Posted on May 1, 2014 | AAII Journal
For the past 20 years—due to the growing research on safe withdrawal rates, the adoption of Monte Carlo analysis (a method of considering many simulations), and just a difficult period of market returns—there has been an increasing awareness of the importance and impact of market volatility on a retiree’s portfolio.
Dubbed “sequence of return” risk, retirees are cautioned that they must either spend conservatively, buy guarantees (e.g., annuities), or otherwise manage their investments to help mitigate the danger of a sharp downturn in the early years.
One popular way to manage the concern of sequence risk is through so-called “bucket strategies” that break parts of the portfolio into pools of money to handle specific goals or time horizons. For instance, a pool of cash might cover spending for the next three years, an account full of bonds could handle the subsequent five-to-seven years, and equities would only be needed for spending more than a decade away. This “ensures” that no withdrawals will need to occur from the equity allocation if there is an early market decline.