When we are young, just embarking on our careers and investing journeys, time is on our side. This doesn’t mean we can sit on the sidelines and watch the market pass us by. Investors should be intentional about their accumulation years and “spend,” or better yet “save,” them wisely. Often, this means we need to put our heads down, make a plan, and invest accordingly while drowning out all the negative headlines that tug at our emotions and can create reactionary behaviors driven by fear.
Drastic volatility in the market can bring out the worst in even seasoned investors. While some people fear volatility, there is a school of thought that considers it an asset class. I am neither defending nor attacking the position of volatility as an asset class; the key take-away is volatility exists in a range and has an average. When volatility appears too high or too low, we should expect it to level back out and return to a historic average, which makes it easier to weather the storm and see volatility for what it is. It is a nutrient that propels markets forward over time – not an immediate threat to destroying wealth. This then allows us to understand that responding to volatility with short-term, reactive attempts to time the markets will probably not help you achieve longer-term financial and retirement goals.
As investors approach retirement, time begins to take on new meaning. This is because the sequences of returns may matter much more in distribution years than they do in accumulation. Sequence of return risk will analyze returns in the order they occur and must be considered. They can have major effects on your investment portfolio and overall financial plan. The order of your returns over periods of time affects the internal rates of return significantly as money’s are either added or withdrawn. The withdrawing of your retirement funds in a declining market it means you can earn a much lower “internal rate of return” than what you expected. Conversely, in a rising market the outcomes will lend to higher rates of return for the investor. Hence Sequence Risk.
Below is a chart to use with the link to a full yet simple illustration to prove the point:
| Hypothetical Return Pattern | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Average Annual Return |
| Portfolio A | 22% | 15% | 12% | -4% | -7% | 7% |
| Portfolio B | -7% | -4% | 12% | 15% | 22% | 7% |
| Portfolio C | 7% | 7% | 7% | 7% | 7% | 7% |
Sourced & synopsized from BlackRock * . Click here for the full illustration & report
- In the three portfolios above, investing $1.0 million dollars (no withdrawals) at the age of 40 for 25 years results in an approximate $5.4 million across all three portfolios. The takeaway is: Before retirement average returns matter more than the sequence of returns as the link shows.
- Now, you enter retirement at age 65 with 1 million dollars and plan to withdraw $60,000 dollars annually, adjusted for inflation for 25 years. The results of our three portfolios are much different. Each portfolio scenario represents the sequence of returns each year of the first five years.
Portfolio A will have approximately $1.1 million left after 25 year
- In Portfolio A as an investor begins retirement, the portfolio initially experiences positive returns in market performance when their income withdrawals begin. Negative returns in later years are much less impactful. Truly a nice legacy.
Portfolio B will run out of funds completely in approximately 23 years.
- In this scenario the investor begins their withdrawal of retirement income as the market and portfolio experience negative returns. Even with performance improving over time Portfolio B struggles to recover from its initial losses. And runs out of money to provide income.
Portfolio C will have approximately $400,000 after 25 years.
- In a perfect world at these rates there is little volatility obviously. These steady rates provide less of a legacy but satisfies the need to draw their $60,000 per year.
- This scenario would be a safe route to planning for income that you do not outlive. Only guaranteed pension plans, Social Security and perhaps lifetime income options such as suitable annuities may provide this. Your should always consult with your financial professional and planner first.
The takeaway now becomes: When withdrawing in retirement, sequence of return risk is much more impactful to your outcomes. Mitigating to running out of money before you run out of life, while providing the steady income over your lifetime necessary is imperative.
The issue of timing, however, is not merely about investing in the markets. Stocks are only one component of the holistic approach that best prepares you for future financial needs.
Sequence of return risk can be helped by being financially responsible in the time before and time during retirement risk. Here are five areas where timing matters in your financial decisions:
- Maximize your retirement plan contributions. Keep in mind to not make yourself cash-flow poor, and be cognizant of minimizing tax consequences.
- Pay off debts – especially credit cards, car loans, and other outstanding liabilities as fast as possible. As you do that, move payments you made monthly to creditors into your retirement savings.
- Evaluate your expenses versus income. Your financial professionals should be well equipped with financial planning tools to help evaluate your spending. What you don’t spend, you should save. What you can save, grows from now until you need it most.
- Right-size your residence. As you approach retirement, determine if it is time to sell the bigger, possibly empty nest. Potential mortgage payoffs or reductions on a new home can help increase your cash flow in retirement.
- Evaluate the best age(s) to tap into Social Security. Currently, if you were born in the first part of the 1950s your full retirement age is 66. Delaying until maximum benefit age of 70 adds about 8% per year to your benefit.
So, when it comes to time and the market, I agree with the Rolling Stones, “Time is on my side, yes it is”. Use time in the market and proactivity in financial planning to your advantage. Keep your emotions in check when volatility shows up, and accept it as necessary waves on the water of your financial journey.
Wayne Anderman CFP® MBA is the founder of Anderman Wealth Partners, based in the Greater Fort Lauderdale Area, and a registered representative of Avantax Investment ServicesSM. Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM.
Sources:
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
* The rates of return shown above are purely hypothetical and do not represent the performance of any individual investment or portfolio of investments. They are for illustrative purposes only and should not be used to predict future product performance. Specific rates of return, especially for extended times, will vary over time. There is also a higher degree of risk associated with investments that offer the potential for higher rates of return. You should consult with your representative before making any investment decision.
