Relying on Luck. The #1 thing retirees should be worried about but aren’t.
Relying on luck? What do you mean? Well, if you like most retirees, you may only be one down market away from losing years off of your retirement income. Financial advisors like to call this phenomenon Sequence of Returns I know what you’re saying…” Sequence of Returns? That’s it? Sounds harmless to me.” But trust me, it’s real and it’s one of the single biggest reason you might run out of money.
In a nutshell, the SOR (for short) reflects that risk that if your portfolio has more large negative returns early in retirement than positive ones. Along with the combination of withdrawing money from those ‘down’ investments, SOR can take literally years of available funds off of your retirement. Let’s use the example of Mr. Smith and and Ms. Jones below to illustrate. *
Mr. Smith and Ms. Jones retire with the same amount for money, 100,000. The only difference is that Mr. Smith retires 10 years before Ms. Jones. Both invested in a mix of stocks and bonds, taking 5% per year initially, then increasing the percentage withdrawn each year to keep up with inflation. The ten year difference in their dates of retirement had a significant impact.
Mr. Smith experienced negative returns in four of the first ten years, as well as elevated inflation rates. Although his rate of return was higher, the combination of lower returns and high inflation caused the inflation adjusted exhaustion of his portfolio after just 15 years. Ms. Jones on the other hand experienced negative returns in only two of the first ten years in retirement. Although she also experienced periods of higher inflation, timely positive market performance helped to grow her assets in the early years, and a strong bull market helped the assets continue to grow as she took income from the portfolio.
The main difference between these retirements was that Mr. Smith had the misfortune to retire at the wrong time.
How can we fix this? One simple solution is to simply invest less aggressively. Most people understand its common wisdom to reduce risk in a portfolio during retirement and not worry about market losses. Heck, just invest in CD’s or heaven forbid Equity Indexed Annuities!
Investing ‘safely’ might fix the issue with SOR risk, but it then exposes you to a problem just as big, inflation. Simply put, things we buy and need will cost more next year than this year. Over time, this erosion of purchasing power can be equally devasting to a portfolio that doesn’t grow. If you invest too conservatively, you will run out of money, just a little later in life. The chart below illustrates how inflation has a dramatic effect over time.
Stated another way, if you presently (2019) need $23,880 to support your life and you’re source of funds is a CD earning 2% per year, in 25 years (2044) you’ll need to withdraw $50,000 from the same CD to buy the same things. Will your 2% CD provide enough ROR to keep up? There is a good chance it won’t.
The Retiree’s Dilemma
If combating inflation is the problem I should invest for more growth. Right?
But if I invest for my growth I might get ‘unlucky’ and expose myself to market risk.
Neither of these scenarios sound like a good idea either. What’s the solution?
The Answer: Time Segmented Investment Strategy
Rather than go for broke or play it safe just do both! But do it with purpose. It’s important to ‘time’ segment your portfolios, assign a very specific investment strategy to them and then spend the money out of their assigned accounts when the time is ready. Conservative accounts do the heavy lifting early on in retirement while the more aggressive accounts are allowed to growth (ups, downs and all) without the need to take money from them until much later.
We create buckets of investments strategies out of our client’s retirement savings and then invest each ‘bucket’ according to the time we need the money. The graphic below represents the core concepts.
No sure, how this is done? That’s where we come in.
Do your retirement a favor and combat both Sequence or Returns and Inflation risk by working with a professional that can develop an income plan that invests across a variety of investment vehicles rather than selling simply you a stock, bond or annuity and relying on luck.
*Data based on two 31-year periods ending on December 31, 1998 and 2008, respectively. Each portfolio assumes a first-year 5% withdrawal that was subsequently adjusted for actual inflation. Each portfolio also assumes a 60% stock/40%bond allocation, rebalanced annually. Stocks are represented by the S&P 500. The Standard & Poor’s 500 Index (S&P 500) is an unmanaged group of large company stocks. It is not possible to invest directly in an index. Bonds are represented by the annualized yields of long-term Treasuries (10+ years maturity). Inflation is represented by changes to the historical CPI. Past performance does not guarantee future results. This illustration does not account for any taxes or fees.
The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.”
Securities offered through Securities America, Inc., Member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc. Mission Point Planning Group and Securities America are separate companies.