Sequence of Returns

Matt Blocki from EWA discusses sequence of return risk in retirement planning. This risk refers to challenges retirees face when withdrawing from their investments. Matt uses three hypothetical investors to illustrate the impact of different return sequences on retirement outcomes. He emphasizes the need for strategic planning, especially when transitioning from saving to withdrawing in retirement, highlighting the importance of asset allocation and having safety nets in place to protect against market volatility. Ultimately, Matt stresses the significance of managing sequence of return risk to secure one’s financial future in retirement.

Video Transcript

I’m Matt Blocki with EWA, excited to discuss the sequence of return concept and the risk that a retiree faces when they finish climbing the mountain and are now beginning to descend the mountain. Sequence of return risk. First, let’s address what this is. So as an example, if you have an investor A, B, and C, and they’re all trying to get to this point up here, if they’re in their working life, it does not matter.

It’s irrelevant if they have a paycheck. What if A goes up and down and up and down, then eventually ends up here? Versus B, if it goes way up, then way down, and then goes here, and then C maybe just goes straight up.

So the point is, if you’re working, you have a paycheck, the market, if you have a good financial plan, an emergency fund, and other reserves, and a sound plan in place, what the market does while you’re working is irrelevant if you get to the top.

If you get that amount of money, that’s gonna make you financially independent. So a sequence of return risk really presents itself once you’re at the top of the mountain and then coming down. And we’re gonna talk about specific numbers if you’re an investor, A, B, and C.

First of all, I wanna cut to this PDF. There’s three examples here. All investors, just an example, have a million dollars at age 40. They achieve a 7% average return over 25 years. However, these are all completely different sequences.

So at the age of 65, you’ll notice the Mrs. Jones in the top right starts with a 22% return at 41, ends with a negative 7% return at 65. Notice at the end, the average return is seven. Mr. Smith has these exact returns in a complete opposite order, still average at 7%, ends up with the same number, 5 .4 million.

And then Mr. Brown, this is just the boring, consistent, 7777, ends up obviously the average of seven, ends up with the same amount of money, 5 .4 million. So I always tell younger clients, don’t worry about what your returns are until you have at least a million dollars saved.

And the reason I say this, if you have great returns when you’re early on, you’re just first starting to save and you get 30 or 40%, on a small amount of money, that’s really irrelevant. But if you have a bad return on a large sum of money, this can really set you back.

Million dollars down 50%, you’re at half a million dollars, up 50%, 50% of half a million is only 250, now you’re at 750. So down 50, up 50, we’re actually still working to get back up to where we were. So a 50% loss takes 100% recovery just to get back to where you were.

So early on in your career, you need to focus on saving, saving and saving, calm time of returns, you wanna be aggressive obviously. You wanna put yourself in a position later in life when you have that large amount of money, where you can also capture those high returns, but you don’t take out of the portfolio when it is at a loss.

And that’s the important of another video we’ve talked about asset allocation, diversification, having fail safes. Today we’re specifically gonna laser in on the sequence of return risk. So let’s flip to the now descending the mountain conversation.

This is the same example, but just for the sake of the example, we’re gonna say the same dollar amount, a million dollars at 65, all three investors have, they all receive the same 7% return over the 25 years. The only difference now is they’re each taking out 60 ,000 a year, no matter what, they’re adjusting this annually for inflation.

So every year 60 ,000 goes up a little bit. The first investor, Mrs. Doe, has that 22% returns, a million goes to 1 .2, 2 million, not a big deal to take out 60 ,000 the first year. The second investor, Mr. White, has a million dollars, goes down 7%, now starting at 9 .30, takes out 60 ,000, now they only have 8 .70.

So as you can tell, taking 60 ,000 out is apples and oranges, because year two of retirement, Mrs. Doe and Mrs. White are completely starting from a completely different position. And as you can see, Mrs. Doe at the end of this time, through the end of 25 years, despite taking 60 ,000 and a little bit more every year, still has her entire principal in place.

The million dollars still is almost 1 .1 million dollars at the end. Mr. White though, same 7% return to some reverse order, just got unlucky with the year he retired, actually runs out of money completely by the AJV 89. So hopefully his friends and Mrs.

Doe, and you know, can pay some expenses that way. But the concept of sequence return is so important. We can’t just haphazardly have an investment portfolio that’s gonna go up and down, up and down.

We need to have a strong baseline of asset allocation, diversification, and we should have a place. If the market even experiences any kind of negative loss, you’re not touching your equities. Having those fail safes in place and those principles will allow you to navigate and be like Mrs.

Doe, where you’re not touching your principal, you’re living off of dividends interest, and you have that other safe money to grab when the going gets tough. So here’s just an example of the importance of this.

This shows an S &P 500 investment from 1998 to 2017, starting with 2 million dollars, presumably in an IRA, taking out 140 ,000 a year. And you can see when the S &P 500’s up or down, and you can see it was down in 2000, 2001, 2002, and then again in 2008, the 140 ,000 was still coming out.

So that 2 million dollars at the start ended with 1 .1 million dollars at the end, despite taking the 140 ,000 out every year. That’s just a haphazard plan. Let’s take it no matter what happens. If we’re actually looking at this and evaluating, okay, let the year happen, based upon what the year happened, let’s make good decisions the next year, and now we have a fail safe in place, where we have at least four years in this 20 year period in safe, so you can withdraw that from something safe and let the equities alone.

So just skipping the red, the 2000, 2001, 2002, and 2008, those four years taking it for some were safe. Your S &P 500 investment, the equity investments, the 2 million that you started with at the beginning, you ended with 3 million at the end.

And remember the first example was a $1 .1 million ending. This example is a $3 million base on actual data. So that’s almost a $2 million difference. Back out the fact that we took $560 ,000 from somewhere else. It’s about a $1 .4, $1 .5 million positive swing.

And this is one of the many ways we plan around the sequence of return risk, is in our distribution system, making sure that we have a few years as a backup so we can only touch equities when they’re up and when they’re not down.

We look forward to answering any questions you have, evaluating your portfolio, evaluating your plan and making sure that sequence of return risk is a discussion, but never a problem in your plan, and making sure that you have these fail -saves all implemented correctly.

Again, Matt with EWA, we welcome your questions and look forward to discussing.

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