Build Your Own Glidepath

I had a crazy idea about creating your own glidepath. I'm not the first person to come up with this per an interaction with Gemini but it's an interesting idea that might come in handy.

The idea ties in somewhat with the bridging concept we have been working with lately. As a quick reminder, the bridge we've been talking about is taking a smaller piece of money to live on for several years until the next financial milestone like taking Social Security or taking RMDs. The idea would be that this piece of money wouldn't need to last for more than ten years, that it would be expected to deplete or maybe get to the end of intended bridge duration with a small emergency fund amount left over. 

More correctly this could be a path to a different type of bridge versus the very yield concept we have been working with. So the example we'll work with starts putting $200,000 into a high yielding derivative income fund, SPXX for this post because it has a long track record. It's high yielding alright but not an NAV incinerator. It's ten year price only CAGR has been 3.29% so the yield has averaged out to 7.59% but in real life it has been lumpier than that. 

Starting out with 100% of a bridge account in equities might be difficult but we can mitigate that quickly. The idea is to take all of the yield from SPXX and put that into Stone Ridge Reinsurance (SHRIX) which is a catastrophe bond fund and reinvest SHRIX's distributions to buy more shares. Each year that goes by, again we are working with a ten year window, the equity percentage goes down as we move closer to retirement. 

Testfol.io says that $200,000 in SPXX ten years ago would now be worth $276,444 (price only gain). Gemini says that the total value of the account, SPXX price only plus the purchases/reinvestment of SHRIX would now be worth $516,000 which is slightly ahead of putting the $200,000 into VBAIX ten years ago instead. Starting with just SPXX would have been far more volatile than VBAIX but the volatility would have steadily decreased as the SHRIX position grew relative to the account. What started as 100% SPXX would now be 53% SPXX and 47% SHRIX. Missing the carnage caused by higher interest rates was a big contributing factor to the long term outperformance. 

I chose SPXX and SHRIX so we could get a decently long time to look back although SHRIX doesn't quite go back ten years but the reality is that with these two funds, this is very inefficient/unfriendly from a tax perspective. The world has evolved plenty since 2016. SPYI pays returns of capital not ordinary income for example. ROC distributions defer the tax, there's no tax owed on the distributions until ROC takes the cost basis below zero then the distributions are taxable at the long term gains rate. Testfol.io has SPYI yielding almost 13% so if that rate persists it would take seven and half years for the cost basis to hit zero. Reiterating, the cost basis would be going down with each distribution. 

There are also funds that could replace SHRIX in that sleeve that are more tax efficient. A mix of some yieldy holdings and some alts like managed futures, some of the macro funds we look at and also long/short strategies could have a similar total return outcome as SHRIX but with far less tax owed. 

Moving from all equity exposure to less and less equity exposure is what glidepaths do. By definition this reduces the threat from an adverse sequence of market returns. Someone who started this in 1998, planning to retire on December 31, 2007 would have had half of this piece of money out of equities when things started to rollover into the financial crisis. 

Even you think this idea stinks, one thing it has going for it is that the process to manage sequence of return risk is systematic. There's nothing close to guessing or predicting anything. It harvests the volatility from the derivative income sleeve to start and then build up a defensive sleeve as someone moves closer to needing their money. Obviously doing something like this in an IRA account of some sort would mean being able to avoid the tax gymnastics. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.