"My Offer Is This: Nothing"

If you know your Godfather Part II then you know the quote in the title of this post. If you are unfamiliar then stop reading this, go find the movie and watch it. 

Barron's has an article this weekend titled 3 Things To Do To Manage A Bear Market Early In Retirement. It's a pretty good read that gives ideas for what to do about sequence of return risk (SoRR). As I read the article I thought about the above referenced scene where Michael Corleone counters Senator Geary. 

The reason for this was the idea expressed by several experts of meaningfully changing the allocation to equities a couple of years before retirement which I don't agree with. This is the default move though, lower equities exposure and allocate more to bonds. Turns out that worked until it didn't this year. 

When we talk about this I usually lead with some version of "set aside some number of months worth of cash to cover expected expenses to ride out the bear market." The mindset behind that if I haven't said it this way is more like taking that money off the table without meaningfully changing your asset allocation to favor bonds with the rest of your portfolio. You could use diversifiers to lower your portfolio's beta (your portfolio's sensitivity to the ups and downs of the broad market). Maybe take 5% from each sleeve, stocks and bonds into 2 or 3 diversifiers that will go up when stocks go down like maybe tail risk and inverse products. If nothing else, that 10% can be a source of additional funds if the stock market does go down. The 2 or 3 diversifiers would likely go up and you'd avoid selling other assets low. 

That is far more incremental versus one of the suggestions in Barron's of going to 70% fixed income. A client couple of one of the advisors in the Barron's article essentially missed out on the three huge up years coming in to 2022. There's a balance here between enduring the consequence of an adverse sequence and completely disrupting the portfolio.

It is fair to assume that couple looking to retire at 60, as was the case in Barron's, might reasonably have had a six month emergency fund. Then we'll assume they carved out another 18 months of expected portfolio income needs, $4000/mo times 18 so $72,000 out of what we'll say was an $800,000 retirement fund, they would have had have a portfolio of $728,000 now with two years of expenses in cash in case the market does poorly as of Jan 1 2019. Yes, the first $24,000 was their emergency fund but the stock market cutting in half might qualify. 

So on Jan 1 2019, instead of have having 70% in bonds you had 90% in Vanguard Balanced Income Fund (VBAIX) a proxy for 60/40 and 10% in a mix of tail risk and and inverse and did not rebalance, then as of Friday, what was $728,000 on Jan 1, 2019 would $895,440 worth of VBAIX. The two alts starting out at $72800 on Jan 1, 2019 would today be worth $46,410. The couple we're talking about from the Barron's article, with plans to retire on Sept 1 of this year would now have a total of $941,850 with two years of expenses in the bank.

If that original $728,000 instead invested 35% in Vanguard Intermediate Treasury ETF (VGIT) and 35% in Vanguard Long Term Bond (VGLT), so the two bond ETFs from the All Weather For The Masses in different weightings would get the client couple to 70% fixed income. The remaining 30% goes into an S&P 500 index fund. That portfolio would today have $244,608 in VGIT a small loss, $236,964 in VGLT a slightly larger loss and $336,336 in S&P 500 index fund for a total of $817,908 plus two years of expenses covered. 

A far more normal asset allocation, going through what has been one of the worst first six months of a year ever came out noticeably ahead...as of now anyway. So right here right now, should they rebalance back up to diversifiers that will benefit if the stock market keeps dropping? To get to $94,100 or 10% in alts they would need to sell down $47,000+ of their VBAIX position which leaves them with almost $850,000 in VBAIX if the market rips higher from here. 

If this was you, these where your numbers, would that extra $123,942 be enough of a difference? Like I often say, there's no wrong answer. While there might be more moving parts in real life, these examples don't require being correct about anything. This study was built on two incredibly simple portfolios assembled 3.5 years ago and left alone. 

I think the difference between the two is meaningful. I regularly say that I think it is a bad idea to drift too far from a "normal" allocation between stocks and bonds unless you're in game-over mode, that's different, and this little study turned out to be an example of why that is the case. 

As a note, I got too far into this to change but if instead of tail risk for this exercise I'd gone with client/personal holding BTAL instead, it would have come out with a much bigger advantage for the closer to normal allocation with VBAIX.