The #1 Hidden Risk of Retirement
Wall Street and the financial media are full of ideas regarding how you should structure your retirement portfolio to generate a reliable stream of income. They argue endlessly about how much you should have in stocks versus bonds, and various methods of selecting exactly how much income you should withdraw from year to year.
What they don’t talk about, however, is probably the most important item of all when it comes to your retirement income: the sequence of returns risk.
What is sequence of returns risk?
Sequence of returns risk describes the impact on your portfolio that a specific order of returns has. For example, what happens if you enjoy good returns early in your retirement and poor returns later? What happens if the opposite is true (poor returns early and good returns later)?
The best way to truly understand how this works is through example. Let’s assume that you and your spouse (if married) turn 60 years old this year, and you decide to retire. We’ll assume you have $1,000,000 saved in your retirement accounts and we’ll also assume that you want to plan for 30 years of income.
You’ve done a good job investing through the years, and you are a big believer in the long-term power of the stock market. You figure you have 30 years; that is still a long time horizon. Further, the research you’ve read tells you that the stock market earns 10% per year on average over time (that’s a lie all on its own, but we don’t have time to get into today). You decide that if the market averages 10% per year over time, you should easily be able to withdraw 6%, or $60,000 per year of income. That should give you sufficient wiggle room in bad market years, at least, that’s what you think, as 6% is much lower than the 10% average.
So how well will this work for you? A lot depends of your sequence of returns.
For example, from 1980 to 2010, the S&P 500 averaged 9.68% per year return. You may remember that the 1980’s and 1990’s performed better than that, but the 2000’s brought the averages back down. Let’s pretend that the next 30 years exactly duplicate the returns from 1980 – 2010. That’s very close to your projected 10% expectation, so how would you do in our example, withdrawing $60,000 per year from your $1,000,000 portfolio?