Higher withdrawal rates via diversification & timing

In an earlier post I introduced a method to time the market, based on the 200-day moving average, that produced higher investment returns, lower volatility, and lower drawdowns than a buy and hold portfolio. As I’ve stated here many times lower drawdowns (max principal loss in any period) is critical for retirement portfolios. The fact the retirees need to make withdrawals every year, no matter what the market is doing, makes principal protection just as important as investment returns.

For this post I wanted to know, can you have your cake and eat it too? Can you have higher investment returns and higher safe withdrawal rates by using proper diversification and market timing? I ran the numbers for portfolios from 1973-2008. Unfortunately, most of the ETFs used for the diversified portfolio were not available before 1973. I used 4 different portfolios; 100% US stocks (S&P500), a traditional 60/40 Stock-Bond retiree portfolio, a buy and hold 5 asset class diversified portfolio, and timing the 5 asset class diversified portfolio. The 5 asset class portfolio is evenly split between US stocks, International stocks, US bonds, US real estate, and commodities. Lets look at the portfolio statistics first:

As the chart shows, as far as investment returns go, you CAN have your cake and eat it too. Not only did the timing portfolio have the highest return but it also had the lowest volatility (risk) and the lowest drawdown (least worst year). By the way, the worst year for all these portfolios during this time period was 2008. I’d say these are pretty impressive results – they not only show the power of diversification, but also of timing. But do these results translate to higher withdrawal rates (SWRs) for retirees? Lets look at the results:

The SWR for the traditional retiree portfolio during this period (1973-2008) was 5.33%. This is higher than the SWR for longer time periods due to avoidance of the awful years of the great depression and the mid 60s combination of high inflation and poor stock market returns. The chart also shows the powerful effect of diversification. By diversifying among the 5 asset classed mentioned the SWR increases to 6.19% or a 16% increase. And adding timing to the diversification increases the SWR further to 6.78% or a further 10% increase. So, diversification and timing could increase retirement withdrawals by 26%. Such an increase would provide many retirees a much more comfortable retirement or similarly allow more people to retire earlier with less assets.

Now, there are some caveats to this analysis. The data set is limited. The data only goes back to 1973. The biggest effect of this is that it limits the number of 30 year retirees portfolios to run the data against. This makes me take the absolute SWRs with a grain of salt. I think its more prudent to use the percent increase in SWRs for the impact proper diversification and timing can have. In this case I would take the 4% SWR that has been tested back to 1900 and apply the 26% increase in SWR due to diversification and timing. That would take the SWR to 5.04%.

There is a lot of work that has not been done on retirement withdrawal rates. Maybe as more boomers start to enter retirement more emphasis will be put in this area. The two biggest issues with withdrawal rate studies are that they do not take into account proper diversification and they don’t take into account the impact of negative returns on retirees and options to avoid that impact. I hope this and other post of this topic show that a retiree has many options to increase their withdrawal rates in retirement.

In conclusion, stay diversified and watch those negative returns! You’ll be better off no mater how you structure your retirement.