Bridge over ocean
1 October 2017 Financial Analysts Journal Volume 73, Issue 4

Reducing Sequence Risk Using Trend Following and the CAPE Ratio

  1. Andrew Clare, PhD
  2. James Seaton
  3. Peter N. Smith
  4. Stephen Thomas, PhD

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.

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