Recovery rates and the effect of volatility on retirement success

Whitepaper

Recovery Rates
and
the Effect of Market Volatility
on Retirement Success

James L. Wiley
Edgar W. Lambert
Alexander F. Cabot, ChFC®

Recovery Rates and the Effect of Market Volatility on Retirement Success

Market volatility over the past few years has been a constant headline. The goal of this whitepaper
is to explain the effect of market volatility on the success of a retiree’s portfolio withdrawals over a
lifetime. The first section will detail some of the history of market volatility and explain how much
it has changed recently. The second section will then outline the problem as it pertains to an
investor making regular distributions from a portfolio. The final section will draw some conclusions
and present ideas on how to minimize the impact of volatility and market uncertainty on the
likelihood of success in retirement.

Day to day market fluctuations are higher now--particularly since the global financial crisis of 2008--
than they have been in years past. Since the creation of the Dow Jones Industrial Average in 1896
many days have been volatile. The past four years represent less than 3.5% of the total time since
the index’s inception. Of the top 20 worst days in the market since 1896, 4 have fallen in the past
three years1 . In other words, 20% of the worst days in the market have occurred in less than 3.5%
of the time elapsed. The only other period in the last century with daily volatility higher than what we
are seeing now was the Great Depression.

Several factors have affected the persistently high stock market volatility in recent years. Attribution
of market returns today is highly correlated to market sentiment, geopolitical news, broad macro-
economic data and investor confidence. It appears that as sentiment and confidence erode, markets
are more and more affected by news. With no clear end in sight to the uncertainty in the world
economy, it appears that higher than average market volatility will last for some time.

The problem that the market volatility presents to investors is not uniform. For an investor whose
sole priority now is accumulating assets, volatility has little effect. As long as long-term averages are
upheld, excess fluctuations in market values do not pose a problem. In fact, often portfolio volatility
can be beneficial to an investor who continually adds to a portfolio. Market dips provide improved
pricing for asset purchases--buy low and sell high. One of the only potential drawbacks for an
investor not taking distributions is the emotional reaction to market swings. Seeing a portfolio
decline by nearly 40% (as the S&P 500 did in 2008) can be a difficult experience. As long as an
“accumulation” investor can stomach the downturns, the profits in the long-run can be great.

1 Source: http://www.djindexs.com/mdsidx/downloads/xlspages/high_low_lights.xls

610-234-2100 | livemore.net | bparrish@livemore.net


The problem arises, then, when an investor is distributing assets, rather than accumulating them. The
impact of portfolio volatility on portfolio distributions can be pronounced.

In modern portfolio management, there is no magic bullet to prevent failure nor to completely
negate the effects of market volatility on success. There are, however, several ways in which
investors can try to protect themselves from its effects.

First, it is critical to plan for volatility in the markets. Regular, large market fluctuations have
become the norm, rather than the outlier. In order to effectively construct a portfolio for income
distribution, the first step is to understand that markets will be volatile. Perhaps in the coming years
daily fluctuations will return to lower, historical levels, or perhaps we have reached what some
economists have termed the “new normal.” In either case, planning for excess volatility is an
important step in long-term success. It is much easier to plan for a higher volatility market and then
adjust portfolio allocations later than to assume steady market returns indefinitely.

Broad diversification in a portfolio of assets is the first step to minimizing risk. Beyond the strategic
allocations, though, tactical adjustments and regular rebalancing can have a positive impact. Often
investors observe events leading up to excess uncertainty and fail to act.. In the face of rising
potential risks, it can be wise to make adjustments to a portfolio allocation, provided that the long-
term goals are not sacrificed. The schedule of these changes is important as well. If an investor
adjusts his portfolio once a year or at some other arbitrary temporal measure, it may have very little
or even a negative impact. The economy does not change on a set schedule. The market does not
change on a set schedule. They change when they change and investors need to be nimble and agile to
avoid risks when they present themselves and to capitalize on opportunities when they arise.

Alternative investments can also play a big role in long-term success for a retiree. Assets such as
precious metals, inflation protected bonds and commodities can add benefit to an investor’s
portfolio since their prices do not move in lock-step with the stock market. By adding assets to a
portfolio that fluctuate differently than the market, overall volatility can drop.

Below are two tables of four hypothetical year-end values for a $1,000,000 portfolio over the past
four full calendar years, the first without portfolio distributions, the second with a 4% annual
distribution adjusted each year for inflation.



Portfolio One is representative of the S&P 500. Portfolio Two is a simple, diversified blend of 60% S&P 500
and 40% BarCap Aggregate Bond Index. Portfolio Three is a more broadly diversified portfolio of 50% S&P
500, 40% BarCap Aggregate Bond Index, 5% S&P GSCI Diversified Trend Index2 and 5% Gold3.
No Portfolio Distributions:
Portfolio Starting Value $1,000,000 on 12/31/2007
Values Shown are at Year-End

When no portfolio distributions are taken during a volatile period of time, the stock market does
recover a good portion of what it loses during a downturn. The benefit of portfolio diversification
over those four years is nevertheless significant. A simple diversified mix of stocks and bonds over
that period would be worth $160,800 more than the S&P 500 portfolio, while a broadly diversified
mix of stocks, bonds and alternatives would be worth $209,000 more.

The effect is more pronounced when distributions are taken into account.

With 4% Annual Distributions Adjusted for Inflation:
Portfolio Starting Value $1,000,000 on 12/31/2007
Values Shown are at Year-End

2 The S&P DTI is an investable long/short strategy that can benefit from trends (in either direction) in the global futures markets. It
consists of 24 futures contracts, with a 50% weighting in financial futures and 50% weighting in commodities futures.

3 The sample portfolios are for illustration purposes only. Returns assumed are annualized index returns, gross of any fees. Actual
returns would be lower. You cannot invest directly in an index.



With the 4% annual portfolio distribution, the S&P 500 portfolio is worth $165,300 less than the
broad stock and bond diversification and $213,800 less than the stock, bond and alternative mix.
For a retiree distributing income over a lifetime, that difference in value over four years will have a
significant impact on expected distributions for the remainder of his or her life.

Accounting for the increased market volatility over the past few years has been challenging for all
investors, professional and otherwise. Planning for the long-term success in a distribution portfolio
takes careful attention to detail in both the planning and execution over time. The Wiley Group’s
goal has always been to minimize the short-term risks and to maximize the long-term probability of
success in distributing assets for a lifetime. If you have any questions about how the recent market
volatility may be affecting your retirement plan, please call the Wiley Group at 610-234-2100.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying
degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or
product (including the investments and/or investment strategies recommended or undertaken by Live Your Vision, LLC ), or any non-
investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding
indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various
factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or
positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of,
or as a substitute for, personalized investment advice from Live Your Vision, LLC. To the extent that a reader has any questions
regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with
the professional advisor of his/her choosing. Live Your Vision, LLC is neither a law firm nor a certified public accounting firm and no
portion of the newsletter content should be construed as legal or accounting advice. A copy of the Live Your Vision, LLC’s current
written disclosure statement discussing our advisory services and fees is available for review upon request.


Recovery rates and the effect of volatility on retirement success

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Recovery rates and the effect of volatility on retirement success