Is Your Portfolio Suffering from Withdrawals?
When analyzing the performance of money managers, the industry standard assumes a single investment is made at the start of a period and that no additional deposits or withdrawals are made. Cash flows in or out of an investment are assumed to be outside of the control of a portfolio manager, and therefore shouldn’t be used to judge the effectiveness of a portfolio manager’s investment skills. This methodology is known as time weighted returns.
However, when analyzing the suitability of an investment for an actual individual, how realistic is it to assume that the investor makes no contributions or withdrawals over a span of five, ten, or twenty years? In the real world, most investors are either in the accumulation or distribution stages, where contributions or withdrawals are indeed occurring. How much can cash flows impact the financial well-being of an investor?
Tackling the Distribution Challenge
In this example, we will consider an investor with a starting portfolio value of $1 million and invested between January 1st, 1998 and December 31st, 2014. We explore three investments alternatives, namely:
- The broad U.S. equity market, as represented by the S&P 500 Index
- The average target date fund positioned for the time frame of 2000–2010. Such a portfolio is designed for an investor at or near retirement during the time frame analyzed
- The Swan Defined Risk Strategy Select Composite.
In the first case, we assume a single investment with no cash flows; the standard, sterilized time-weighted return analysis.
Source: Zephyr StyleADVISOR, Swan Global Investments
In the above case, because all have positive average annual returns over the 17 years and no withdrawals are taken, the ending value of the investment is significantly higher than the initial investment.
Withdrawing Income Changes the Picture
But what if the investor is retired and in the distribution stage? What if the investor takes out $50,000 at the end of every year and grows that by 3% a year to account for inflation? What impact would that have on the investment?
Source: Zephyr StyleADVISOR, Swan Global Investments
As one can see here, this can have an extreme impact on the value of an investment.
For the retiree, bear markets are no longer a golden buying opportunity. An investor in the distribution stage of their life cycle is forced to liquidate holdings at a market low.
- If the market sells off 45% over the course of three years, like it did in 2000–2002, the principal left to make a recovery will be much diminished if the investor was taking out an additional 5% each year to meet living expenses.
In other words, withdrawing funds in a bear market just makes the hole deeper. This is can be thought of as the opposite of “the miracle of compounding returns.”
By design, the DRS was meant to minimize losses. One of the core beliefs of Swan Global Investments is that the best way to make money is to not lose it in the first place. This is especially important for those investors in the retirement stage, drawing down their accounts to fund living expenses. That is why the DRS always hedges the portfolio against catastrophic market losses.
To learn more about Swan’s DRS investment approach and how this approach has fared in the past, please contact Swan at 970–382-8901.
About the Author:
Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions, is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy. Formerly, Marc was the Director of Research for 11 years at Zephyr Associates.
S&P 500 — The S&P 500 Index is a market cap weighted index of 500 widely held stocks often used as a proxy for the overall U.S. equity market.
Swan Global Investments, LLC is a SEC registered Investment Advisor that specializes in managing money using the proprietary Defined Risk Strategy (“DRS”). SEC registration does not denote any special training or qualification conferred by the SEC. Swan offers and manages the DRS for investors including individuals, institutions and other investment advisor firms. Any historical numbers, awards and recognitions presented are based on the performance of a (GIPS®) composite, Swan’s DRS Select Composite, which includes non-qualified discretionary accounts invested in since inception, July 1997, and are net of fees and expenses. Swan claims compliance with the Global Investment Performance Standards (GIPS®). All data used herein; including the statistical information, verification and performance reports are available upon request. The S&P 500 Index is a market cap weighted index of 500 widely held stocks often used as a proxy for the overall U.S. equity market. Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index. Swan’s investments may consist of securities which vary significantly from those in the benchmark indexes listed above and performance calculation methods may not be entirely comparable. Accordingly, comparing results shown to those of such indexes may be of limited use. The adviser’s dependence on its DRS process and judgments about the attractiveness, value and potential appreciation of particular ETFs and options in which the adviser invests or writes may prove to be incorrect and may not produce the desired results. There is no guarantee any investment or the DRS will meet its objectives. All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is not a guarantee of future results and there can be no assurance, and investors should not assume, that future performance will be comparable to past performance. All investment strategies have the potential for profit or loss. Further information is available upon request by contacting the company directly at 970–382-8901 or www.swanglobalinvestments.com 061-SGI-111915