Rising Equity Glidepaths and Early Retirement
Rising Equity Glidepaths are an important consideration for those facing early retirement. You have a long horizon, so you want to be aggressive. This, however, sets you up for sequence of return risk. See my piece on Safe Withdrawal Rate in Early Retirement for more details.
If you are thinking of more of a traditional retirement, see SWR in Retirement.
There is nothing traditional about a 60-year retirement. Everything is different. Can a rising equity glidepath help you combat sequence of return risk?
Rising Equity Glidepaths
Kitces and Pfau are known names in the financial planning world. Both have studied rising equity glidepaths. That said, they admit a 60/40 portfolio is just about as good as anything else for traditional retirement.
Their model glidepath, however, has been criticized. They use a 30/70 stock to bond portfolio at retirement that increases slowly to 60/40. They do note “there’s still far more research to be done to optimize the exact shape and slope of the … glidepath.”
ERN at Early Retirement Now has done some advanced modeling for rising equity glidepaths especially for 60-year retirements.
ERN criticizes Kitces and Pfau for using Monte Carlo simulation, where he uses historical data. He goes on to say:
Unless we believe that the past observed dynamics of equity returns no longer apply in the future, we should disregard the Kitces/Pfau glidepaths because they’d likely perform worse than even most static asset allocations.
He suggests that glidepaths that increase from 60 to 100% equity rapidly are more successful over long periods.
Modeling Rising Equity Glidepaths for a Long Retirement
For the purposes of this simulation, asset allocation decreases to 60/40 five years before retirement. Sequence Of Return Risk is highest 5 years before to 10 years after a 30-year retirement. I will look at two different glidepaths. First, Glide10 increases from 60/40 to 90/10 over 10 years. I picked 90/10 rather than 100% stocks to maintain some diversification over the long haul.
Second, Glide20 increases from 60/40 to 90/10 over 20 years.
Also, future dollars will be used. Though inflation is assumed to be 2% annually, future dollar results represent the future value of present-day dollars. Sixty years is a long time for inflation and compounding to interact, and sums worth $1M now seem absurd to present eyes.
Assume a $1M portfolio is invested in US stocks and bonds. Upon early retirement at 30 years of age, a 3.5% a year withdrawal rate is used and adjusted by inflation. The simulation ends at 90 years of age; 60 years post retirement.
SORR is simulated by the actual stock and bond returns from 2000-2010. Before or after, assume stocks and bonds return 9% and 5%, respectively. I also briefly look at lower assumed returns (7% and 3.5%, respectively) below.
Results of the Models
Assuming 9% stock and 5% bond returns, let’s look at the results.
On the left, you see 4 different types of portfolios: 100% bonds, 100% stocks, 60/40, and Glide20.
On the top—when SORR starts—never, or at year 1, 6 or 11 from retirement.
How do these portfolios perform is SORR never arrives? Obviously the higher the stock allocation in a fixed increasing environment, the better. Bonds expire after 85 years, and stocks do great.
But next, let’s see what happens if you retire at the worst possible time.
SORR at Year One
What if there is a bear market at lasting three year and another big decline in year nine?
Above, the x-axis is age in years from 30-90 and the y-axis is portfolio size.
SORR at year one devastates 100% stocks (top right), but 100% bonds (top left) ends the 10-year period with $0.6M (again, future dollars).
On the bottom left is the 60/40 portfolio. Glide20 is shown bottom right.
Now you can see Glide20 has an increasing slope to the tail, and 60/40 decreases over time. Glide20 wins this round with $1.4M and the 60/40 portfolio is left with $0.2M.
What if SORR arrives later?
SORR at Year Six
What if the nasty 10-year sequence starts at year six?
As seen back in Figure 1, Glide20 is the winner again.
Note the money scale on the left is different for all of the pictures.
Again, find 100% bonds top left and 100% bonds top right. They end up with $0.4m and $2.7M respectively.
Find the 60/40 portfolio on the bottom left and Glide20 on the bottom right. 60/40 has $2.1M vs. $3.7M for Glide20.
SORR at Year 11
Looking back at Figure 1, you can see a 100% bond portfolio didn’t do very well. When SORR is delayed in a lengthy retirement, the higher the stocks, the better you do. In this case, 100% stocks returned $3M, Glide20 $2.5M, and 60/40 $2M.
What Happened to Glide10?
Glide20 beat Glide10 in all situations for both low and high expected returns aside from when SORR was not present. This is seen below.
So, Does Glide20 beat a Fixed 60/40 Portfolio?
As seen above, over a 60-year period, Glide20 beats a fixed 60/40 portfolio with no SORR, and with SORR at years 1, 6, or 11.
Can a 3.25% Rate Save the Low Return Scenario?
When I modeled SORR with low return assumptions (stocks 7% and bonds 3.5%), a 3.5% SWR did not survive any of the scenarios. Due to these depressing results, I looked at a 3.25% rate rather than a 3.5% rate.
As seen above, if SORR arrives at year 1 or 11, none of the portfolios survive. With low assumed rates of return for stocks and bonds, Glide20 does a bit better than 60/40 except with SORR arrives at year 11. It seems even a 3.25% rate can’t save a 60 year portfolio against SORR with long term low assumed rates of return.
Lesions Learned from Different Models of Rising Equity Glidepaths
In this scenario modeling different Rising Equity Glidepaths, Glide20 beat Glide10 in all scenarios with Sequence Of Return Risk. Perhaps it would be interesting to see what Glide15 does up against Glide20. Certainly, as ERN points out, a Glide30 is not ideal.
In addition, returns matter. In this scenario, assumed 7% stock/3.5% bond returns failed miserable for all portfolios with a 3.5% rate of withdrawal, and a 3.25% rate didn’t really help this much. However, when returns were assumed to be 9% for stocks and 5% for bonds, all portfolios did much better. As we know, small changes over large periods of time results in large improvements in outcome.
In this scenario, both Glide10 and Glide20 beat a fixed 60/40 portfolio.
A rising equity glidepath for early retirement may be just the ticket.