Entering into retirement isn’t for the faint of heart.
David Littell from The American College has identified 18 risks that retirees face which must be mitigated for a successful retirement. He lists the following:
- Longevity risk
- Inflation risk
- Excess withdrawal risk
- Health expense risk
- Long-term care risk
- Frailty risk
- Elder abuse risk
- Market risk
- Interest rate risk
- Liquidity risk
- Sequence of return risk
- Forced retirement risk
- Reemployment risk
- Employer insolvency risk
- Loss of spouse risk
- Unexpected financial responsibility risk
- Timing risk
- Public policy risk
Wow! It makes me think that continuing to work may be a better alternative.
In this article I thought I would elaborate on 11, the sequence of return risk.
The sequence of return risk is unique to retirement because retirement is the only phase of life in which we systematically withdraw money out of our investments. During the accumulation phase of life, the order of the investment returns that we receive has no bearing on the ending balance that we have once we reach retirement. In other words, I could put the sequence of my investment returns in any order or variation of order each and every one of my working years and still accumulate, to the penny, the exact same amount of money. This is due to the fact that there are no withdrawals being taken from the investments.
Once I begin to make withdrawals from my investments during retirement, the order of the investment returns that I achieve is of critical importance for the longevity of the portfolio.
The Achilles’ heel of a retirement portfolio is in the initial 10 years of withdrawals. If a significant investment drawdown occurs simultaneously with systematic withdrawals during this time period, the ability of an investment portfolio to sufficiently recover and maintain a high level of longevity is seriously jeopardized.
For example, a retiree in 1999 may have felt extreme confidence after a decade of record high stock market gains. The subsequent 2000 through 2003 and 2008 bear market cycles, though, could have decimated the portfolio if you account for ongoing withdrawals needed for income. Additionally, if the retiree reacts emotionally at the bottom of a bear market and sells the equities portion of the portfolio, locking in the loss, the problem is further exacerbated.
Such is the plight for the retiree that relies on systematic withdrawals and market performance for their regular income needs.
A much better approach is to divide retirement assets into two types. The first type are the assets that can be dedicated to creating predictable or guaranteed income that provide for ongoing retirement income needs regardless of stock market performance. The second type of assets would be those not needed for income needs but can be dedicated for liquidity, growth, and future adjustments for inflation. Since these type of assets do not have systematic withdrawal needs, greater levels of risk can be taken.
If you have any questions about your retirement portfolio, please contact me.