It finally happened. The longest bull market has officially come to an end. It was inevitable that the bull market that began in 2009 would end eventually, but few could predict that a global pandemic would usher in the next bear market.1
It’s always difficult to predict the direction of the financial markets, especially in the short term. It’s especially challenging in the post-COVID world. It’s yet to be seen how the pandemic and financial fallout will impact the economy in the months and years ahead.
There is one thing that is certain, though: retiring during a down market presents a unique risk. It’s called sequence of returns risk, and it means that if you are taking income, the order of your investment returns can impact your performance just as much as your overall average return.
Consider the following example. Two individuals retire at age 65 with $1 million. Investor A starts retirement with a three-year bull market and then ends retirement at age 90 with a three-year bear market.
Investor B has the reverse experience. She starts with the three-year bear market and ends with the bull market. They have the exact same annual returns in reverse order. In fact, they have the same 7% average annual return through retirement.
As you can see in the chart below, both retirees end up in the same place - $4.3 million at age 90. They take different paths to arrive at that point, but both retirees end retirement with the same amount.
The outcomes are different, however, when withdrawals are introduced. Assume that each retiree withdraws $50,000 each year in retirement income. This time, Retiree A ends retirement at age 90 with $2.5 million. Retiree B runs out of money at age 83.
Why does this happen? Why do withdrawals change the outcome for Retiree B so drastically?
It happens because Retiree B experiences a bear market in the early years of retirement. Here are her returns over the first few years:
Just three years into retirement, Retiree B’s portfolio has already been cut in half due to market declines and withdrawals. Her annual withdrawal of $50,000 represents more than 10% of her balance, making it difficult to recover even if she achieves better market performance.
Clearly, you can’t use a crystal ball to predict market performance over the next few years. Fortunately, you don’t need to predict the future to minimize sequence of returns risk. Below are a few steps you can take to protect yourself:
Take variable withdrawals.
One of the biggest issues for Retiree B in the previous scenario is that she continues to take a $50,000 withdrawal even as her portfolio drops in value. She could minimize the damage to her nest egg by adjusting her withdrawals.
At the beginning of retirement, Retiree B’s $50,000 withdrawal represents only 5% of her account. After one year, it represents 7.14%. After two years, it represents 9.05%. At year three, a $50,000 withdrawal represents 11.19%. While taking less income may not be ideal, it could help you protect your long-term financial stability.
Review your allocation.
It’s always helpful to regularly review your allocation and make sure it’s consistent with your unique goals and objectives. It’s possible that a shift to more conservative assets could be right for you. That could help you reduce your risk exposure and protect your nest egg. A financial professional can help you review your risk tolerance and your strategy to see if a change is appropriate.
Use income protection tools.
There are financial vehicles, like annuities, that provide a guaranteed stream of income for life, regardless of how the market performs. These products typically provide a set amount of income each year, depending on the terms of the contract and the amount you contribute. You receive that income each year as long as you live, even if the market declines. Again, a financial professional can help you determine if these types of vehicles are right for you.
Ready to protect your income during these uncertain times? Let’s talk about it. Contact me today at 480.659.2146 or [email protected] I can help you review your income needs and your strategy. Let’s connect soon and start the conversation.
Guarantees provided by annuities are subject to the financial strength of the issuing insurance company; not guaranteed by any bank or the FDIC. Guaranteed lifetime income available through annuitization or the purchase of an optional lifetime income rider, a benefit for which an annual premium is charged. Annuities are long-term products of the insurance industry designed for retirement income. They contain some limitations, including possible withdrawal charges and a market value adjustment that could affect contract values.
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