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Fixing Fixed Income: Systematic Withdrawals

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Where the DRS Fits: The Case for the DRS as a Systematic Withdrawal Vehicle

In a pre­vi­ous blog post, we com­pared the risk-return char­ac­ter­is­tics of the Swan Defined Risk Strat­e­gy (DRS) against tra­di­tion­al and alter­na­tive bond strate­gies. The idea was to illus­trate how the DRS, with its focus on cap­i­tal preser­va­tion, has per­for­mance met­rics sim­i­lar to the mul­ti-sec­tor and non-tra­di­tion­al bond funds that have been mak­ing their way into investor port­fo­lios.

But beyond cap­i­tal preser­va­tion, what about the oth­er role bonds have tra­di­tion­al­ly per­formed with­in a port­fo­lio, that of pro­duc­ing income?  Since the Finan­cial Cri­sis, it has been the lack of yield in tra­di­tion­al fixed income that had pushed investors to mul­ti-sec­tor and non-tra­di­tion­al bonds in the first place.

 

Reconsidering Ways to Generate Income or Cash-Flow

We live in a low-yield envi­ron­ment spawned by a “new nor­mal” of world­wide mon­e­tary pol­i­cy focused on stim­u­lat­ing with ultra-low or even neg­a­tive inter­est rates and mas­sive liq­uid­i­ty injec­tions into the finan­cial sys­tem. Con­se­quent­ly, bonds will be hard pressed to pro­vide the same return streams going for­ward as they have over the past 35+ years. In this new invest­ment land­scape,  savers and retirees are starved of yield (income). This will require investors and advi­sors to recon­sid­er how to gen­er­ate the nec­es­sary cash flow in retire­ment.

Sys­tem­at­ic with­drawals are an option, pro­vid­ed investors min­i­mize expo­sure to major loss­es in bear mar­kets, as explained in our post “Suf­fer­ing from With­drawals.”  How­ev­er, an invest­ment strat­e­gy that can min­i­mize large loss­es and gen­er­ate con­sis­tent returns over mar­ket cycles may sus­tain sys­tem­at­ic with­drawals.  While investors and advi­sors alike may also strug­gle with the notion of active­ly with­draw­ing funds ver­sus clip­ping a coupon, the real­i­ty of our low-yield envi­ron­ment is neces­si­tat­ing a change in per­cep­tions for how to gen­er­ate sus­tain­able cash-flow in retire­ment.

 

So How Does the Swan DRS Perform as a Systematic Withdrawal Vehicle?

Because the DRS has his­tor­i­cal­ly been lim­it­ed to sin­gle-dig­it loss­es in its worst years and has had mean­ing­ful par­tic­i­pa­tion in up mar­kets, one could make the case it ful­fills the role of a dis­tri­b­u­tion vehi­cle in a port­fo­lio.

To be clear, the DRS does not gen­er­ate yield like a tra­di­tion­al bond fund with a month­ly dis­tri­b­u­tion. Instead, the DRS can be used with­in a sys­tem­at­ic with­draw­al plan.

His­tor­i­cal­ly, one could have safe­ly liq­ui­dat­ed a per­cent­age of their DRS hold­ings to gen­er­ate cash and yet not endan­ger prin­ci­pal. In fact, if some­one imple­ment­ed a sys­tem­at­ic with­draw­al plan with the DRS at its incep­tion, the prin­ci­pal val­ue of a DRS invest­ment still grew.

Setting the Scene

Let us walk through a sim­ple, hypo­thet­i­cal sce­nario:

  • Our ini­tial invest­ment of $1 mil­lion dol­lars invest­ed is made on Jan­u­ary 1st, 1998.
  • We have three invest­ment options: the DRS, the S&P 500, and a bal­anced port­fo­lio of 60% S&P 500 and 40% Bar­clays US Aggre­gate.
  • We take out $5,000 on a month­ly basis with an ini­tial annu­al with­draw­al rate of 6%
  • We com­pound the with­drawals by an annu­al infla­tion rate of 2%.

Due to infla­tion, the orig­i­nal $60,000 with­draw­al grows to $85,695 by the end of 2016.

At the end of the sim­u­la­tion on Decem­ber 31st, 2016, an aggre­gate $1,370,434 had been with­drawn from each option.  How­ev­er, the end­ing val­ues were quite dif­fer­ent:

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Ending Value Comparison Table - Where the DRS Fits Blog Series: DRS as a Distribution Vehicle, Part 2

Source: Zephyr StyleAD­VI­SOR and Swan Glob­al Invest­ments. *Based on his­toric per­for­mance of the Swan DRS SMA Select Com­pos­ite, peri­od from Jan­u­ary 1998 through Decem­ber 2016. Indices are unman­aged and can­not be invest­ed into direct­ly. Past per­for­mance is no guar­an­tee of future results.

How is this pos­si­ble?  How can the end­ing val­ues be so dif­fer­ent? Let’s take a look at each invest­ment bro­ken out on a year-by-year basis start­ing with the S&P 500.

Systematic Withdrawals and the S&P 500

In the graph below, the red/burgundy lines rep­re­sent the year­ly sys­tem­at­ic with­drawals of $60K, com­pound­ed by the 2% annu­al infla­tion rate. These will always be neg­a­tive. The blue bars rep­re­sent the unre­al­ized gains and loss­es on the account.

While usu­al­ly stat­ed in per­cent­age terms, here we see gains and loss­es stat­ed in terms that most peo­ple care about: dol­lars gained or dol­lars lost.

Final­ly, the gold line rep­re­sents the val­ue of the account.

Withdrawals from S&P 500 - Where the DRS Fits Blog Series: DRS as a Distribution Vehicle, Part 2

Source: Zephyr StyleAD­VI­SOR & Swan Glob­al Invest­ments. Indices are unman­aged and can­not be invest­ed into direct­ly. Past per­for­mance is no guar­an­tee of future results. The charts and graphs con­tained here­in should not serve as the sole deter­min­ing fac­tor for mak­ing invest­ment deci­sions.

When some­one says the S&P 500 lost 37% in 2008, what does that real­ly mean?

In the con­text of this sce­nario, the $312,352 loss­es in the account in 2008 rep­re­sents over four years of spend­ing. The three-year bear mar­ket of 2000-02 was arguably worse since it last­ed longer and the mar­ket took longer to recov­er. The unre­al­ized loss­es were $485,097 and with­drawals of $191,042 were tak­en out over those three years.

Although mar­kets did ral­ly between 2003 and 2007, the port­fo­lio had been seri­ous­ly impaired by the long bear mar­ket.

Is a bull mar­ket enough to cov­er these loss­es?

The above analy­sis is sober­ing.  Please keep in mind that the cur­rent U.S. bull mar­ket is the sec­ond longest on record, and the S&P 500 is up over 300% since March 9, 2009. How­ev­er, if one were to look at the gold line through that peri­od, it is essen­tial­ly flat.  From 2009 to 2016 the unre­al­ized gains were $537,987 while with­drawals were $640,311.

Through this amaz­ing bull mar­ket, the port­fo­lio was essen­tial­ly tread­ing water.

Systematic Withdrawals from the 60/40 Balanced Portfolio

Withdrawals from 60/40 | Where the DRS Fits Blog Series: DRS as a Distribution Vehicle, Part 2

Source: Zephyr StyleAD­VI­SOR & Swan Glob­al Invest­ments. Indices are unman­aged and can­not be invest­ed into direct­ly. Past per­for­mance is no guar­an­tee of future results. The charts and graphs con­tained here­in should not serve as the sole deter­min­ing fac­tor for mak­ing invest­ment deci­sions.

The sto­ry isn’t much dif­fer­ent with the bal­anced 60/40 port­fo­lio. Although the highs aren’t as high and lows aren’t as low, the gen­er­al pic­ture remains the same.

A “glass-half-full” opti­mist would argue that the port­fo­lio has main­tained a fair­ly aggres­sive lev­el of with­drawals and is hold­ing up well dur­ing the dis­tri­b­u­tion stage. Con­verse­ly, a “glass-half-emp­ty” pes­simist would won­der how many more years of spend­ing the port­fo­lio could main­tain and would be right­ful­ly fright­ened of anoth­er bear mar­ket sell-off.

Systematic Withdrawals with the Defined Risk Strategy

Withdrawals from DRS | Where the DRS Fits Blog Series: DRS as a Distribution Vehicle, Part 2

Source: Zephyr StyleAD­VI­SOR & Swan Glob­al Invest­ments. Indices are unman­aged and can­not be invest­ed into direct­ly. Past per­for­mance is no guar­an­tee of future results. DRS results are from the Select Com­pos­ite, net of fees, as of 12/31/2016. The charts and graphs con­tained here­in should not serve as the sole deter­min­ing fac­tor for mak­ing invest­ment deci­sions.

Final­ly, we see the same sce­nario using the Defined Risk Strat­e­gy. In the 19 years of this study, the DRS Select Com­pos­ite has only had four years of loss­es and the aver­age unre­al­ized loss dur­ing those years was $46,499.

The worst cal­en­dar year in the DRS’s his­to­ry was 2011 when it was down -5.4%. Dur­ing that year, the unre­al­ized loss ($76,154) was rough­ly equal to one year of spend­ing ($77,616).

Most impor­tant­ly, the DRS was able to grow its account val­ue through­out the course of this sim­u­la­tion while main­tain­ing the same lev­els of with­drawals as the S&P 500 and the 60/40.

How Do the Three Compare?

The final graph below com­pares the account val­ue of these three options against each oth­er.

Withdrawals Comparison Graph Where the DRS Fits Blog Series: DRS as a Distribution Vehicle, Part 2

Source: Zephyr StyleAD­VI­SOR & Swan Glob­al Invest­ments. Indices are unman­aged and can­not be invest­ed into direct­ly. Past per­for­mance is no guar­an­tee of future results. DRS results are from the Select Com­pos­ite, net of fees, as of 12/31/2016. The charts and graphs con­tained here­in should not serve as the sole deter­min­ing fac­tor for mak­ing invest­ment deci­sions.

 

 

Continuing the Conversation

The Swan DRS can serve var­i­ous roles in a port­fo­lio. We have made the case for how this unique invest­ment approach can serve investors look­ing to accu­mu­late wealth and those need­ing cash-flow or dis­tri­b­u­tions to live on in retire­ment. We will con­tin­ue the Where the DRS Fits blog series in future posts exam­in­ing how the Swan DRS can be applied to mul­ti­ple asset class­es.

The Defined Risk Strat­e­gy was built around the prin­ci­ples out­lined by Mic­ah Wake­field in his white paper “Math Mat­ters.”  In this paper, Mic­ah iden­ti­fies four key fac­tors to an investor’s suc­cess:

  1. Mag­ni­tude of com­pound­ing return
  2. Min­i­miz­ing draw­downs
  3. Mit­i­gat­ing volatil­i­ty
  4. Man­ag­ing the shape of the dis­tri­b­u­tion

It is our belief that by build­ing a strat­e­gy around these four key con­cepts not only improves returns but also, ulti­mate­ly, improves wealth.

 

Feel free to review more infor­ma­tion on the Defined Risk Strat­e­gy per­for­mance, or its com­po­nents, or call 970.382.8901.

For more infor­ma­tion on the Defined Risk Strat­e­gy per­for­mance, call 970.382.8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout 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.

 

 

Impor­tant Dis­clo­sures:

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 Glob­al Invest­ments offers and man­ages the Defined Risk Strat­e­gy for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. All Swan prod­ucts uti­lize the Swan DRS but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS  prod­uct  offer­ings  will  have  dif­fer­ent  per­for­mance  results  and  com­par­ing  results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. Indices are unman­aged and can­not be invest­ed into direct­ly.  Past per­for­mance is no guar­an­tee of future results.  DRS results are from the Select Com­pos­ite, net of fees, as of 12/31/2016. The charts and graphs con­tained here­in should not serve as the sole deter­min­ing fac­tor for mak­ing invest­ment deci­sions. Hypo­thet­i­cal per­for­mance analy­sis is not actu­al per­for­mance his­to­ry. Actu­al results may mate­ri­al­ly vary and dif­fer sig­nif­i­cant­ly from the sug­gest­ed hypo­thet­i­cal analy­sis per­for­mance data. This analy­sis is not a guar­an­tee or indi­ca­tion of future per­for­mance. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non­qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997 and are net of fees and expens­es. All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request.

The bench­marks used for the DRS Select Com­pos­ite are the S&P 500 Index, which con­sists of approx­i­mate­ly 500 large cap stocks often used as a proxy for the over­all U.S. equi­ty mar­ket, and a 60/40 blend­ed com­pos­ite, weight­ed 60% in the afore­men­tioned S&P 500 Index and 40% in the Bar­clays US Aggre­gate Bond Index. The 60/40 is rebal­anced month­ly. The Bar­clays US Aggre­gate Bond Index is a broad-based flag­ship bench­mark that mea­sures the invest­ment grade, US dol­lar-denom­i­nat­ed, fixed-rate tax­able bond mar­ket. The index includes Trea­suries, gov­ern­ment-relat­ed and cor­po­rate secu­ri­ties, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). 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 advisor’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advi­sor 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. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970.382.8901 or vis­it swanglobalinvestments.com.  159-SGI-062817

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By | 2017-08-17T16:55:24+00:00 June 29th, 2017|Blog|Comments Off on Fixing Fixed Income: Systematic Withdrawals

About the Author:

As Director of Investment Solutions, Marc 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.