I Hope Pfau, Kitces, and Collins Know What the Hell They’re Talking About

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The stock market’s bull run, which began in 2009, is now 8 years old. That’s the equivalent of about 80 dog years. And many talking heads are convinced that Wall Street is ripe for a nasty correction.

Were I in my 20s or 30s, I would welcome such a correction. I love buying stuff on the cheap, stocks included. But come next month, I’ll be retired. My nest egg will no longer have an income to help prop it up. I need stock prices to keep getting higher. The last thing I need is a 2008-like correction—especially in my first year of retirement.

Financial planners refer to stock market losses early in one’s retirement as sequence-of-returns risk. Investopedia defines the sequence-of-returns risk as follows:

Sequence risk, also called sequence-of-returns risk, is the risk of receiving lower or negative returns early in a period when withdrawals are made from an individual’s underlying investments. The order or the sequence of investment returns is a primary concern for retirees who are living off the income and capital of their investments.

So how do Mrs. Groovy and I protect ourselves from the dreaded sequence-of-returns risk?

Two financial cats that I really dig are Wade Pfau and Michael Kitces. They believe the best protection against sequence-of-returns risk is to begin your retirement with a low equity allocation (20-40% of your portfolio), and then gradually increase your equity allocation to 60 or 70% of your portfolio over a couple of decades. They call this strategy the glidepath strategy.

The Test

Intuitively, the glidepath strategy makes sense. But how does it stack up against the classic balanced-portfolio strategy? To find out, I put both strategies to the test, beginning in 2008. Here are the testing parameters.

  • Begin 2008 with a million dollar portfolio.
  • Take $40,000 out of the portfolio at the beginning of each year for living expenses (four percent rule).
  • Factor in a three percent inflation rate for withdrawals after the first year. So in 2009, we will withdraw $41,200 for living expenses. In 2010, $42,436. In 2011, $43,709. And so on.
  • Re-balance every year after living expenses are withdrawn.
  • For the balanced-portfolio strategy, we will begin 2008 with a 60/40 split between equities and bonds. Every year after that we will re-balance to maintain that 60/40 split.
  • For our glidepath strategy, we will begin 2008 with a 40/60 split between equities and bonds. Every year after that we will re-balance to achieve a 2 percentage point increase in the equity allocation. In 2009, then, we will re-balance to a 42/58 split between equities and bonds. In 2010, we will re-balance to a 44/56 split. In 2011, we’ll move to a 46/54 split. And so on.
  • Our equity benchmark is the S&P 500 Index.
  • Our bond benchmark is the Barclays US Aggregate Bond Index.

Okay, here are the results of our balanced-portfolio strategy.

Asset20082009201020112012201320142015
Equities-37.0026.4615.062.1116.0032.3913.691.40
$362,880$550,710$563,203$531,274$598,777$723,686$704,640$665,167
Bonds5.245.936.547.844.22-2.025.970.55
$404,122$307,537$347,666$374,058$358,647$357,060$437,861$439,728
Portfolio Value$767,002$858,247$910,869$905,332$957,424$1,080,746$1,142,501$1,104,895

Not bad. The balanced-portfolio strategy handled the sequence-of-returns risk better than I expected. Sure, this portfolio lost nearly a quarter of its value in 2008. But by the end of 2015, the portfolio was worth $1,104,895. And it provided an average of $44K in income per year.

Now let’s take a look at the results of the glidepath strategy.

Asset20082009201020112012201320142015
Equities-37.0026.4615.062.1116.0032.3913.691.40
$241,920$428,571$446,470$436,318$519,071$647,335$637,689$622,663
Bonds5.245.936.547.844.22-2.025.970.55
$606,182$495,756$526,157$540,942$505,222$479,084$548,665$548,724
Portfolio Value$848,102$924,327$972,627$977,260$1,024,293$1,126,419$1,186,354$1,171,387

Not bad as well. The glidepath strategy shoulders the crash of 2008 better (a 15% loss vs. a 23% loss), provides the same amount of income, and produces a portfolio that is roughly $65K larger at the end of 2015. It’s not a blowout victory. The glidepath strategy didn’t demolish the balanced-portfolio strategy. But it did win. And that’s good enough for Mrs. Groovy and me. The last thing we want in retirement is drama, especially during the first five years. A less volatile portfolio will allow us to sleep at night.

The Funds

Right now, the Groovy portfolio is split evenly between equities and bonds. By the end of the year, we’ll move to a 40/60 split.

But what asset classes will we use in our equity and bond holdings? Right now, our equity holdings consist of 7 asset classes—large cap, mid cap, small cap, energy, real estate, and international. Our bond holdings consist of 3 asset classes—intermediate US, high-yield corporate, and emerging markets. Are these 10 asset classes really necessary?

One cat who doubts the necessity of so many asset classes is Jim Collins. Jim blogs over at jlcollinsnh.com, and his site’s tagline says it all: The Simple Path to Wealth.

Jim is a big proponent of just two funds: a total US stock market index fund and a total US bond market index fund. And his reasons for advocating a two-fund portfolio are pretty convincing.

  • The average investor sucks at picking stocks.
  • Professionals suck at picking stocks.
  • Since the average investor can’t beat the market, and since the average investor can’t rely on a fund manager to do it for him or her (once fees are accounted for), the average investor’s best strategy is to shoot for market returns. Nothing more, nothing less.
  • You get market returns by buying low-cost, broad-based US stock and bond index funds.
  • Forget international funds. S&P 500 companies do business all over the world. That’s enough international exposure.
  • Forget real estate (i.e., REITs). The inflation protection it offers is no better than that offered by US stocks.
  • Buy the Vanguard total stock market index fund (VTSAX) and the Vanguard total bond market index fund (VBTLX).

Mrs. Groovy and I know our limitations. We are very, very, very average investors. In other words, we have no delusions that we can beat the market. We will be more than happy with market returns over the next thirty or forty years. And if we can do that with two asset classes rather than ten, sign us up. The less complexity in our retirement the better.

Final Thoughts

Okay, groovy freedomists, that’s the game plan. To deal with the sequence-of-returns risk, we’re going with the Phau-Kitces glidepath strategy. And to make portfolio management as easy as possible, and still get whatever the market is kind enough to give, we’re going with the Collins two-fund portfolio approach. What say you? Does our game plan make sense? Do these cats know what they’re talking about? Let me know what you think when you get a chance. Peace.

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37 Comments

  1. I’m glad I found this post. We arelooking at retirement within 1-2 years and this gives us a lot to think about.

    What is perplexing for us is whether to start moving our 2016 gains (9% so far) into cash or bonds in case of a crash, or stay the course with our index funds….

    • Mr. Groovy

      Hey, Mr. Grumby. Tough problem. Mrs. G and I are now at 40% equities and 60% bonds and cash. We have 4-5 years of living expenses in cash, so we should be good if we have a repeat of 2008 in the next year or two.

      I wish I had more faith in my fellow Americans, but I don’t. We have way too much debt, dependency, crony capitalism, and crony socialism. And I don’t see how we avoid a major correction in the near future.

      But then again, I’m just a little ol’ country blogger. What the heck do I know? Maybe things will work out. My advice, though, is to prepare for the worst. Lower your equity exposure (30-40%) and have at least three years of living expenses in cash.

      Best of luck, Mr. Grumby. The next few years should be interesting.

      • Glad you put the word “crony” in front of “capitalism” – it makes all the difference, and my experience is it is increasingly difficult to find people who see the difference!

        • Mr. Groovy

          How true! That one simple word changes everything. I’m not pro-business. I’m pro-markets. So I don’t want government with its finger on the scale. I love unfettered competition.

  2. I’m really glad to hear that you have 4 years of expenses in cash. Being able to let the market do it’s thing and not touch it no matter what’s going on in the first few years will have enormous benefits. I’m at a much different stage and have high debt. I have a Target Retirement Date IRA set to as high a risk tolerance as they allow (I’m actually risk averse, but I know that is bad for my money), and I have just two index funds in my brokerage account. One that models the S&P500 and a Total Market Fund. If I knew more when I opened my IRA/brokerage, I would have gone with vanguard, but Schwab is treating me well enough and it is started, which is a huge step.

    • Mr. Groovy

      The 4 years of cash really helps us sleep at night. I hope I’m wrong, but I think we’re headed for a 2008 type of crash soon. Having that much cash will hopefully protect us from selling stocks at a loss. We’ll see.

      I love target date funds. They’re a no-fuss way to achieve an age-appropriate asset allocation. And there’s nothing wrong with Schwab. I routinely see their funds in every list of top-ten index funds I come across. And in many cases, Schwab index funds are actually cheaper than corresponding Vanguard index funds.

      Thanks for stopping by, ZJ. I always feel better after reading your comments.

  3. Greetings Mr. Groovy…

    Great post!

    Let me start by saying I’m honored and a little amazed to be mentioned in the same breath (well, post anyway) as Mr. Pfau and Mr. Kitces. They are likely saying “who the hell is this Collins guy??”

    And your brief summary of my general position is very well done. Most I’ve seen tend to mistake at least in part my views. I might only add that using just the two funds I recommend, one’s allocation can be adjusted to reflect just about any point in life and/or risk profile.

    As to your competition, let me only observe that your time period starts with the worst collapse since the great depression. In just about any other period I would expect balanced to soundly thrash glidepath.

    So while glidepath is a safer alternative, readers should be aware that in most cases it will carry a performance penalty in exchange. Just as holding bonds does.

    Let me also second Mr. Pie’s recommendation of Darrow Kirkpatrick over at Can I Retire Yet?. Smart, insightful stuff, even where he and I disagree. 🙂

    Finally, glad you and Amanda enjoyed my little video. As it happens this weekend we are headed down to MA to visit our friends/film producers Joan and Brian who made it happen. 🙂

    • Mr. Groovy

      I hear you about the performance penalty. Frankly, I was shocked by how well the balanced-portfolio responded to the 2008 hit. I thought the glidepath strategy was going to blow it away. And upon seeing the results of the competition, I even suggested to Mrs. G that we take a hybrid approach. Go with the glidepath strategy until we get a 20+ percentage point correction and then jump to the balanced-portfolio strategy immediately. So we’ll see. There are great arguments on both sides. And I have much homework to do (haven’t delved into Mr. Kirkpatrick’s stuff but I intend to do so this week).

      On a lighter note, here’s a secret for you. I never heard of you until a year or so ago. Mrs. G and I were listening to Stacking Benjamins one day and Joe, Paula, Len, and Greg were fawning all over you. And I remember blurting out, “Who is this Collins guy?” Well, Mrs. G and I have since gotten very familiar with your blog and the fawning exhibited on Stacking Benjamins was well justified. And in our minds, you’re right up there with Pfau and Kitces. In fact, when my boss asked me how I was able to retire, I directed her to two websites: Mr. Money Mustache’s and yours.

      Thanks for taking the time to stop by my humble little blog and sharing your wisdom, Jim. I’m truly honored.

  4. Mr. Groovy

    Thanks, Amanda. Have you seen Jim’s take-off on YouTube of the Gambler? If you haven’t, check it out. It’s hilarious. Yeah, I think the two-fund portfolio should be fine. And the glidepath strategy strikes me as a very effective defense. But only time will tell. The plot thickens.

    • YES! I watched it! It was great. I just about fell off my chair – he did a fantastic job.

      Looking forward to seeing how the two funds using the glidepath strategy works for you guys. Looking forward to following along.

  5. GREAT information! We are still a few years out from FI and are still heavily invested in equities. The glidepath strategy actually makes complete sense, especially for an early retiree. I completely subscribe to Jim Collins’ philosophy on investment simplicity. Right now we are mostly in VTSAX but will move more into the bond fund as we near retirement. Thanks so much for this post – incredibly valuable information.

  6. Great read and it appears to me you have a good handle on dealing with Sequence of Returns Risk. As you noted in one of your replies, whatever draw down one chooses, the key is to be aware and to develop – and manage – a comprehensive plan

    • Mr. Groovy

      Thanks, James. I think we got a handle on it. But like you said, “the key is to be aware and to develop – and manage – a comprehensive plan.” Beautiful summation. As long as we pay attention and adjust, we should be good.

  7. Admittedly I don’t know nearly enough about withdrawing from my portfolio as I should. T

    hank you for shining a light on this subject and debunking the idea that you will run out of money if you have stocks during retirement.

    Too often you read that’s it’s too volatile to hold stock in retirement and that you have to be ultra conservative. Based on the numbers above it definitely pays to hold a certain percentage of stock in your portfolio.

    Excellent post!!!

    • Mr. Groovy

      Thank you, MSM. I wish stocks could be avoided. No one likes a bumpy ride when one’s in retirement. But it’s the only way to keep pace with inflation. Playing it too “safe” would be even more dangerous. I would say keep a minimum of 40% stocks in your portfolio. This way you have a fighting chance of maintaining your purchasing power.

  8. I think it’s wise that you’re not trying to beat the market.

    BTW, once you guys get more readers, have you thought about monetizing the blog?

    I guess I’d be a little nervous if I were in your shoes over not having an income. I don’t mean to be a downer 😉

    • Mr. Groovy

      Hey, Lila. You’re never a downer! In fact, we agree with you. That’s why we waited until now to retire. We had the money to retire at least a year ago but decided to wait until my mini-pension kicked in. Like you said, it is scary not having an income–especially since I’ve been getting a weekly paycheck since I was 16. My pension isn’t a lot, but getting that check every month will make the transition into retirement a lot more bearable. We’re definitely wimps when it comes to FIRE. Thanks for stopping by Lila. Always love your perspective on things.

  9. So, this is over my head. OK. Now that we got that out of the way, I really like the two-fund portfolio approach. I have a Target retirement fund with Vanguard now. But I know those are a bit more pricey. I will look into this and that site. Also, my hands got sweaty when you said if you were younger, you’d welcome a correction.

    I would like to just ride out the delusion that I will make slow and steady progress until I die, thankyouverymuch. This millennial’s investing heart is far too timid to wish for a correction! 🙂 I’ll follow these posts–and all your others–with fervor. Happy Friday!

    • Mr. Groovy

      LOL! You caught me on my false bravado! When the market tanked in 2008, Mrs. G and I were still early in our investment careers. I think we had $50K-$60K combined in our Roths and workplace accounts. So the setback wasn’t too painful. And at that time, we thought we were working until at least 62 anyway. Now I worry a lot about a correction. Losing 30 percent of our portfolio over the course of 4-6 months would hurt a lot. But I really think you’ll be fine. A target date fund is perfect. That’s what Mrs. G and I started out with. As you learn more about investing and feel more comfortable, you can switch to the two-fund approach and manage the allocation between equities and bonds yourself. The thing to do now is to prepare yourself mentally. I wish Janet and Hillary (or Donald) well, but I just don’t think they can stop a major correction from happening in the next couple of years. So you’re gonna to take a hit. You’re gonna lose (on paper) a good chunk of your portfolio. But as long as you stay the course, and keep dollar-cost averaging, you’ll be fine. And 10-15 years from now, you’ll be telling the youngins how you survived the crash of 2018!

  10. Greetings Groovy investors.

    Those wise money cats you highlight are indeed the cats whiskers when it comes to investing. Who am I to woof at their work?

    Here are some other considerations from Da PIE Dog.

    Are you planing to hold any cash to mitigate the dreaded down market? That is, perhaps 3-4 years or so of expenses in cash where you avoid selling either equities OR bonds in an extended bear market.

    Whatever ratio of bonds to equities you hold, you may wish to take a look at some interesting work from Darrow Kirkpatrick over at Can I Retire Yet on CAPE withdrawal strategy which provides guidance on when to sell equities and when to sell bonds, depending on the CAPE ratio.

    The chickens of doom are projecting for a much lower return on bonds. Even Jack Bogle is projecting for much lower overall returns based on his simple return formula, which interestingly has played out amazingly well over a long period of time. “A Wealth of Common Sense” blog by Ben Carlson has a good summary of this stuff.

    The international allocation is always ripe for debate and I tend to fall more toward the Jim C camp instead of many others who argue for as much as 50:50% allocation between US and International. Yes, international has been trashed by US over the last decade but that has not always been the case.

    Finally REITs have killed equities and bonds over the last 7 years since the 2009 low. Just take a look at the performance of the Vanguard REIT ETF (VNQ) over this period relative to the SP 500. The backtesting tool from Portfolio Visualizer is very helpful if you want to play with different asset allocations versus benchmarks of your choice.

    OK, this is perhaps more reading than you cared for. You are perhaps thinking about kicking Da PIE dog out the door to his kennel. With all this overload of information, it truly is raining cats and dogs.

    • Mr. Groovy

      Not fair, Mr. PIE! Your barking is making me re-think our strategy. But I still think we’re good. First, we have at least four years of expenses in cash. So we won’t have to sell anything should our retirement coincide with some market ugliness. Second, I have a mini-pension starting next month that covers roughly half of our expenses. So once our cash goes away, we can go with a two percent withdrawal rate and still be fine. But there are still many things to learn. Thanks for the tip on Darrow Kirkpatrick. I’m not familiar with his work, and I’m looking forward to learning about withdrawal strategy based on the CAPE ratio. And I do worry about bond returns in the future. I don’t see us getting back to those six and seven percent annual returns anytime soon. Damn this retirement stuff is hard! So keep barking, my friend. I don’t mind the racket at all.

  11. Have never heard of the Glidepath strategy, but I haven’t spent a lot of time investigating these strategies yet (unfortunately have a lot of work life ahead of me)

    I will cheer for a correction in the next 2 months, then another rise for a few years while you coast into retirement

    • Mr. Groovy

      Ah, a correction in the next two months followed by a nice rise in the first few years of my retirement. From your keypad to God’s ears! Thanks for the support, AE. I really appreciate it.

  12. Withdrawal strategy is not yet for now. I was only vaguely familiar with the glide path, thx for pointing that out.
    It does makes sense to me to go that route.

    With regards to simplicity: do it. Why 10 asset classes? For equity, I have 3. One day I might simplify this even more.

    Atl

    • Mr. Groovy

      Thanks, AT. Yes, I think simplicity is the way to go. It’s a lot easier to maintain a portfolio of two funds versus a portfolio of ten funds. At some point in the future, as more and more people turn to index funds, good active managers may be able to deliver alpha. Until that time, though, I’m sticking with index funds. And if two index funds can get the job done, I see no reason to complicate matters.

    • Mr. Groovy

      Same here, Emily. I was really concerned about the drawdown phase. But running these two retroactive tests gave me a little more confidence. Things can get hairy, but as long as you have a sound game plan–and stick to it–you should be alright. Thanks for stopping by, Emily. Always a pleasure.

  13. I’m still far enough away from my retirement date that I haven’t started thinking about withdrawal strategies too much. But, like you, I’m aware of, and somewhat nervous about the early sequence of returns. I like how you’re combining the strategies of Jim and Michael to make something work you two Groovy Cats.

    • Mr. Groovy

      Jim, Michael, and let’s not forget Wade, are financial rock stars. And for good reason. What I like about them best is this: they know the importance of a good defense, and they show the average investor how he or she can achieve it. I had a professor who always used to remark that “there’s beauty in simplicity.” I never appreciated the wisdom of this axiom until the last five years or so. Thanks for stopping by, Ty. And don’t worry too much about your sequence of returns. I’m sure you’ll handle retirement with much aplomb.

  14. Amazing minds…I just finished a post (out next week) on withdrawal strategies to avoid sequence of return risk. I’m going a different route – keeping 3 years in “Bucket 1”, 5 years in “Bucket 2”, the rest in “Bucket 3”. Have a look when it comes out, it may be of interest.

    BTW, a dog year is 7 years! (http://www.akc.org/content/entertainment/articles/how-to-calculate-dog-years-to-human-years/)

    Smiles.

    • Mr. Groovy

      Mrs. G was all over me too for my dog math. I knew it was wrong, but I just thought 80 had a better literary ring to it than 56. My bad.

      And, yes, we are definitely kindred spirits. Looking forward to the bucket-list strategy next week. I read about this strategy before, but I’ve never seen anyone provide real-world mechanics of how to set up the buckets and maintain them through retirement. It’s going to be a great read. Always a pleasure, my friend. Talk to you soon.

  15. I haven’t dug into withdrawal strategies and portfolio holdings much since I’m still a handful of years from FI, so I’ve only scratched the surface. The glidepath approach makes sense though, protecting you early on from losses. But my question is how much the longevity of your portfolio is expected to differ since you aren’t getting as much upside in your portfolio early on?

    Regarding the simple approach of holding two funds, I don’t think you could go wrong. The funds each hold assets from multiple classes, so while you won’t have all 10 that you currently have, you’ll still be well diversified.

    Thanks for the overview of your approach and congrats on your early retirement!

    • Mr. Groovy

      Excellent question, my friend. I was very surprised by how well the balanced-portfolio strategy rebounded from the 2008 crash. It’s nice having a large equity footprint when the S&P is up 16, 26, or 32 percent in a given year. Part of me wants to maintain a 40/60 split until the next major correction (i.e., a 30% or great loss) and then immediately jump to a 60/40 or a 70/30 split. I’m gonna run the numbers on that strategy and see what happens. Thanks for the very insightful question, TGS. You definitely got me thinking.

  16. This is what I love about the personal finance community. I’m still a young dude, so all I know is to be heavy on the equities. I’ve never even thought about how to handle your portfolio as you are actually entering retirement. Seems so counter intuitive to be increasing equities as you age in retirement, but as Matt above pointed out, your biggest risk in retirement comes early on.

    Totally agree on keeping your investments simple. You just need enough to make it, not to be some investing superstar.

    • Mr. Groovy

      Love your attitude, FP. For most of us, simplicity works best. The market will give. You just got to remain mentally strong when the market decides to take. You can’t run for the hills and lock in paper losses. The glidepath strategy will give us the backbone to stay in the game. Like you said, we don’t need to become “investing superstars.” We just need enough “to make it.” A lot of wisdom there, my friend. Thanks for stopping by.

  17. I really like the work that Kitces does. It is insightful and analytical while also being accessible.

    The glidepath strategy makes a lot of sense when you stop and think about it. At first it seems counter-intuitive to be adding more stock (and more risk) to your portfolio as you get further into retirement, but where the risk of running out of money is mostly found in the first decade, then it makes a lot of sense to lower your risk for that first decade.

    • Mr. Groovy

      My sentiments as well, Matt. Mrs. G and I are a little risk adverse. Since we’re in our mid-50s, the first 10 years of retirement are crucial. If things go well, we’ll still have a sizable portfolio just when we’re able to get a boost from Social Security. So all we got to do is play it smart. The glidepath seems like the best approach. Got my fingers crossed. Thanks for stopping by.