Financial Analysts Journal Fourth Quarter 2017 Volume 73 Issue 4
Reducing Sequence Risk Using Trend Following and the CAPE Ratio
The risk of experiencing bad investment outcomes at the wrong time, or sequence risk, is a poorly understood but crucial aspect of the risk investors face—particularly those in the decumulation phase of their savings journey, typically over the period of retirement financed by a defined contribution pension scheme. Using US equity return data for 1872–2014, we show how this risk can be significantly reduced by applying trend-following investment strategies. We also show that knowing a valuation ratio, such as the cyclically adjusted price-to-earnings (CAPE) ratio, at the beginning of a decumulation period is useful for enhancing sustainable investment income.