It is so important to think in advance about your retirement lifestyle and how much income you will need to maintain that lifestyle before you retire. Usually, before people hit retirement, they may think about what options they have and how to attain the financial goals they have set for themself and their families. In this article, I’m excited to elaborate on what you should know as you plan on generating your retirement income from your portfolio. But first, let me fill you in on what “sequence of returns” means.
Have you ever heard of a sequence of returns, or maybe “sequence risk”? These terms are used to describe the risk an individual’s investments will have and the negative impact of returns on their portfolio later on in their career or very early in their retirement years. Sequence risk could be detrimental to retirees, as they have very little time to make up for their losses. Let me help you understand different scenarios to avoid this risk as well as offer you some helpful tips to guide you down the road.
Traditionally, wealth managers followed what was called the 4% rule. Theoretically, this means you have $1 million and draw down $40,000 or 4% every year as fixed income in retirement and continue to live on that. Now, let’s say you retired in 2007 with $1 million and made annual withdrawals of $40,000. In 2008, the market dropped by 38%. So, your portfolio shrunk to $582,000. The following year, the market bounced back about 24%, and your portfolio went up to $610,000. So, in two years, even though you’ve only withdrawn $80,000, your portfolio has lost almost $400,000 or 40% of its total value. At this point, unless steps are taken to mitigate this sequence of returns, you are going to lose all your money in the next five years.
So now you must be wondering if there is anything retirees can do about this, right? Well, the answer is: Yes. First, you need to seek an adviser who understands that many of the old conventions don’t hold true anymore. Nobody can predict the markets. On average, over the past 20 years, there have been six so-called “black swan” market events. With increased market volatility, it is safe to assume that in the future they will happen more frequently. Aside from that, every client is different. That is why it is important to discuss all of this in detail with your adviser and provide all the necessary information for them to consider and take your individual circumstances into account to design portfolios that protect against such market swings.