What is Sequence of Returns Risk and Why You Should Care
Can you average 6% return in your portfolio, withdraw 5% of initial balance yearly and run out of money? The answer is yes. Your retirement may last 25 years or more. Well, if you average 6% return from your portfolio, your financial success can vary greatly depending on whether you experience a negative sequence of returns or a positive sequence of returns.
This Sequence of Returns Risk story may assist you in better understanding our approach to long term income planning versus the accumulation phase you were in for most of your life. On the first page, Mr. Green and Mr. Brown both have a $1 million and do not take any money out for 25 years while each averaging 6% return. Their sequence of returns were exactly opposite with Mr. Green having better returns early (positive sequence) in his 25 years and Mr. Brown having better returns later (negative sequence) in his 25 years. Despite opposite sequence of returns, with 6% average return, they both accumulated the same amount of money over 25 years ($4,288,197).
However, go to the second page and the two scenarios have significantly different outcomes when they are taking $50,000 of annual income!
Mr. Green experienced sustainable income 25 years until his age 90 and had $2,517,217 remaining for his heirs.
Mr. Brown was broke at age 83 with zero portfolio income and zero for heirs.
My intention in providing this information is for you to understand that the income phase of life is very different from the accumulation phase of life. Both Mr. Green and Mr. Brown had the same 6% average rate of return over 25 years and took income equal to 5% of their original $1 million ($50,000). Sequence of returns matters!
There is no financial outcome more damaging to your retirement than large drawdowns in your portfolio early in retirement when you are receiving income. I believe that we have shielded you from the unfortunate Mr. Brown story. This is why our focus on a client’s Income Stability Ratio (ISR) is so important. Additionally, protecting against significant loss is more important than seeking large gains.
Let me know what you think or let's schedule time to discuss.