{"id":9718,"date":"2020-03-26T10:05:08","date_gmt":"2020-03-26T14:05:08","guid":{"rendered":"http:\/\/staging-prblog.paladinregistry.com\/blog\/?p=9718"},"modified":"2021-01-29T06:53:15","modified_gmt":"2021-01-29T11:53:15","slug":"one-of-the-most-prominent-retiree-risks-sequence-of-returns","status":"publish","type":"post","link":"https:\/\/www.paladinregistry.com\/blog\/retirement\/one-of-the-most-prominent-retiree-risks-sequence-of-returns\/","title":{"rendered":"One of The Most Prominent Retiree Risks: Sequence of Returns"},"content":{"rendered":"

Imagine spending decades meticulously planning and conscientiously saving for retirement only to experience a bear market shortly after leaving the workforce. Suddenly, you\u2019re ready to begin relying on your investment income and it isn\u2019t all there.<\/p>\n

What will you do? Will your portfolio be able to sustain your anticipated annual withdrawal rate? Or will you be forced to reduce your lifestyle to avoid outliving your assets?<\/p>\n

Conversely, imagine waking up and learning your portfolio value has dramatically increased due to upward market movement. Suddenly, the amount you originally planned to withdraw each month sounds too conservative. Adjust too much in one direction, though, and you may not be prepared to weather downturns in the years ahead.<\/p>\n

What is Sequence Risk?<\/strong><\/h2>\n

The two antithetical scenarios above illustrate Sequence of Return Risk, <\/strong>one of the biggest and arguably most concerning risks a retiree could face. Unfortunately, this risk is one that retirees seldom think about. They are so worried about other common areas of concern such as rising health care costs, inflation, and social security strategies that this very real and potentially injurious foe gets lost in the noise.<\/p>\n

Because the sustainability of portfolio withdrawals is driven by the sequence of returns of any given portfolio, timing is everything. Essentially, the danger of sequence risk is that the markets turn sour just as a retiree becomes fully dependent on the income generated from his or her invested assets.<\/p>\n

Let\u2019s look at this phenomenon of sequence risk through two examples: Jack and John.<\/p>\n

Jack and John both have retirement portfolios comprised of 60% stocks and 40% bonds, and both anticipate the same long-term returns over a forty-year retirement.<\/p>\n

However, in the five years subsequent to Jack\u2019s retirement, the markets are ill-fated and Jack\u2019s portfolio suffers significantly. Because Jack lacks substantial income from outside his retirement portfolio to fund his lifestyle, he continues to withdraw at a modest 4% rate. But, even low withdrawals from a portfolio with initially negative returns can severely deplete a portfolio and affect its ability to return to that break-even point, let alone compound for growth. In order to plug the leak in the ship, Jack must lower his withdrawal rate or find a way to begin funding his accounts to accelerate his recovery from loss.<\/p>\n

In the five years subsequent to John\u2019s retirement, however, markets are booming. His portfolio sits 25% higher than at his retirement date and he can maintain his 4% initial withdrawal rate with confidence. Even accounting for the inevitability of volatile years ahead of him, John\u2019s sequence timing positions him to begin building wealth early on, while Jack must begin his retirement on the road to portfolio recovery (and to no fault of his own).<\/p>\n

How will my Portfolio Recover from a Loss?<\/strong><\/h2>\n

It takes exponentially higher returns realized over time for an account to recover from loss. A portfolio that takes a 4% hit one year, won\u2019t recover with a 4%+ recovery the next.<\/p>\n

In fact, a portfolio that suffers a 10% loss will need to realize 11.11% to return to its original value. A portfolio that takes a 50% hit will take 100% to return to original value. The greater the loss, the higher return required to repair the damage. And this is not even factoring in the rate of inflation which negatively impacting the purchasing power of those dollars simultaneously!<\/p>\n

How do I Plan Ahead?<\/strong><\/h2>\n

Sequence risk has always been one of the challenges in determining a reasonable spending or drawdown rate in retirement. Even if the anticipated long-term return rates are favorable, ongoing withdrawals paired with a series of poor returns early on in retirement can forever stunt the recovery and subsequent earning potential of a retirement portfolio.<\/p>\n

There is no way to prevent volatility from occurring, but there are ways to mitigate its impact on your financial health.<\/p>\n