Portfolio, Quant Investing, Retirement

A better retirement through quantitative investing

Today I finally get around to doing something I mentioned way back in my first post on quantitative investing. Quant portfolios can help an investor handily beat the market over time and often with even lower risk. If that is the case then how could they impact safe withdrawal rates (SWRs) in retirement? Lets find out.

I’ve sort of already shown the effect of quant or automatic investing systems on SWRs in my posts on the various flavor of the IVY portfolios. For example, you can more than double your SWR with certain versions of the IVY portfolios. Beyond the basic buy and hold versions, the IVY portfolios are just different versions of quant systems in which whole asset classes and ETFs are used instead of individual stocks. In the IVY systems the quant metrics just happen to be trend following and momentum for the whole asset class. But I warned that the attractive SWRs from the IVY portfolios were too good to be true because the historical data did not encompass the worst period to retire in history, 1966, which defines the worst case SWRs. I want to extend that analysis of SWRs to quantitative systems using individual stocks I’ve discussed here before, namely the trending value portfolio and the combined consumer staples/utilities portfolio. These portfolios exhibit very high risk adjusted returns. Also, maybe the best part, is that we have historical data that encompasses 1966, the worst case retirement period which allows a very valid comparison to traditional retirement portfolios. OK, lets get to it.

First thing to be done is to re-run the standard stock, bond retirement portfolio (SP500) data for the period studied which is 1964 to 2013. Then do the same for the trending value (TV) portfolio and the consumer staples/utilities portfolio (XLP/XLU). Diversified portfolios are constructed with the US 10 year note. Below is a comparison of the SWRs for different stock bond allocations for the three portfolios.

SWRs for SP500 TV XLPXLU Portfolios Sep 2014

Although it’s not my purpose here, note that when you remove the great depression from the data set that even for the SP500 portfolios SWRs rise along with allocation to stocks. This is not the case when you include the great depression where the SWR falls off after its peak at 70% stocks 30% bonds. Probably a whole other topic for another day where I’ll muse about institutional learning, the rise of fiat monetary systems and the like. But for now lets just say there is not much incremental benefit for SWRs beyond 60/40. At 60/40 look at the increase in SWRs from both the quantitative portfolios; 6.39% SWR for the XLP/XLU portfolio and 7% SWR for the TV portfolio. Pretty darn good. But what about the two other retirement portfolio metrics I like to look at; maximum drawdown and average end wealth? I present those two tables below.

Max DD and AEW for SP500 TV XLPXLU Portfolios Sep 2014

MaxDD in the top table is the maximum drawdown, peak portfolio value to trough portfolio value, on an annual basis. It is the same as the worst year if there is only one down year. In the case of multiple down years it represents the compounding of those bad years after retirement withdrawals which is what matters most. $AEW is the Average Ending Wealth, or ending portfolio value, of all the 30 year retirement periods in the analysis. This is the value of the portfolio you could potentially bequeath to your family and/or charities. The quant portfolios deliver on these metrics as well. Those high SWRs in the first table come with lower drawdowns and more wealth on average across the board. Again great news across the board.

In the MaxDD and $AEW table I highlighted the 30% stocks, 70% bond rows for a good reason. The more and more I talk to retired investors the more I think that SWR is not the parameter that most retirees should try to maximize. Losses or drawdowns are what gives retired investors the most fits and more importantly is what most often derails their investment plans which leads to very poor investment results. Keeping that in mind I highlighted in the MaxDD table a level that I think most investors can tolerate, less than 10% peak to trough loss on a yearly basis. That level is at a 30% stock 70% bond allocation for the various portfolios. With the quant portfolios even at that conservative allocation level you can support an SWR of over 5% and at the same time end your retirement with an average wealth that is almost as great as a 100% stock allocation if you were just using the SP500 for your equity investments. This is an example of what Larry Swedore calls ‘low-beta, high tilt’ portfolios where in you use the bond allocation to control beta or risk (i.e. drawdowns) to a tolerable level and use a ’tilt’ to factors that increase return such as small cap, value, and momentum. This is just one example. You can choose your own optimal allocation based on your preferences.

In summary, quantitative portfolios can significantly improve the important metrics of retirement portfolios; SWRs, maximum drawdown or loss, and average ending wealth. Or at a minimum they can vastly improve the odds of a successful retirement even at very conservative SWRs or equity allocations.

Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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9 thoughts on “A better retirement through quantitative investing

  1. Very thorough analysis with keen observations about Max DD. I am 2 years to retirement and have already found myself thinking more about drawdowns than returns, which is why my core is IVY GTAA. My 25% allocation to Trending Value will reach the 1 year mark tomorrow, but unfortunately it just started underperforming (down from 19% to 13%) the S&P (16%) within the past week . I still haven’t lost faith in it though and I know the other TV portfolios for this year have outperformed the S&P.

    1. Thanks Jeff. BTW, The Russell 2000, IWM is a more appropriate benchmark for the Trending Value portfolios. If you want to mimic more large cap characteristics there are other quant ports that are more suitable. Also, base rates for any quant port over 1 year periods are always way below 100%.

  2. The MaxDD concept is quite insightful. Thanks for presenting this alongside $AEW and SWR for various allocations. Surprised MaxDD isn’t more common in the literature–as you stated it would tend to be what could cause one to abandon their AA at the wrong time.

    Off-topic but what’s your opinion on including SSI NPV, Annuity NPV and Housing Equity (shelter annuity) as “bonds” in asset allocation? This would make holding more stocks more palatable. (BTW Bogle recommends categorizing SSI NPV as bonds; with Bonds = Age.)

    1. Hey Bob,

      Your comment had ended up in my spam folder. Sorry about that.

      On the annuity and SSI, I prefer to include them as additional cash flows, sources of income, in later years, in my retirement models – rather than NPVs. As long as they are single premium or deffered annuties. For some it may make holding more stocks more palatable but that has not been my experience. People react to the volatile part of the portfolio. I’ve seen people with mere 20% equity allocations panic like it meant their retirement was over…

      As for housing, I do include housing equity in my asset allocation, especially since I don’t live in it. I could see going either way with this depending on one’s plans for the home.


    1. Hi John, yes, that is what the historical data shows. BIV should perform slightly better over the long run than intermediate gov’t bonds as well.
      As with all these things, history is only a guide. I also think its important to maintain flexibility in spending just in case the future is not like the past.


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