Sequence Risk and Allocations

Barron's had a couple of good articles over the weekend, one was an interview with Harold Evensky about sequence of return risk and the other was about the death of the 60/40 portfolio. 

The Evensky article attributed the well known bucket strategy to him. I always though that was from Ray Lucia but either way. The context in the article I'm referencing was how much cash to set aside to cover expenses. The balance to be struck is between being able to endure a prolonged decline and too much cash being a drag on returns.

The article is a good read. I would stress there is no single right answer for everyone. The comments belie this with some people liking ten years of cash set aside while others questioning having even one year's cash needs set aside. If you do some research, I think you'll find that the average bear market has been 24-30 months. The great recession, as bad as it was, found a bottom in just 18 months. 

Not every financial plan has the luxury of setting aside multiple years worth of cash needs. If you have just enough saved to allow for a 4% withdrawal rate with no great margin for error then five years worth of expenses seems problematic.

I'm not in the ten years camp for the typical investor/retiree. If the average bear market goes back to 24-30 months then I like the idea of two years if it makes sense in a "drag on returns" context. If you have $2 million but only need to take $50,000-$60,000/yr then sure two years makes sense, I should say the math for two years makes sense. If you do any sort of hedging whether that is the way I do it (and write about all the time) or some other way, the hedges can be a source of cash if the market does go down. If the stock market drops 30% and something you use for protection goes up 25% or 30% or more you can sell it for cash. There is less need to protect against a large decline after a large decline and 30% down is pretty big. This is potentially a way to avoid selling low if only one year's worth of cash set aside is the best path based on a thin margin for error. 

The article about 60/40 featured opinions from KKR and if you want to be cynical you could title it "Company that sells liquid alt funds thinks investors should have 30% the type of liquid alt funds it sells." 

This is old ground for us of course. The consequence for the risk of buying longer dated bonds for many years now finally matters. An indexed 60/40, which includes intermediate and longer bonds, has offered no protection in the current market event. Alts, the right kind of alts, selectively chosen alts, don't discount lucky alts, have offered protection. I'm all in on alts in terms of believing in them, not in terms of 30%, but using them requires work. You have to understand what makes them work so you can understand what would make them not work. 

Even still, there can be no guarantee, sometime the right exposure might just not do well in some sort of event that hits the stock market. Gold is a good example. I describe gold the same way all the time, it has the historical tendency of going up when stocks go down. It happens often enough that I believe in it. Gold should offer protection but it will not do so every time. For any given event, it may not work. That doesn't necessarily change the idea that it will work more often than not. If you can't live with that uncertainty, then yeah, don't use gold.