Welcome to The Drawdown Protocol

This Number Crunch Nerds official quiz has been designed to test your knowledge of cashflow planning concepts that could SIGNIFICANTLY impact the resilience and longevity of your portfolios in retirement.

Question 1:

John and Mike each start their 30 year retirements with a $1 million dollar portfolio inside of a taxable brokerage account (i.e. there are no tax advantaged retirement accounts to consider in this example). The table below compares information about their returns and distributions. Ignoring income taxes, which person will generally have the largest portfolio balance at the end of the 30th year? Note that "ROR" in the chart below means "Rate of Return."

Reveal Answer to Question 1

Mike's portfolio is likely to have a larger balance at the end of the 30 years.

The planning concept in question here is Sequence of Returns. Despite having (1) a higher average ROR, (2) a larger ROR in any single year and (3) a larger ROR in a larger number of years, John's portfolio is still likely to sustain a worse outcome due to a combination of two factors: (a) negative returns in earlier years, combined with (b) consistent distributions in down markets.

Said more simply, when losses coincide with ongoing withdrawals, each distribution forces the sale of more shares at depressed prices, permanently shrinking the base available for recovery.

To address this issue, we will develop an appropriate Bucketing Strategy within the FRPC Program, based on your facts & circumstances, in order to manage cashflow needs in down markets while simultaneously minimizing withdrawals from accounts with significant down-market exposure.

Question 2:

Jane and Susan each have a $1 million dollar portfolio inside of a taxable brokerage account at the start of their retirement. Assume that right after they each retire, the market enters a wild 5-year period where it oscillates as follows:

Jane's withdrawal strategy calls for 5% of Portfolio Value annual distributions (i.e. Fixed Percentage Distributions), while Susan's withdrawal strategy calls for a $50,000 dollar annual distribution (i.e. Fixed Dollar Distributions).

Based on this fact pattern, (1) identify what financial concept each person is prioritizing with their withdrawal strategy and (2) identify which person is ahead at the end of Year 5. Ignore the effect of income taxes in your analysis.

Reveal Answer to Question 2

In this fact pattern, Jane is prioritizing Income Predictability while Susan is prioritizing Portfolio Sustainability.

Fixed Dollar Distributions prioritize budgeting and lifestyle consistency.

Fixed Percentage Distributions prioritize portfolio resilience and longevity.

Based on your facts & circumstances, it may not be practical to simply "choose one or the other." That's why in the FRPC program, we will consider distribution strategies that follow a Guardrails Approach, which attempts to balance budget and lifestyle requirements with portfolio resilience.

Regarding which person is "ahead" in this strategy. They are both ahead. It just depends on what we are referring to. Jane is ahead in that she received $50,000 x 5 years = $250,000 cash in hand, while Susan was forced to make budget and lifestyle sacrifices due to lower distributions. Alternatively, Susan is ahead in that her portfolio is worth $72,623 more than Jane's portfolio at the end of the 5 year period.

Neither the Fixed Dollar Approach nor the Fixed Percentage Approach are "right." They are only right or wrong based on your facts & circumstances.

Question 3:

Paul and Jerry each start their 30 year retirements with a $1 million dollar portfolio inside of a taxable brokerage account. They have both been listening to the Talking Heads who have been yelling that there is a lot of uncertainty in the market right now. Paul believes Sequence Risk may be high over the first few years of retirement and therefore decides on a conservative portfolio allocation between equity and fixed income.

Jerry also believes Sequence Risk may be high. But Jerry argues that an aggressive portfolio will recover any losses quickly and therefore Sequence Risk doesn't matter. Both of their starting allocations are shown in the table below.

Assume that the market experiences the rates of return below over the first 10 years of retirement. Further assume that both Paul and Jerry take distributions of $60,000 in Year 1 and increase that amount annually by 4%. Ignore income taxes.

(1) At the end of Year 10, which person will have the greater portfolio value? (2) What is the financial planning concept being demonstrated by this example?

Reveal Answer to Question 3

Under this fact pattern, Paul's portfolio will have the greater value at the end of Year 10.

The planning concept in question here is Sequence Risk Amplification through Equity Concentration in Early Retirement.

Both Paul and Jerry invested in the same markets and saw the same market returns. But their portfolio weighting choices in early retirement, combined with sequence of returns risk led to significant differences in the value of their portfolios (and probably their ability to sleep comfortably at night). After 10 years, Jerry's portfolio had still not recovered enough value to be in excess of Paul's portfolio, despite the greater equity exposure for 8 years of 15% compounding returns.

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Question 4:

Emma and Olivia each have a $1 million dollar portfolio inside of a taxable brokerage account at the start of their retirement. They are both trying to decide between (a) two portfolio weighting options based on (b) two possible ROR on equity scenarios in the market for the next ten years. The choices they are facing are summarized below.

In the scenarios above, whatever percentage is not weighted to equity, will be weighted to fixed income. And the ROR on fixed income will be a flat 3% for all 10 years of the example.

Both Emma & Olivia will take an annual distribution in Year 1 of $50,000 and the amount will increase annually by 4%. Ignore the effect of income taxes. There goal is to select the Weighting Option which ensures that their portfolio will have at least $500,000 remaining at the end of Year 10, regardless of which Equity ROR scenario plays out.

(1) Based on the information above, Emma selects Option 1 and Olivia selects Option 2, which person has selected the correct option to meet the stated goal? (2) What is the financial planning concept being demonstrated by this example?

Reveal Answer to Question 4

Emma has selected the correct option to satisfy the stated goal of at least $500,000 in the portfolio regardless of market outcome.

The concept being demonstrated here is the potential of a Rising Glide Path for equity allocation as you progress through retirement, in contrast with the Conventional Declining Glide Path.

Emma's low equity allocation in the early retirement years helps protect her from sequence risk in down markets, while her growing equity allocation as retirement progresses allows her to participate in the recovery of the markets to a greater extent than remaining in a low equity allocation the entire time. In either scenario, Emma's portfolio balance remains over $500,000 at the end of Year 10.

Olivia's equity allocation decision offers her more extremes. It's true that in Scenario 2, when a bull market exists early in retirement, the value gained by participating with a higher equity allocation allows her portfolio at the end of Year 10 to achieve the highest value of all 4 possible combinations of scenarios. However it's also true that in Scenario 1, when a bear market exists early in retirement, sequence risk causes her to ultimately achieve the lowest portfolio value at the end of Year 10.

The Rising Glide Path concept for equity allocation contemplates that by starting retirement with a more conservative allocation toward stable assets, you may reduce the magnitude of potential early losses. Then as time passes and the portfolio survives its most vulnerable window, equity exposure can gradually increase to sustain long term growth and combat inflation. The strategy front loads protection against the risk that is most destructive when it arrives earliest, then shifts back toward growth once that critical early window has passed.

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