Many investors nearing retirement are taking risks that they are unaware that they are taking.  I would like to share with you an analogy, that I will hope can make the concepts I am presenting easier to understand.  It is between 2 casino games Roulette and Blackjack.  The risks that some people are taking can be like playing Roulette.  In the game of Roulette, you make a bet on Red or Black.  If your color comes up you win, if it doesn’t you lose.  So, this is a game of chance.  There is nothing that you can do to increase your odds. Neither practice nor strategy will improve your odds of success.  You are just hoping it will all work out.  Hope and luck are your strategy.  In contrast to this, the game of Blackjack is a game of strategy and probabilities when played by experts.

     Let’s look at how Blackjack is played.  You are dealt 2 cards and so is the dealer.  One of the Dealers cards are face up, this give you an idea of what his next move might be.  Once it is the Dealer turn, he has to turn over cards until his score reaches 17 or more. So, you can use strategy and probabilities when taking your cards, based upon what you think the dealer might do next. By knowing these probabilities, you can increase your odds of success.  It doesn’t mean you will always be successful but being a knowledgeable/ skilled player will allow you to improve your chances at winning vs. Roulette. With practice and strategy, you can improve your odds of success.  How does this relate to investors nearing retirement?

     I believe that that the typical investor does not understand that their current investment strategy is based somewhat on hope. They hope that what they are doing will get them to the end.  The typical investor turns their money over to a financial person.  This person tells them they will build them a diversified portfolio based upon their risk tolerance using Modern Portfolio Theory. I will define this as a Strategic Portfolio for our conversation.  Another version of this is using a Target Date fund in your 401k.  Many investors use these funds and because it is considered the easy button (maybe your company defaulted you into it).  Why do I say these strategies are based on hope? 

     The reason these strategies are based upon hope is because what happens to in the first couple of years of your retirement will have the greatest impact if you are using a consistent distribution strategy.  To try to provide confidence to their clients, most financial advisors use planning software that incorporates Monte Carlo Theory.   What Monte Carlo Theory does is runs a bunch of scenarios and then gives you a probability of success.  Then advisor tells their client the probability success. They might say your odds of success are 92%.  The client goes away feeling pretty good, because they won’t be in the 8% of unsuccessful people.  If your portfolio takes large loses in the first years of retirement, you have a much greater chance of running out of money.  Let me show you a recent example of how this could have happened.

     Let’s look at 2 friends, one is going to retire on January 1, 1998 (Tom) and the other on January 1, 2000 (Jerry).  After meeting with their advisors, they determine they need to take 5% from their investments each year to live on.  They each have $1 million dollars in the year they start retirement.  So, 5% is $50,000 and to keep up with expected inflation they will increase their distributions by 3% per year.  With the great stock market in late 90’s, they decide to go with a 100% equity portfolio, invested in the S&P 500.  Let’s see how they do.

     Now that you have seen the numbers, I would like to point out a couple of things that I think are important.  Even though the both used the same investment over basically the same time period their results are very different.  If I had asked before I showed, you the chart above who would have a higher account balance Tom (made distributions of $1.4 million) or Jerry ($0.9 million).  I would think most people would say Jerry because Tom took out $400,000 more over that time period.  But not only does Tom have more money, Jerry ran out of money. How is that possible you may ask. It is the power of reverse compounding. 

You may say hold on, no one is going to invest 100% of their money is stocks if they are about to retire.  They would have a moderate portfolio instead.  A typical moderate portfolio might consist of 60% stocks 40% bonds.  So, let’s look at how a 60% S&P 500 40% Barclays Aggregate Bond Index portfolio performed over this period. 

     These results look much better.  The bonds really helped Tom and Jerry out.  Neither one of them have run out of money.  Tom ended up at $746,607 and Jerry is at $269,742.    So again, even thou Jerry took out about $200,000 less than Tom he significantly underperformed him.  Tom has almost $500,000 more.  Their success came down to did you turn 65 in 1998 or 2000.  This is where I came up with the analogy of Roulette.  You were born (spin the wheel) did retirement land on 1998 or 2000.  

     Back to traditional financial planning, 3 of these results would be considered a success, you made it thru retirement without running out of money!  This is what the simulation says happened if our 2 retirees could hang in during those periods without panicking.  Although, I wonder what Jerry’s emotional state was when in 2008 he was down over 40% from his original investment (60/40 portfolio). Also, what if we have a period like the 1970’s where you had stock market declines and rising rates.  How would that affect the results? 

     So, I hope I explained why I feel a lot of investors are playing Roulette with their investments.  Now let me talk about some alternative strategies that many investors may not be aware of.  These strategies I would define as Tactical investments.  A tactical strategy is one in which a portfolio manager is using some process that helps them determine when to take risk and when to reduce it or is using a strategy that hedges investment risk.  So back to my analogy, in Blackjack the player sees the dealer’s face up card.  He then uses strategy to determine if he wants to take more cards or not.  He also thinks about his odds to help him determine if it is a good time to place additional money at risk.  He doesn’t know what the outcome will be, but he uses probabilities to help him decide his next move.  The player is not always successful, but by using strategy, he is able to increase his odds of success.  I would like to relate this to tactical money management.  While each manger has their own process, they are looking at their past research and how they feel it aligns with current situation to help them determine their next move.  Should they buy more stocks or sell some.  Should they rotate to international vs domestic?  If their investments hit a trigger do they sell? Based upon their methodology they believe it will help them achieve a better result over time.  They are not trying to beat at index in any given year, they are trying to get the investor to their goal with less risk.  If you would like to read why risk management is important check out The Tale of Two Investors.

     There are many different types of tactical strategies.  Today, I just want to mention a few of them.  If you would like to discuss if these types of strategies might be beneficial for you, please feel free to contact my office.

     While there are many different types on Tactical strategies today, I want to share with you 5 different types.  My goal is to introduce these methodologies and to encourage you to learn more about them. These strategies are: 1. Hedged Equity 2. Trend Following, 3. Moving Average, 4. Rotational, 5. Seasonal.  To fully explain each of these strategies could be a blog post on their own.

Hedged Equity- Manager invests in Equities and then buys Puts on the portfolio to hedge the risk.

Trend Following- Often called Managed Futures.  The money manager has the ability to take positions in different securities that can make money if the markets are going up or down.

Moving Average- Managers will use different time periods but the 200 day is very common.  So, the manager averages the closing price over the last 200 days.  If the price of the security being tracked is above the average, they will stay invested.  If it falls below, they will sell their position.

Rotational- The manager will decide what time frame they will trade, monthly is very common.  They will also decide what basket of securities can be invested in.  So, each month they will decide which of those securities to hold for the next month.  They will then repeat the process again.

Seasonal- One of the most popular is Sell in May go away.  In this methodology, the manager will sell all of his stocks say April 30^thand then buy them back on November 1^st.

With each of these strategies different money managers will put their own twist on the concept.  As you review these concepts, I would encourage you to talk with someone that understands them.  You will find many “advisors” who don’t understand and will dismiss them, saying tactical doesn’t work.  One example of this is Sell in May Go Away.  Every time the market is positive in the summer the pundits come out and say see that strategy is not providing value.  From 1950-2017 the market was positive 60% of the time during the May 1- Oct 31 period.  So that is more than half of the time.  Sounds like the pundits are right.  Let’s did one step deeper, $10,000 invested during this period grew to $11,031.  What happened if you invested from November 1 – April 30^th, an investment of $10,000 grew to $1,018,721.  The Dow was only positive 79% during this period.

     I am not giving anyone investment advice in reading this article.  The example above about seasonal investing is not a recommendation that you should invest this way.  You need to meet with a qualified financial advisor to access your own personal situation.  My goal in sharing this information with you was to hopefully expand how you view investing and to give you a reason to learn more.

This article is to illustrate some concepts to cause investors to speak with a financial professional to evaluate their strategy. It will hopefully give them some questions that they can discuss with this professional.  The writer understands that to fully explore this conversation would take a book or several books to cover ever topic or concept fully.  The information in this article is not to be considered investment advice.  This writer does not equate investing to gambling. The references to Casino games was to help the readers visualize the concepts the writer wanted to illustrate.