8 minute read
On Monday, August 5, the stock market experienced its most significant one-day selloff in two years. Although stocks recovered as the week progressed, dismissing a downturn in equities of such magnitude is challenging.
The Retirement Investment Paradox
These market fluctuations can cause considerable anxiety for retirees and pre-retirees. This unease highlights what Dunham terms the Retirement Investment Paradox, which presents financial advisors with greater challenges than ever before when planning for a client's retirement.
As an advisor, you must address three major risks:
- Inflation: Even at the 2% target rate that the Federal Reserve aims to achieve, inflation can significantly erode purchasing power, particularly in the later stages of retirement.
- Increased Longevity: Today's 65-year-old retirees may live for another 40 years or more, requiring a substantial extension of retirement savings.
- Sequence Risk: This risk can potentially undermine even the most carefully crafted retirement plans.
The Paradox in Action
Historically, equities have been the go-to asset class for outpacing inflation and generating growth in client portfolios, thereby addressing longevity risk.
However, herein lies the paradox. The very same asset class that potentially mitigates inflation and longevity risks is also the primary source of sequence risk.
The paradox becomes even more challenging when exploring conservative approaches. Methods like bucket strategies and annuities can help mitigate sequence risk, but they often fall short of delivering the growth needed to counteract inflation and longevity risk. As a result, clients may still face the danger of depleting their savings during the later stages of retirement.
This situation presents a significant challenge for financial advisors. Balancing the need for growth against the necessity of protecting against market downturns requires careful and sophisticated planning strategies.
It is akin to deciding to protect against inflation and longevity risk and introducing sequence risk, which can lead to going broke early in retirement.
Alternatively, adopting a conservative approach and failing to keep pace with inflation and longevity risk can result in running out of funds later in retirement.
How Does DunhamDC Tie into This?
DunhamDC was specifically created to find an investment overlay that can help mitigate sequence risk while providing what we believe is the growth needed for retirees to combat inflation and longevity risk.
DunhamDC Buys Fear and Sells Greed, creating what we believe is a sensible strategy inspired by Warren Buffett, who said, “Be fearful when others are greedy and greedy when others are fearful.”
When you examine how DunhamDC operates, you see its potential to work with annuities and bucket strategies to help reduce sequence risk, but how it could also provide the growth to overcome inflation and longevity risk, helping to combat the Retirement Investment Paradox by joining forces with annuities and bucket strategy, rather than selling against them.
Addressing Sequence Risk
DunhamDC accomplishes this by adjusting its equity exposure, increasing it during market declines when stock prices are generally lower, and selling portions of its equity holdings during market upswings and price increases.
In our view, this is the opposite of what most investment strategies do.
Most investors hold more stocks when the market cycle peaks, and fewer when it bottoms out and begins to rise again.
By systematically selling as equity prices increase, the overlay owns fewer equities at the market high. This may limit the full brunt of a drawdown and possibly help mitigate sequence risk.
Potentially Combating Inflation and Longevity Risk
Because DunhamDC is designed to buy when fear grips the market and systematically increases equity exposure as prices fall, it tends to hold more equities at market bottoms. This approach can accelerate the recovery of your client’s portfolio and provide the long-term growth essential for retirement.
In today’s era of extended lifespans, retirees may need to support themselves for many years longer than expected. With inflation steadily eroding purchasing power, it’s crucial to adopt an investment strategy that not only mitigates market declines but also helps growth outpace inflation. By owning more equities during market lows, DunhamDC seeks to generate the returns necessary to meet these challenges, ensuring retirees can maintain their lifestyle throughout retirement.
This overlay strategy addresses the complexities of the Retirement Investment Paradox by potentially reducing drawdowns during market declines and delivering strong returns as markets recover, thereby supporting both longevity and inflation-adjusted income needs.
DunhamDC Works Alongside Annuities and Bucket Strategies
When you examine DunhamDC, you can see how it was built to work together with annuities and bucket strategies. This approach addresses multiple aspects of the Retirement Investment Paradox.
DunhamDC, when used with these traditional methods, allows financial advisors to develop a more comprehensive strategy. The combined approach helps manage sequence risk, which is important in early retirement. It also offers growth potential to address inflation and longevity risk, which become significant in later retirement years.
DunhamDC does not compete with annuities and bucket strategies but rather complements them. Each component contributes to the overall retirement plan.
Annuities and bucket strategies manage short-term needs and volatility, and DunhamDC offers sequence risk mitigation and, more importantly, the growth potential for long-term planning. Together, these form a retirement strategy that balances current low volatility needs with future growth requirements.
This approach changes the view of retirement strategies as separate options. It shows how growth and low drawdown tools can work together to create a retirement plan that addresses the Retirement Investment Paradox.
Disclosure:
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation. Any investment products or services named herein are for illustrative purposes only, and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
Past performance may not be indicative of future results. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. There may be economic times where all investments are unfavorable and depreciate in value.
DunhamDC (“DunhamDC”) is a proprietary algorithm of Dunham & Associates Investment Counsel, Inc. (“Dunham”) that seeks to mitigate sequence risk, which poses a threat to an investor's returns due to the timing of withdrawals. The algorithm employs what Dunham considers to be a pragmatic strategy, generally making incremental increases to the equity allocation when global stock market prices decrease and decreasing it when global stock prices increase. The U.S. variant of DunhamDC generally increases equity exposure as domestic stock prices decrease and reduces equity exposure when domestic stock prices increase. This approach is objective, unemotional, and systematic. Rebalancing is initiated based on the investment criteria set forth in the investors application and is further influenced by the DunhamDC algorithm.
Due to the large deviation in equity to fixed income ratio at any given time, investor participating in DunhamDC understands that a large deviation in equity to fixed income ratio can have significant implications for the risk and return profile of the account. Accordingly, during periods of strong market growth the account may underperform accounts that do not have the DunhamDC feature. Conversely, during periods of strong market declines, the account may also be underperforming, as the account continues to decline, due to the higher exposure in equities. Similarly, if the fixed income investments underperform the equity investments, it is possible that the accounts using the DunhamDC feature may underperform accounts that do not have the DunhamDC feature, even though they may have adjusted the exposure to equity investment before a decline. Therefore, the investor must be willing to accept the highest risk tolerance and investment objective the account can range for the selected strategy. Please see the Account Application for the various ranges.
DunhamDC uses an unemotional, objective, systematic approach. The algorithm does not use complex formulas and is designed to create a consistent process with limited assumptions based on historical data.
DunhamDC may make frequent purchases and redemptions at times which may result in a taxable event in the account and may cause undesired tax-related consequences.
Trade signals for DunhamDC are received at the end of each trading day with the implementation of the trades not occurring until the next business day, which means that there is a one-day lag that may result in adverse prices.
DunhamDC operates within predefined parameters and rules, some or all of which may not be available to review. While this approach can reduce emotional biases and enhance consistency, it may limit adaptability to changing market conditions, economic considerations, or unforeseen events. Extreme conditions may require deviations from the program’s prescribed approach, and such adaptability may be challenging to incorporate. The DunhamDC algorithm is programmed based on specific criteria and rules, it may not capture certain qualitative or contextual factors that can impact investment decisions or movement in the markets. Beyond the initial assumptions used to develop the algorithm, it lacks other inputs or considerations that human judgement and discretion may be necessary to evaluate. DunhamDC may utilize historical data, statistical analysis, and predefined rules. It does not make any predictions and may add to certain investments before they perform poorly or may divest from other investments before they perform well. Dunham makes no predictions, representations, or warranties as to the future performance of any account.
Accounts invested in DunhamDC are subject to a quarterly rebalance to its target allocation at the time based on DunhamDC in addition to the signals provided by DunhamDC at any given time.
Dunham makes no representation that the program will meet its intended objective. Market conditions and factors that influence investment outcomes are subject to change, and no program can fully account for all variables and events. The program requires making investment decisions based on factors and conditions that are beyond the Account Owner’s and Dunham’s control.
DunhamDC is NOT A GUARANTEE against market loss or declines in the value of the account or a timing strategy. Investor may lose money.
Asset allocation models are subject to general market risk and risks related to economic conditions.
DunhamDC has a limited track record, with an inception date of November 30, 2022.
DunhamDC US has a limited history, with an inception date of July 1, 2024.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA / SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.