Mar 17, 2020

A change in the wind?

The current events unfolding in real time are more or less what I've worried about for a good long while in my personal planning and this blog. It's exactly why I fired an advisor for once glibly saying "c'mon, live a little" to me when I laid out my spending approach that conserves early for the possibilities for later risk and uncertainty. That the banker-peasant could not see the convexity of model-able risk as well as being totally blind to the hammer blows that can come from unmodel-able uncertainty was and is certainly his problem, between him and his family (and no doubt between him and the other co-clients I left behind), but me? I did not want that kind of cavalier attitude to infect my family where "infect" seems to be the appropriate analogy in 2020.

But a big question for a lot of people, myself included, is to what extent extreme volatility is already baked into a plan and just needs to be ridden vs being a situation where there have been material changes in the world and the plan no longer obtains, the plan in broken. Spoiler: that distinction is more art than science in my humble opinion and one will never 100% know, except maybe in retrospect.


1. Take a look at the 4% rule for example.

The 4% rule, the Bengen thing, was cooked up using historical data, a fixed allocation and a constant spend assumption. It also assumed a "normal" age 65 start and a known horizon of 30 years. It "worked" most of the time using what is basically an historical back-test. But use a different data set, different start age, random death age and there is no longer magic in the 4% rule. It would start to fail more in different and more complex worlds. How much "fail" in a back-test is too much? There are no real objective measures or thresholds for that that I know of and the concept of fail is often properly criticized. In addition, the whole 4% edifice was static and did not look at dynamic evaluation over the interval. It was more or less just one plan[1], locked and loaded, and it got lucky and "worked" for that set of assumptions. Volatility was pre-baked into the plan and was to be ignored or ridden-out. But...

I did a blog post once were I went back and from some year, 1966 I think, I rolled forward, using Bengen's approach, and then also did a forward estimation of sustainability for each subsequent year using then available portfolio values (in each forward period) and the effective spend rate in that period based on the constant spend approach. The "fail rate" estimates (forget critiques of that metric for a moment) went sky high, as did the effective spend rates. Knowing what I know now that new dynamic dashboard info would have been terrifying. At some point I would have said "holy sh*t, the plan is broken" and then done something probably not very constructive. It's only in retrospect that one would have known that staying the course would have worked...again, as long as we constrain ourselves strictly to the assumptions, assumptions that my current world may not like.

In that dynamic model, I'm convinced that I would have called the plan "broken" even though it didn't break for the artificial 30 year horizon. Live 31 or 35 or 40 years and yes it breaks. When exactly would I have called it and what would I have done. No idea though the biggest lever at that point is spending which is why we saw a proliferation of dynamic spend rules proffered by experts in the last decade.  The alternatives might have been to go back in time and retire later or save more but those are un-actionable counterfactuals. The other alternative would have been to either early or as a type of boundary pull the rip-cord on lifetime income via something like an annuity but that is not explored here.

2. Or look at my experience with 2008

In the summer of 2007, back when I was married and naive and headed towards a personal debacle that would have been entirely impossible to imagine at the time, I caught myself being a little too happy with the feeling of being "flush." I checked the account statements a little too often and patted myself on the back once too many times for what a genius I was.  But the onset of self-awareness of that destructive attitude gave me the seeds of doubt. Hubris is unattractive and dangerous. Think of Icarus.

So I approached my advisor in July 2007 and flipped a 70/30 portfolio to something more like 35/65 and took a fairly large tax hit to do it. In retrospect that looks prescient, if not genius, but it was more fear and some residual greed. I wanted to protect the wodge.  And even that wasn't enough. We all know the story of the GFC. My personal experience of it was visceral. My ex and I, though we were only down a peak 17% or so -- which was pretty good -- felt like the absolute moves in asset values were stomach churning, or at least I did.  Then, even though we now use 2008 as shorthand for the GFC, it was March 2009 that really got me.  The world had been hit hard for a long time and quite a few people thought the storm was over. Then in March 2009 there was one last downflush: repo freeze risk, end of capitalism, etc. The change in my account values that month would cover years of my current consumption rate. I about lost my mind. I was also that month going through discovery and forensic accounting for my divorce. That didn't help the mood. I lost a lot of weight.

The question the whole way down was "do I stick with the plan or is it broken?" I stuck with the plan. Partly because what was I going to do? Sell a relatively small allocation and lock in losses and guarantee a permanently diminished lifestyle in my new "retirement?" No. Also I was pretty conservatively positioned so I kind had to trust that was what that positioning was for.  Also, I was in a divorce/crash/move crouch of fear so I was a tad paralyzed for any movement for a moment in time. 

But I not only stayed the course, I also broke out of the "crouch" long enough to take advantage of the historic opportunities that had been laid at my feet. The one example that I've mentioned here before was the historic spread that emerged between 10y treasuries and high yield which at one point was 25 points. There were others and I made some moves that helped me and my ex soften the financial impact of the split and her pre-split spend rate. Those kind of opportunities arise in all large dislocations, the exploitation of which favors the patient and brave. They'll happen again. Whether I can conjur patience and bravery again is unknown.

The other big lesson for me from 2008, given a remove now of 12 years -- even including the current debacle in 2020 -- was that it all worked out. A body blow to be sure but not a financial death.  I have a little extra faith in my now older body from that experience of recovery from a hard place.

The net experience of 2008 was that the plan was not broken and the decision -- even though the end of the world was being predicted -- was to ride the crisis out in its full glory after trimming the sails a bit. Being conservative helped and positioned me for modest, constructive gains as we came out of the nosedive.

3. What about now in 2020?

I don't know about this one.  It's been interesting, though.  In late 2019 and early 2020 I started to have the same seeds of doubt creep into my consciousness that I did in 2007. I had had an historic bull market lift my retirement from the ashes of divorce. I had also blogged extensively so I knew the lifecycle model and it's potential discontents if and when things change. We were all riding really high in 2019. I personally didn't want to see that success wounded too much. And then...I started getting some early info on this virus thing.  I told myself and a friend in early February that this would be the most prospectively predictable economic contraction in my lifetime (I didn't ever really see the mortgage crisis and effects prospectively though I get it now). You know what I did with that conviction?  Nothing.  I had to shame myself (you "moron") a day later into taking action, action which turned out to be smaller than I could or should have taken but whatever.

I worked with my advisor who, though I think he thought I might have been trying to be a little over-cautious, helped me reallocate the portfolio, again like 2007, to a very trim 35% or less risk allocation with liberated funds going to alt risk and cash.  Also, I manage ~20% of my own assets myself as a type of hedge. In that account, I had gotten lazy in my systematic alt-risk program and it had morphed into some kind of a passive long-only portfolio heavily allocated to energy.  I vaporized the whole thing in a single afternoon and then went long investment grade G&C credit, short the market, short high yield, and long trend following.  This was on February 18.  Look at the chart now. I won't claim too much on that move other than luck and the beneficence of a self-kick-in-the-pants given a conviction in my hypothesis.  Glad I did but it could have turned out differently.

Now what? I have no idea. Personally I think the world will not be the same business-as-usual coming out of this. The virus will not go away anytime soon. Patterns of social congress will change, probably for good or until we forget the lessons. Patterns of supply will change. Schools may not even re-open in the fall making things dicey for me and my kids. Politics will intrude.  Social unrest is not entirely unlikely. I don't consider the volatility in the market "normal" volatility. It feels more like a state change, a change in the wind.

In communications from some of the CIOs of large brokerage houses the message this week is one of optimism: recession is priced in, we're already down the average recession, rebound forthcoming, buy buy buy (or, rather, don't sell and look to allocate back in tranches shortly -- I was being dramatic about the buy buy). I don't share their optimism yet. We have not yet seen the full effects of this epochal social withdrawal experiment nor do we know what the trajectory of the virus or our medical/tech responses will be. I expect more fallout like layoffs, defaults, continued economic contraction and additional market retreats. I'll stay flat or short for now with the consequence that I'll miss the best days of large up moves before the recovery really starts. That miss can hurt people and is why trading portfolios can be bad.  While the "average expectation" may not favor a major depression, the risk of that is most certainly in "the tail" of the distribution of possible futures. That has my attention is the least I can say.

But, even given that, and ignoring the opportunistic "trades" that will present themselves this year with varying degrees of clarity, here's what I believe in when it comes to America and Americans. I believe in their:

- ingenuity
- enterprise
- productivity
- entrepreneurial spirit
- blunt stubbornness
- inventiveness

When the time comes, which it will, that (generally speaking) is what I will invest in to secure what is left of my own plan. There is indeed a change in the wind for me but I think that the plan is not broken yet and, assuming I don't spend myself into a hole during times of trouble, I/we may yet prosper.



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[1] not really a plan. He looked at the spend rate that worked across scenarios.




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