blue line. Even after spending more than $400,000, this investor is worth about as much today as ((s))he was worth in 2008. Retirees who stayed in their TDF have fared OK, despite the potential ravages of sequence of return risk. Also, investors on the Moderate and Aggressive glide paths have done very well primarily because those glide paths re-risk as they leave the Risk Zone.

So what happened to the conservative investor?

Even though the conservative investor came through 2008 relatively unscathed, his edge over the typical TDF investor ended 5 years later in 2013 when his wealth became about the same $900,000 as the TDF investor. And then beyond 2013 the defensive investor lagged all of the other 3 investors.

So what happened? The Defensive Path is 80% in T-bills at the target date, and gradually re-risks beyond that. Treasury Bills have had very low returns, lower than any other time in history except 1937-1941. T-bills have returned near zero, while the average T-bill return over the past 45 years has been 5%. These measly returns on T-bills cannot support a 4% spending rule.

So what?

Despite the incredible run-up in stock markets around the world, this has been a terrible time for retirees because they cannot afford to play it safe. Quantitative Easing is designed to make risk takers out of those who might rely on an income stream to support their retirement needs. It's working. So the big question now is what lies ahead.

Coming soon

We're working on an investment portfolio construction service that goes beyond simple risk-based models by integrating age into the risk equation. Risk has different meanings for people of different ages. Please follow me for updates.

See also The Finish Line Remains A Value Trap on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks
Referenced Symbols: TDF

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