In previous articles, I’ve touched on the topic of sequence of return risk, which, in my opinion, may be the biggest risk retirees face. So what is sequence of returns? It’s the order in which you get the returns that your investments receive. Why is this so important? Before retirement, it doesn’t matter what order your returns come in. The end result is the exact same number. But look at what happens when I take withdrawals from the account in the example below:
Year Fund A Fund B
1 5% 12%
2 25% (-30%)
3 (-30%) 25%
4 12% 5%
Assuming I started with $1,000,000 and withdraw $60,000 per year, at the end of 4 years this is what my account would look like:
Fund A $720,000 Fund B $831,768
The accounts both earned the exact same rate of return and yet there is a $111,768 difference between them in only four years! Imagine going out 10 or 20 years. You can see why I feel sequence of returns risk is one of the most important risks you face and nobody even talks about it. I don’t care nearly as much what return you get on your money in retirement, I care about the way you get it. A portfolio with a lower return can clearly leave you with more money if it is structured properly. This is the heart of income planning for retirees.
To put it simply, you do not want to lose money in your early retirement years. Losing money in the beginning of your retirement, when you are withdrawing money from your retirement plans has the opposite effect of compound interest. Every withdrawal is compounded by the fact that the market is going down, causing you to spend down your retirement savings faster.
The reason advisors tell you to be more conservative in retirement is because you can’t afford to lose money in the early years of retirement or you might run out of money. In reality, this might be bad advice. Being very conservative when interest rates were 11% or when retirees lived to age 70 worked. Today, interest rates are not high enough to sustain most retirees and many of them are living 30+ years in retirement.
So, what is the solution? You need to mitigate sequence of return risk. If you can minimize the impact of early down market years, you may greatly improve your chances of not outliving your savings. You may possibly even withdraw a larger percentage of your assets each year than what would normally be recommended. If it is done properly, you should also be able to increase your income with inflation.
Increasing retirement account withdrawal amounts, increasing withdrawals with inflation, and ensuring that your savings lasts as long as you do are the ultimate goals of retirement income planning.
T. Eric Reich, CIMA, CFP, CLU, ChFC is president and founder of Reich Asset Management and can be reached at 609-486-5073 or email@example.com.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.