Summary

The sequence-of-return risk significantly impacts retirement income, necessitating a strategic approach to retirement planning that includes guaranteed income sources to mitigate market volatility.

Abstract

The article emphasizes the importance of the sequence in which investment returns occur during retirement, a concept known as sequence-of-return risk. While average returns may even out over time when contributing to a retirement portfolio, the timing of these returns becomes critical when income is being withdrawn. Poor returns in the early years of retirement can drastically reduce the portfolio's longevity, potentially leading to a shortfall in retirement income. The author suggests that creating an "income floor" with guaranteed income sources, separate from market-dependent funds like pensions and Social Security, can protect against this risk. This approach allows for a portion of the retirement portfolio to be invested more aggressively for growth, as the basic expenses are covered by secure income streams. The article advocates for a balanced strategy where some retirement funds are designated for income to cover essentials, while the remainder is allocated for growth and flexible spending.

Opinions

The author is skeptical of money managers who promise high average returns in retirement without considering the sequence-of-return risk.
There is a critical view of overly optimistic investment projections, such as an "8% per year" return coupled with a "6% withdrawal rate," which is seen as unrealistic and potentially dangerous for retirees.
The author believes that markets are not reliable for providing retirement income due to sequence-of-return risk, advocating instead for a mix of guaranteed income sources and market investments.
The article suggests that retirees should be cautious about relying solely on market returns for retirement income and should consider strategies that protect against market downturns in the early years of retirement.
The author promotes the concept of an "income floor" as a crucial element in retirement planning to ensure basic expenses are met regardless of market performance.

Your Returns Matter MORE When You Start Taking Income in Retirement (the sequence-of-return risk)

Photo by Cristofer Maximilian on Unsplash

(Checkout the video of this blog too)

When you’re saving for retirement, it doesn’t really matter WHEN you get good returns or when you get bad ones.

Over time, the returns of a portfolio average out (if the average return is the same as seen below).

Notice that one portfolio loses money early & makes up for it, and the other makes money early and starts to lose it later. Same resulting end value because no income is being taken.

But when you start taking income out of your portfolio everything changes…

This is when the TIMING of your returns matter the most.

In fact, this is one of the biggest risks retirees face (and most are unaware of it).

You see, most money managers will tell you what your “average return” will “likely” be… especially in retirement.

In fact, a couple of months ago an investment guy told my father that he would be able to get him “8% per year throughout his retirement in the market AND provide a 6% withdrawal rate” (these are outrageously high numbers that would require a raging bull market for 30 years, but I digress).

I asked my dad, “well when does he plan on getting you the higher returns, and when does he plan on getting you the lower ones?”

Obviously, this is a bit of a facetious question, but it’s a very important question (and money managers cannot answer it because nobody knows what the market is going to do).

The average returns that most money managers promise are NOT the actual returns you will take home once you start taking income out of your retirement portfolio.

This is a key point that people approaching retirement must understand.

If the market drops in the early years of your retirement, you are MUCH more likely to run out of money in retirement. 😦

This is what’s called the sequence-of-return risk and it can very negatively affect your retirement income (see the example below)!

You can see here that these 2 portfolios received the same exact “average” return, but because income was being withdrawn, the sequence-of-returns makes a HUGE difference in the end results (almost $450,000)

The best way to alleviate this risk from your portfolio is to create guaranteed income sources that are NOT dependent on the market (in addition to your pension and/or social security income).

This gives you complete protection against the sequence-of-return risk because you are transferring that to a company built to absorb the volatility of the market.

I’ve talked about this before, but creating an income floor (or a guaranteed, retirement income that covers your basic expenses in retirement) allows you to take the money that you are NOT using to create income to GROW in the market (since you can invest more aggressively when your retirement income is accounted for).

Because markets are good at GROWING your money, but because of the sequence-of-returns they are not effective at providing retirement income.

That doesn’t mean you shouldn’t utilize them because you absolutely should.

You just want your mentality in retirement to be simple…

Designate some of your retirement money for INCOME and designate the rest for GROWTH & flexible spending in retirement. 🤝

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To your success,

Matt