Retirement’s Greatest Risk, Part II
Last time we discussed one of the biggest risks to the retiree looking to turn their assets in to a systematic paycheck, that is, the sequence in which you get your returns is far more important that your average rate of return. In this article, we explore some examples.
Sequence Risk Illustrated
Consider two hypothetical retirees, Joan and Jane:
- Both retire at age 65 with identical $1 million dollar stock portfolios.
- Both start withdrawing $50,000 annually at the start of each year (not adjusted for inflation).
- Both earn the same 7% average annual returns over their 25 years in retirement.
With so much in common, you might assume their portfolios would perform similarly. But what if Joan happens to enter into retirement during a horrible market? Let’s imagine her portfolio returns –30% and –20% in her first two years, while Jane earns 7% both years, and (implausibly) every year thereafter.
Markets recover nicely for Joan after two years so, again, she ultimately earns the same average 7% annual return as Jane. But sequence risk takes a heavy toll on Joan’s remaining shares. She ends up with only about $150,000, while Jane’s portfolio grows nicely to around $2 million.
Hypothetical illustration…your results could be different.
If we take the same two portfolios and same two sequences of returns – but eliminate the $50,000 annual withdrawals –Joan and Jane would both end up with about $5.4 million after 25 years. This illustrates why sequence of returns is usually not nearly as significant when you’re still accumulating wealth, but can matter quite a bit in the early years of depleting your portfolio.
Hypothetical illustration…your results could be different.
Managing the Sequence Risk Wild Card
Sequence risk should NOT change your overall approach to investing. As 2020 has clearly shown us, you never know what’s going to happen next. Crashes usually occur without warning, while some of the strongest rebounds arrive amidst the darkest days.
So, whether you’re 20, 40, 60, or 102, we still recommend building and maintaining a low-cost, globally diversified portfolio that reflects your personal goals and risk tolerances. We still suggest you only change your portfolio’s asset allocations if your personal goals have changed – never in raw reaction to changeable market moods.
What can you do to mitigate sequence risk if it happens to you?
Keep working. If you are willing and able, you might postpone retirement, or even return to the workforce. Even part-time employment can help offset an ill-timed sequence of negative market returns. If your circumstances allow, you may be able to not only avoid spending retirement reserves during down markets, but even add more in (buying at bargain prices).
Spend less. Were you planning for higher investment returns than reality has delivered? Since your portfolio is most vulnerable to negative sequence risks early in retirement, you may want to initially spend less than planned, to give your portfolio the fuel it needs to replenish itself.
Tap other assets. When you retire, you typically have several sources of income to draw from. You may have traditional investment accounts, retirement accounts, Social Security, or pension plans. Your investments are usually divided between stocks and bonds. You may have equity in your home. You may have, or be in a position to create an annuity. You may have cash reserves. If you encounter stock market sequence risk early in retirement, you might be able to tap a combination of your non-stock assets for initial spending needs. This can mitigate the hit your portfolio will otherwise have to take if you must liquidate shares of stock.
Ask for help. Sequence risk is usually not the only consideration at play in retirement planning. There are taxes to consider. Estate plans to bear in mind. Carefully structured investment portfolios to maintain. Logistics to learn. All this speaks to the value an experienced advisor can add before, during, and after this pivotal time in your financial journey.
At PLC Wealth, we help our clients prepare for and mitigate sequence risk within the greater context of their goals for funding, managing, spending, and bequeathing their lifetime wealth. If we haven’t discussed this in detail with you in the past, please plan to do so in our next conversation. Until then, be safe. |
