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Must be This Tall to Retire: How Sequence-of-Returns Risk Can Sink Your Plan


Making the leap into retirement is like planning a family vacation. Along the way, we face challenges. Some of which we can prepare for, and others can strike suddenly, with no warning. Having recently returned home from a Disney cruise with my family, I can relate. Despite my wife’s planning every detail of our trip in advance as always, we ran into some unexpected issues…

Our 4-year-old son Connor had been looking forward to the Aqua Duck water slide for six months. When the dude at the top of the slide told me that he had to take off his water shoes to get measured, I knew we were in trouble. When he came up 1/16th of an inch short, it set into motion a chain of events that nearly sank the whole ship. As we dragged our screaming kids across the quarter-deck of shame, we wondered where we went wrong.

The pitfalls of retirement can strike just as suddenly, but with much bigger consequences. In 2008, the S&P 500 Index lost 37%1. The average 60/40 portfolio lost 25%2. One -25% year may not necessarily prevent an investor from achieving that 7% average rate of return he had projected to fund his retirement. But hitting the average rate of return isn’t the real goal, is it? Time to walk through some numbers:

In a hypothetical example, let’s say a retired couple with $2 million of investments is planning on withdrawing 4% of the portfolio, or $80,000/year to support their standard of living. If they can earn 7% over time on their investments, they are on track to be just fine. In year #1 of their retirement, 2008 repeats itself and the portfolio loses 25%.

$2,000,000 Starting Portfolio Value
-$500,000 -25% return in year #1
$1,500,000 Year #1 ending value before withdrawals
-$80,000 Year #1 withdrawals
$1,420,000 Year #1 ending value

According to the initial projection, their 7% rate of return would have offset the 4% withdrawal plus provided a net increase of 3% to $2,060,000. The reality is, only 12 months into retirement they are $640,000 behind their projection. The ship hasn’t sunk yet, but most of the afternoon events are in serious jeopardy.

I’ll spare you any further math (unless you want to read the tables below). If they want to catch up with the initial projection by the end of year #2, the portfolio needs to earn a 55.23% rate of return in the second year. If they are comfortable waiting until year #10 to catch up, their 60/40 portfolio needs to earn an average return of 12.36% per year. Do we feel good about those numbers? Nope. Time to call Goofy and cancel the dinner plans…

Though 2008 repeating itself is unlikely, the market is more volatile than most investors realize. In the last 25 years, the S&P 500 has averaged 11.2%. In only 6 of those years, the return was between 6% and 16%. In 2017, the S&P 500 earned 21.83%. Huge year, right? Actually it was only the 9 th best year in the last 251. Though we haven’t felt much serious downside volatility recently, the market has a history of fluctuating in a wildly unpredictable manner.

To prevent sequence-of-returns risk from sinking your retirement ship, ask us about the following:

  • Monte Carlo simulation and its fatal flaw
  • What is a comfortable P/E level of the market at my retirement age?
  • Alternative investments
  • Portfolio layering
  • Integrating guaranteed lifetime income

1 Source: http://www.moneychimp.com/features/market_cagr.htm See table below.

2 Source: JP Morgan Guide to the Market, Q1 2018 (slide 60)

The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. It is a market value weighted index with each stock's weight in the index proportionate to its market value. It is not possible to invest directly in an index. The performance of an unmanaged index is not indicative of the performance of any particular investment. The performance of an index assumes no transaction costs, taxes, management fees or other expenses. Past performance does not guarantee future results. 

G. Adam Weingartner is a registered representative of LPL Financial. Securities and investment advisory services offered through LPL Financial., a broker-dealer (member SIPC) and registered investment advisor. Bluestone Wealth Partners is a marketing name for business conducted through LPL Financial.  CRN-3280715-101220