To increase your cash flow in retirement you need to become comfortable with failure. This is why successful investing in retirement is a lot like baseball.
The game of baseball is a game of failure because it’s so difficult to play. A 300 hitter, a superstar fails seven out of ten times at the plate. So what does that tell you about the game and its difficulty?
Goose Gossage, former Major League Baseball pitcher
The sequence of returns risk and volatility tax are side-effects of large losses. Avoiding large losses requires an investment process that prioritizes risk management.
We demonstrated this with our story of Rita and Chase. Chase outperformed Rita 6 out of 10 times. Yet, Rita outperformed Chase over the period analyzed.
Rita’s investment process managed risk through diversification of Stocks and Bonds. Chase’s investment process concentrated his investments in Stocks.
Concentration is a tool for building wealth. It is not a tool for living on your wealth.
Diversification takes many forms, which is beyond the scope of this article. Ultimately, diversification is a commitment to failure. Diversification is the intentional dilution of returns.
Committing to your investment process
Each year Dalbar runs a survey of individual investment returns versus market returns. The survey finds a stunning gap between investors’ underperforming market returns.
This gap is known as the behavior gap.
My belief is that this gap exists because there is a lack of commitment to a process. This lack of commitment is likely due to a misunderstanding of the process.
The proper investment process requires you to believe in and commit to that process.
Selecting an investment process is like a wedding vow:
“I take thee to be my wedded husband/wife, to have and to hold, from this day forward, for better, for worse, for richer, for poorer, in sickness and in health, to love and to cherish, till death do us part, “
Traditional wedding vow
The advantage of marriage is that you get to date before you commit. This test drive might give you an idea of whether it’s worth sticking with that person through good times and bad times.
With investing, we don’t have to “date” different investment processes. With investing, we have the benefit of a large data set and history whitepapers. We can look at the past to understand market dynamics.
This look into what’s happened in the past helps create a framework for what might work in the future. History never repeats but it sometimes rhymes. These lessons can be leveraged for making better decisions in the future.
Understanding history can go a long way in committing to your investment process. If you’re not sure how your strategy has reacted to certain market conditions, then how can you be confident when you hit a rough period?
As an individual, you might become another statistic of the behavior gap if you don’t understand your retirement income portfolio’s philosophy.
In the end, you might choose to hire an investment manager to implement a strategy. However, delegating portfolio management is still risky if you don’t understand the philosophy.
Historical example of extended failure
In our example (see Why Draw Downs Matter) with Rita and Chase we saw Rita end retirement with more money than Chase. To achieve victory she had to sit through many years of losses compared to Chase.
I cherry-picked that period to illustrate the value of risk management. This time I cherry-picked a series of returns where risk management looks foolish.
The Great Financial Crisis of 2008 has been followed by tremendous US stock returns. If Chase and Rita had started with their $1 million portfolio in January 2009 the race wouldn’t be close.
Without taking any withdrawals, Chase’s 100% investment in the S&P 500 has generated $2 million more than Rita’s 60/40 portfolio as of December 2020.
The S&P 500 is represented by Vanguard 500 Index Fund (VFINX). US Bonds are represented by Vanguard Intermediate-Term Treasury Fund (VFITX).
If they both took out $50,000 per year, Chase would have almost $1.7 Million more than Rita.
We’re only through year 12 of their hypothetical 30-year retirement. We have no idea how it will end.
The sequence of returns risk is ugliest during the first half of retirement. Yet, large losses never feel good and are public enemy #1 to retirement portfolios. Maybe Chase’s lack of risk management pays off this time. Maybe Chase’s fast start ends with a sad finish. Only time will tell.
Risk management shines in bear markets while drowning in bull markets. Getting comfortable with failure is an important step to embracing a smart investment process.
The most important thing to remember…
The future is unknowable.
We don’t get to know what will be the best investment process for the next 10, 20, or 30 years.
What’s even harder is that the process we used to build our wealth may not be the best process to live on our wealth.
•The information set forth in this document has been obtained or derived from sources believed by NKB, LLC (“The Author”) to be reliable. However, The Author does not make any representation or warranty, express or implied, as to the information’s accuracy or completeness, nor do The Author recommend that the information serve as the basis of any investment decision.
•PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE AND INVESTMENTS IN EQUITY SECURITIES DO PRESENT RISK OF LOSS.
•The strategies discussed in this presentation are not appropriate for all investors. The results shown in this presentation are hypothetical and do not represent returns that an investor actually attained.
•No representation is being made that any account will or is likely to achieve results similar to those shown.
•The content of this presentation is provided for informational purposes only, and nothing herein should be interpreted as personalized investment advice. Under no circumstances does this information represent an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction.
•None of the content in this presentation is guaranteed to be correct, and anything shown here should be subject to independent verification.
•You, and you alone, are solely responsible for any investment decisions that you make.
•The strategies discussed in this presentation are for educational purposes and are provided with the benefit of hindsight and may not perform in the future as they have historically. They do not reflect actual trading by the Author or any of the Author’s clients.
•There can be no assurance that any investment strategy or style will achieve any level of performance, and investment results may vary substantially from year to year or even from month to month. An investor could lose all or substantially all of his or her investment. Both the use of a single adviser and the focus on a single investment strategy could result in the lack of diversification and consequently, higher risk. The information herein is not intended to provide, and should not be relied upon for accounting, legal or tax advice or investment recommendations. Any investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. You should consult your investment adviser, tax, legal, accounting or other advisors about the matters discussed herein. These materials represent an assessment of the market environment at specific points in time and are intended neither to be a guarantee of future events nor as a primary basis for investment decisions.
•Investors should understand that while performance results may show a general rising trend at times, there is no assurance that any such trends will continue. If such trends are broken, then investors may experience real losses. The information included in this presentation reflects the different assumptions, views and analytical methods of The Author as of the date of this document. The views expressed reflect the current views as of the date hereof and The Author should not be expected to advise you of any changes in the views expressed herein.
•This commentary has been provided solely for informational purposes and does not constitute a current or past recommendation or an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such. This commentary should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.
•This document does not reflect the actual performance results of any investment strategy or index currently run by NKB LLC or its affiliates.
