When it comes to wealth accumulation, many are a fan of Harry Browne’s Permanent Portfolio. Recently I wrote about it here.
One of the main take away from my article yesterday on how do you make $500,000 last for 60 years by withdrawing an initial amount of 5% of the portfolio was that high volatility is not very desirable when it comes to spending down our wealth.
So naturally, the permanent portfolio comes to mind a portfolio that is made up of components very uncorrelated that reduce the overall volatility.
If we revisit the table of portfolios recommended by famous experts the PERM and Risk P have the lowest standard deviation, lowest maximum draw down (MaxDD), good risk adjusted returns (Sharpe).
So how would they do in Timeline App?
I try to fix as much of the variables as yesterday’s base case, with only modification to the portfolio allocation:
- I have a wealth of $500,000 that I wish to live off of
- I want to see if I can start off spending $25,000 for the first year of my financial independence. This is 5% of my initial wealth of $500,000 (we call this an initial withdrawal rate of 5% versus the 4% withdrawal rate)
- For subsequent years, I increase and decrease the $25,000/yr based on the inflation rate. If inflation is +4%, it will be the previous years’ spending x (1-0.04) and if inflation is -2%, then it is previous years’ spending x (1-(-0.02)). I will maintain my purchasing power (inflation adjusted)
- I invest in a portfolio of 25% Global Equities, 25% Global Aggregate Bonds, 25% Cash, 25% Gold
- I have factored in 0.75% total all in cost for this portfolio. This is to simulate expense ratios, commission or sales charges, investment platform asset under management and platform fees
- The portfolio will be re-balanced once a year every year
- Assume I am 40 years old, and I need the money to last till 100 years old. That is a duration of 60 freaking long years
- In terms of withdrawal, I will withdraw evenly from my portfolio allocation. So this means that for each year, I will withdraw equally from equities and aggregate bonds
- There will be no taxes factor in
- I will adjust my withdrawals for inflation every year
- I will not implement any Dynamic spending rules. Dynamic spending rules are periodic systematic spending shifts due to portfolio and spending changes in order to ensure the wealth last longer
- No minimum withdrawal floor will be set. This means that I did not set a particular annual real spending amount say my spending will at least need to be $12,000 a year and it cannot fall below that
- I factor in no government pension plans like CPF Life
So what is in red is the main difference.
Disappointingly, the 10th percentile portfolio depletes at age 60 or 20 years later.
To recap, this was the original base case:
It seems the original 50% Global Equities and 50% Bonds portfolio at 10th percentile did better.
In some of the least likely cases, at least the 50/50 portfolio was able to sustain till more than 90 years old.
In a lot of the parallel universe, the permanent portfolio was not able to last that well.
The Success Rate of 1% is very low.
What could be the culprit here?
I can think of four:
- The 5% initial withdrawal rate is too high! Even for a low volatile portfolio
- Lower overall returns versus a 50/50 portfolio
- “High fee” of 0.75%
- Cash Drag. 25% of the portfolio is in cash. If we talk about probability of occurrence for all the 4 different asset classes in the permanent portfolio, most of the time equities have been performing better than the rest, so if you have 25% in cash, it might be inefficient
We can explore bringing down the initial withdrawal rate to 4%.
The author in my REITs article explored whether we can do away with the cash component to have 1/3 in equities, 1/3 in bonds, 1/3 in gold.
We can do that.
And we can hypothetically reduce the fee to say 0.25%.
So this is closer to the standard 4% Withdrawal Rate.
The success rate improved from 1% to 27%.
For the 10% percentile, we see an improvement to the base case yesterday. The 10th percentile of the base case yesterday depletes at age 64 while for this it depletes at age 71.
But for most cases, you do see that the shape is not a “Fan” shape but a downward slope.
It is as if the portfolio is a continuous portfolio amortization.
This ultimately did better perhaps due to a 4% withdrawal rate versus 5%.
If I had use 5%, the 10th percentile depletes at age 63 years old, which is slightly worse than the base case yesterday.
What if we use USA Equities and Bonds?
I got a hunch it might be due to the lower returns in the countries that is not USA. This might be strange since these countries should be more risky, and thus the returns might be higher.
So I changed Global Equities and Bonds to USA.
In terms of the 10% percentile, the wealth actually lasted WORSE than the Global Equities. Median result also showed it actually fared worse.
But the main benefit is you see the spectrum of results “fan out”. This means there are more sequences that your portfolio would last longer.
Some Possible Lesson Learnt
I would have thought the low volatility component would help a lot but apparently it didn’t help the portfolio to last 60 years.
It struggle to last even the standard 30 years.
Firstly, it is damn difficult to make the money last 60 years!
I think one of the reason might be you need a high enough volatility adjusted rate of return.
The amount you withdraw in the initial year is the biggest impact.
It goes back to how much you withdraw in the first year. If you take out too much, based on a lot of historical sequences, your money might run out.
I ran a few more simulation. The solution should be flexible withdrawal spending strategies as I use in the previous article.
In the case of the permanent portfolio it did not help much because perhaps, that will work better in a higher volatility portfolio.
Oh well, back to the drawing board.
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Monday 27th of May 2019
Not surprising results. The low returns from cash (obviously) and gold (long periods historically -- it's main aim is to preserve purchasing power afterall) work against decumulation.
For such portfolios, withdrawals should be more from cash & gold & maybe bonds first. Try not to touch the equities (it's already only 25% allocation!). During market down years, rebalance from low-vol assets into the cheaper equities.
The permanent-style portfolios aim is mainly to support good behaviour by reducing volatility, while still achieving typical balanced portfolio returns --- so that man-in-the-street investors don't self-sabotage e.g. throw in the towel at market bottoms, stop contributing whenever news & headlines cause portfolio to drop by 10% or more.
The larger returns from equities still required to provide longer term decumulation support. The problem is always the 1st few years of bad sequence risk.
So either 3% withdrawal.
Or to start decumulation phase with high % of low-vol assets & then slowly shift to higher equity % over 5-7 years. Basically the see-saw approach. But may need to start with slightly higher portfolio size than normal (e.g. 10% bigger) to balance the lower returns in the initial years.