If you’re young, you may not mind a market downturn, correction, or even a bear market. More opportunity to “buy the dip”, right? But as we near retirement, those bear markets can impact our retirement plans in significant ways, largely because we may have to access our nest egg in the near future while the market is down. This can permanently damage our ability to keep a steady withdrawal rate from a portfolio and impact our ability to spend into the future. The timing of a market downturn in relation to your retirement is called sequence of returns risk. In short, sequence of returns risk comes from poor investment returns early in retirement, combined with ongoing withdrawals which may permanently deplete your portfolio faster than if those same, or even worse, returns happened later.
Consider 2 retirees who have identical assets
$1m in assets
$40,000/year needed from the portfolio
Same investment portfolio - an S&P500 Index Fund
Same time period and same average investment return
The only difference being the order of returns can completely change someone’s situation. See below:
Client A - Retires on Jan 1, 2000 (pre-dot-com bubble) and withdraws $40,000 annually, increasing with inflation
2000: -9.1%
2001: -11.9%
2002: -22.1%
These returns, coupled with a $40,000 annual withdrawal rate, leaves the portfolio at almost HALF of what Client A started with in just 3 years. This leaves a significant recovery needed to get back to their initial investment. Plus, we all know what happened in 2008, so another massive hit there could completely derail their retirement.
Client B- same exact assets and withdrawal rate, but retires on Jan 1, 2009
2009: +26.5%
2010: +15.06%
2011: +2.11%
This investment, including withdrawals, puts Client B at around $1.36m after 3 years.
Now, (despite what JBA would love for you to believe) we can’t control what the market does, but we can be prepared for downturns. All of these assumptions are based on the S&P500 Index, which can experience violent losses during bear markets. This leads to the importance of having a financial plan, and an advisor to help you determine how much risk you can afford to take.
You can’t control when the next bear market happens. You can, however, be prepared for downside protection and have an income strategy if and when the bear market does come. The most important thing to do is plan! This can be done on your own, or with a financial advisor who can help you know exactly where to take income from based on what’s happening in the market. They can use modern portfolio theory to help you determine how much risk you can afford to take. That way, when the headlines get scary, you can sleep better knowing you’re prepared for whatever the world throws at you.
*Please note, these opinions are my own and do not necessarily reflect the opinions of Cambridge or JBA Wealth Management Group.
Sources: Morningstar Sequence of Returns Charting, SlickCharts S&P Returns by Year, Investopedia Modern Portfolio Theory