The Sequence of Returns Roller-Coaster in Retirement Income Planning
A look at how variable rates of return do (and do not) impact investors over time.
In the world of retirement planning, sequence of returnst refers to the yearly variations in your investment portfolio's rate of return. Have you ever felt like your retirement savings are riding a roller-coaster? Picture the exhilarating twists and turns, the heart-pounding moments, and the stomach-churning drops. It's quite an adventure, isn't it? Well, for some, retirement planning can feel like that roller-coaster ride.
Changing Tastes in Risk as We Age
Take my husband, for example. He used to love those thrilling roller-coaster rides with me, but as he's gotten a bit older, his enthusiasm has waned. Now, he prefers the slower, more serene “It's a Small World” boat ride at theme parks. Just like our taste in amusement park attractions changes with age, so does our approach to investing as we prepare for retirement. You see, when you're further away from retirement, you might not pay too much attention to the stock market's ups and downs. It's like being on that roller-coaster when you're not quite sure when the next drop will come—it's all part of the fun. But when you're nearing retirement, those market twists and turns can feel a lot scarier. It's as if you're on that roller-coaster again, but this time, you're holding on for dear life, hoping to keep your lunch down.
The Importance of Sequence of Returns
And here's the thing: it's not about trying to time the market. Trust me; nobody can predict the market's every move with 100% accuracy. What truly matters is something called the “sequence of returns.” What exactly is this mysterious sequence of returns? It's simply the year-to-year variation in your investment portfolio's rate of return. Over the decades of saving and investing for retirement, how do these ups and downs affect your portfolio's final value? The surprising answer is that, during the accumulation phase when retirement is still a distant dot on the horizon, these fluctuations don't make much of a difference. Whether your returns vary wildly or stay relatively stable, it's like being on a roller-coaster that's all part of the experience. Let's simplify things with an analogy: think of your portfolio's average annual return as a dynamic statistic, much like a baseball player's batting average over a long career. As you save and invest, the sequence of annual returns can influence your average yearly return, but the twists and turns are unlikely to significantly alter the portfolio's final value. It tends to even out over a long period of time, based annual variations.
The Distribution Phase and Sequence of Returns Risk
However, once you shift from accumulating assets to distributing them during retirement, the story changes. Now, you need to protect your invested assets against the dreaded sequence of returns risk. This risk arises when your early retirement years coincides with a bear market or a period of poor returns. Even if your portfolio performs well over the long term, a rocky start to retirement could lead to concerns about running out of money down the road.
A Bear Market Impact
Take, for instance, the tough times of the 2007-2009 bear market. Imagine a couple who retired at the start of 2008 with a $1 million portfolio, split between stocks and bonds. The bond market did reasonably well that year, gaining 5.7%, but the stock market plummeted by 37.0%. Suppose that in this fictitious scenario that their portfolio dwindled to $800,800 over a year's time,raising fears about their financial longevity in retirement.
Creating a Resilient Investment Strategy
So, how do you balance safety and growth for a secure retirement? The answer lies in a well-thought-out financial plan that includes a thorough risk analysis. It's vital to work with a financial planner who can create a resilient investment strategy, stress-tested for various scenarios. Think of it as designing your roller-coaster with safety harnesses and brakes, so you can enjoy the thrill while knowing you're protected. The sequence of returns will have its most significant impact during your transition into retirement.
Your Journey Through the Sequence of Returns
So, should you step off the roller-coaster of investing? If retirement is on the horizon, careful planning is your ticket to a smoother ride. But if you're still far from retirement, embrace the adventure while saving and investing wisely. Your journey through the sequence of returns will have the most significant implications as you approach retirement's doorstep.
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance. She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help her clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones with less tax burden, planning makes the difference. Her Amazon best-selling book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.
