Sequence-of-Return Risk

December 10, 2014 // Bucket Strategy Investing

Large ups and downs in the stock market can be scary for a new retiree. When volatility reigns, those who depend on their portfolios for support through their retirement years can start to feel queasy. They begin to wonder if their 4% rate of withdrawal will have to be cut to 3%, or even 2%, just to avoid running out of money. This is a real danger, and it even has its own name: sequence-of-return risk.

Michael Kitces at Nerd’s Eye View had something to say about this: “It is the idea that, even if short-term volatility averages out into favorable long-term returns, that a retiree could still be in significant trouble if the sequence of those returns are unfavorable – i.e., with the bad returns occurring at the beginning of retirement.” In other words, if a retiree begins taking money out of his or her equity portfolio using a systematic withdrawal method during times when the market is in a downward swing, it could have a negative impact on how long his or her money will last. But if a down market occurs during the first few years of retirement, the result can be even worse.

This is because the value of your portfolio is reduced by both negative market performance and any withdrawals one takes out. Thus, a smaller amount is left behind to experience any potential future growth. Similarly, if the market experiences a sharp downward turn in the last few years leading up to one’s retirement, this can dramatically lower one’s portfolio value as well.

So how can this be avoided? Clearly, without being able to predict when market downturns will occur, a strategy should be considered to potentially minimize the damage that downward swings in the market can do to your portfolio. Everyone’s situation is different, so it’s always best to consult your financial advisor to see how you might be able to withstand a stock market downturn early on in retirement. For more information on how to set up a strategy custom tailored to your personal situation, call Lucia Capital Group at 800-644-1150.

 

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