MARCH 2017


By Eliseo "Jojo" Prisno, CRPC, MS Chartered Retirement Planning Counselor


Sequence of returns risk,
how to defend your portfolio

A couple of months ago, I articulated the “Sequence of Returns” risk and how it can affect your portfolio. Since this risk is merely due to market performance timing versus stepping into retirement, and obviously no one can really predict how the market will perform in future years, practically all retirement nest egg is subject to this type of risk. How do we then defend our nest egg from this risk?

The best approach is diversification and asset allocation. Generally, there are two types of security investments: Bonds, which is fixed in return or interest with guaranteed return of principal upon maturity, and Stocks, where an investor takes the actual valuation on face value but subject to day to day reprising or technically called volatility. Stocks has infinity in as far as returns are concerned but an investor’s principal could be lost if the investment folds. Bonds, on the other hand, can potentially preserve your principal, however, on hedging for growth, it’s not the most efficient asset class.

Let’s look at our two retirees again, Arlene and Nico. Nico’s obviously did well in terms of growth from the equity side while Arlene’s did not perform well. Looking at the Bond side of the portfolio, both simply ended up the same, given the same duration (this case 15 years). If you look deeper however, take year 2008 of Arlene’s, note that the equity portion on Arlene lost 14% denting her equity assets by 14% ($86,887.35). Her Bond side on the other hand did far better ($145,000).

Because of her balanced allocation, 50% on equity and 50% on bonds, her portfolio was still a little bit ahead from where she started ($200,000) by at least 16% ($145,000 plus $86,887.35). Imagine if she doubled down on equities or stocks (100%), her portfolio value by end of 2008 could have ended at $ 173,000 plus change and that would be a haircut of about $27,000. Note, this is after 10 years of being invested.

This scenario could be worst if she’s creating distributions or income from the portfolio.

To defend your retirement portfolio from “sequence of returns” risk is obviously asset allocation programming, the interplay between stocks and bonds. This classic approach however, the past decade had most money managers lagging in portfolio performance.

The current low yield environment (the FED policy of near-zero interest rate) had made most bond funds’ yield performance inefficient, to a level of almost just at par with inflation (which by the way is another type of risk to consider when you are retiring or planning for retirement; I will have a separate article on this in the next coming issues). If your growth or interest is merely mirroring the inflation rate then you’re technically not getting anywhere in terms of gains.

The most efficient way of hedging for principal stability with potential higher interest returns is passing on your “sequence of returns” risk to institutions. Most insurance companies are willing to take this type of risk in your investments via annuity contracts. The most popular approach is using a fixed indexed contract or fixed index annuity products where interest credit is hedged against a market index like the S&P 500, Dow Jones Industrial Average or the NASDQ. Other insurance carriers can also access international indexes like the EuroStoxx for better diversification.

Note that it is only the “crediting of interests” that is tied up with the market index, the principal however is not and is protected from “downside risk” or from losing its value. This is another “asset class” which I can educate you further in another article. Using this type of “asset class” or investment vehicle proves to be more efficient than the past decade versus simply engaging in mutual bond funds.

If you want to learn more of this approach, consult your investment advisor. Note that the approach in bringing in Fixed Index Contracts or Annuities may differ from advisor to advisor. If your financial consultant is simply licensed as an insurance agent, sometimes they merely sell this as a “product” and in most cases they do not look at the real interest of the client. My advice in using this product is as a replacement from bond funds, however your stock portion should still be incorporated on your retirement nest egg.

Again, look at the table and consider Nico’s portfolio performance.


ABOUT THE WRITER: Eliseo Jojo Prisno is a Chartered Retirement Planning Counselor (CRPC) and holds a master's degree in engineering For over a decade, he has managed the wealth of select families and business owners. He founded P/E Capital Investments in 2010, a State Registered Investment Advisory Firm (CRD# 172695) and is currently the firm’s Managing Director and Senior Investment Advisor.

Mr. Prisno also manages a Fund of Funds investment program with Ameritas and runs an All-Equity Growth and Income customized portfolios in separate accounts via E*Trade Securities. He is also a licensed professional on insurance products and annuities. If you have questions or desire a complimentary analysis of your investments or retirement readiness, email or call 1-888-929-2825. Visit our website and our Facebook Page.


Featured Sponsors

completely free