The spleen is an organ that sits below left diaphragm in the abdomen. It’s generally thought of as an organ that filters bacteria and old blood cells. You can live without a spleen but you live better with one. Not only does it filter but it stores considerable blood, and it’s contractile. In the case of shock, a spleen through contraction can auto-transfuse it’s stored blood into the general circulation improving blood pressure and oxygen carrying capacity, just in the nick of time. Of course massive hemorrhage can overwhelm the spleens storage ability, but in terms of the so called golden hour where shock turns from a reversible phenomena to terminal that extra auto transfusion can make the difference.
I’ve written a good deal about my theory of a large portfolio risked at around 60/40 or 70/30 and a smaller portfolio risked as the tangent portfolio on the efficient frontier. I’ve written extensively about the risk and inefficiency involved in portfolios off the efficient frontier. The inefficiency is described using Monte Carlo analysis as an increasing portfolio failure rate and a failure rate that starts sooner into retirement. In my reading it appears poor SOR in the first 1/3 to 1/2 of retirement dominates the sequence and available funds in late retirement. The classic graph from the homepage of FIREcalc is:
This graph is of 3 identical 750K retirements, red starting in 1973, blue starting in 1974, and green starting in 1975.
This is GDP growth during 73-75 and the red line is average GDP from 1947-2009. GPD growth therefore were contracting by as much as -7.5% since normal is around +3.5%. This is the bad Juju of SOR. This chart describes 9 quarters of bad SOR Q2-73 to Q2-75, which is consistent with the red 1973 portfolio above, 6 quarters of bad SOR consistent with the 1974 portfolio’s outcome, and 2 quarters of bad SOR consistent with the 1975 portfolios outcome. A 30 year portfolio consists of 120 quarters so only a tiny fraction i.e. 9/120 quarters or 7.5% of a 30 year retirement was sufficient to run the ’73 portfolio out of money in just 20 years. ’74 survived 30 years but ended at half of it’s initial value, and ’75 thrived despite some bad SOR to start to close at more than double it’s starting value. To be fair the withdrawal load on these portfolios was 35K/yr or 4.6% so a smaller withdrawal could have lead to ’73’s survival as well. But what if you had a financial spleen? Could a reservoir of efficiently stored dough auto-transfused at the right time make a difference?
An alternative to a smaller WR would be to hold 3 years of WR in a differently risked portfolio, namely a efficient frontier tangent portfolio. So in this case for the 750K portfolio, 105K would be stashed in a 20/80 tangent portfolio and the remaining 645K left in a riskier say 60/40 or 70/30 portfolio that also rides on the efficient frontier. The idea would be in times that are good to remove money from the $645K portfolio and when times were bad to remove money from the $105K portfolio. To do this effectively you need to know when to pull the money from which account. A 35K withdrawal on a 645K portfolio constitutes a 5.4% WR so in years where you make greater than 5.4% take your money from the higher risk portfolio. In years when you make less take your money from the splenic portfolio.
In a 50% market downturn you would loose half your money if 100% in stocks. You would loose 33% if in a 60/40. You would loose 14% in a 20/80 since it’s mostly bonds.
The rule is to sell high, and in a crash the portfolio with the 14% drop is the high portfolio so sell from that portfolio. In normal times the 60/40 would be high and you would sell from that portfolio. The result of this is each portfolio has a chance to automatically donate at the proper time and recover in the proper time, according to it’s relative value. In the case of a crash the high risk portfolio is closed and re-balanced and no money extracted. Money is extracted from the low risk. In the case of good times money is extracted from high risk and low risk is allowed to grow unmolested. The expected rate of return on a 20/80 is 6.8% which isn’t chicken feed. The expected return on the 60/40 is 9.17% So a small percent of your money (14%) is growing at 6.8% and a large percent (86%) is growing at 9.17%, but in the down turn the portfolio with the larger risk suffers the worse insult and can least afford liquidation and is protected from the ravages of bad SOR. The protection isn’t perfect and given a long enough drain in bad times the low risk fund will run out of money, but it’s in bad times early in retirement that you you want the protection. It’s less necessary as time goes on. If you don’t use the smaller portfolio once it begins to accumulate interest over inflation, you can start to dollar cost averaging the excess from the low risk to the higher risk. If low risk runs out of money early do not refill it, as it served it’s purpose to protect the high risk portfolio. As retirement proceeds you begin to move out of the period of portfolio failure due to bad SOR, say year 10 – 15 in a 30 year retirement. As long as the low risk portfolio insurance exists you can start to glide up your total asset allocation by say 1%/yr as you re-balance every year with the added excess and dollar cost average from the low risk fund.
This technique solves the issue with the usual bucket theory problems where the cash bucket is constantly draining money from the riskier buckets. Instead you are using a buy low sell high strategy. It also solves the problem of a bucket of cash which returns virtually nothing. The low risk portfolio is in fact risked most efficiently and though returns aren’t stellar they are quite consistent because their risk is low, adding their own value to the portfolio in terms of stability. The other thing I like about this is it mechanically forces you to buy low and sell high. In the case of a crash by not selling low in the riskier portfolio you are effectively buying low relatively speaking. You sell high and buy low when you re-balance from the bond money you have been stashing from selling high on the way up. That excess money sold high is then reconverted to cheap stocks when they are at the best value. If the low risk portfolio is transfusing it’s excess gains into the higher risk portfolio it is another form of buying low. This portfolio is cutting it to the bone with a 4.6 WR. The S&P 500 has only returned 5.5% on the average over the past 19 years. I would feel much better about a 4% WR or a little less but none the less this takes advantage of a kind of risk shifting over time to protect at least to some extent against SORR. Add a little SS to the mix and you’re golden. I don’t think I would get hyper anal about precisely a 5.4% return as the trigger but in a year like last year where the market was down 5% that a net of 10% below where you need to be and I’d think about pulling the trigger. I haven’t done an in depth analysis especially on when to pull the trigger so I won’t recommend this but I wanted to get it in the archive while I had it in mind.