THE IMPACT OF VOLATILITY ON CASH FLOWS
Investors are never excited about losses in their portfolios.
But when does it really hurt? When you’re using portfolio-generated cash flows to live your life.
For investors that have systematic withdrawal plans on their account, where either a fixed dollar amount or percentage are withdrawn from the account on a regular basis, losses can impact both investors’ asset base and cash flow.
The illustration highlights an important factor of why so many investors that are using their portfolios are concerned about the impact of volatility on their portfolios. And rightfully so, which leads to a related concept: the way you earn returns matters.
To drive home this point, let’s take a look on the next page at Harry and Sally, two investors using their portfolios to generate cash flow.
Harry and Sally are both retiring and have the same sized accounts, which they plan to use to fund their living costs. They both earn the same rate of return on their accounts. The difference is the way in which they earn those returns. Harry is taking on more risk (volatility) to earn his returns than Sally is.
And as you can see above, the extra risk Harry took on leaves him in a tough spot over time. After a 30-year period, Harry runs out of money, while Sally still has over $1.3 million to live on or leave to her family. The takeaway? Volatility matters when you’re using your portfolio to fund your lifestyle and seeking to manage that volatility should be something that investors are discussing with their advisors.
The idea above seems simple enough but executing it is challenging. Most investments that help significantly lower your volatility often do so at the cost of returns. The reverse is generally true as well: generating higher returns often involves taking on additional risk. Navigating this traditional relationship requires a clear view of an investor’s goals and risk tolerances, as well as an understanding of available risk-mitigating strategies.
If you’re seeking ways to lower equity volatility while still participating in equity market upside, TrueShares Structured Outcome ETFs may be worth exploring. To learn more, contact your financial advisor or view our Structured Outcome series.
1. Source: SpiderRock Advisors. For illustrative and discussion purposes only. Performance shown is hypothetical and based on certain assumptions. It does not represent the performance of any TrueShares fund. The illustration is meant to illustrate the impact of higher vs. lower volatility on overall account results when clients are making withdrawals. Performance shown is hypothetical and based on assumptions. As illustrated above, the key assumptions utilized in the analysis above include a.) holding equal geometric mean returns, initial annual withdrawal amounts, and annual cost-of-living adjustments to the annual withdrawals, and b.) the stated differences in the annual volatility (as represented by annual standard deviation) between the two investors’ portfolios. The returns streams used in this analysis are hypothetical and are not tied to, or meant to represent any index or security. They are intended to solely represent a mathematical exercise. Results may vary with each use and over time. IMPORTANT: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. There is no guarantee that the goal to seek less volatility would be achieved in any time frame. Market Risk is still present and investors may still be susceptible to general stock market fluctuations and to volatile increases and decreases in value as market confidence in and perceptions of their issuers change. These investor perceptions are based on various and unpredictable factors including: expectations regarding government, economic, monetary and fiscal policies; inflation and interest rates; economic expansion or contraction; and global or regional political, economic and banking crises.
2. Annualized Standard Deviation: The Annualized Standard Deviation is the standard deviation multiplied by the square root of the number of periods in one year.