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DISCUSSION PAPER PI-1606

Sequencing, Perfect Withdrawal Rates and Trend Following Investing Strategies: Making the Decumulation Experience more Predictable.

Andrew Clare, James Seaton, Peter N. Smith and Stephen Thomas.

ABSTRACT

We use the concept of Perfect Withdrawal Rates to compare decumulation investment strategies for a 100% equity portfolio with and without a trend-following overlay to show that the important concept of Sequence risk can be ameliorated by a technique which successfully smooths returns: two strategies with the same mean, variance, Sharpe ratios and cumulated returns will offer very different decumulation experiences if the sequence (or order) of returns differ. Using US data from 1872-2014 we show that 20-year (constant) withdrawal rates can vary between 4% and 12% p.a. but are raised considerably by smoothing returns using simple trend-following. The distribution of Perfect Withdrawal Rates shifts to the right, reducing left-tail possibilities. We show that knowing the Cyclically Adjusted Price-Earnings ratio (CAPE ratio) for the S&P 500 index at the beginning of the decumulation process is useful for predicting the sustainable withdrawal rate for that period.

Keywords: Decumulation; Sequence Risk; Perfect Withdrawal Rates; Trend-Following; CAPE (Cyclically Adjusted Price Earnings' ratio).