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The Sequence of Returns Risk

The Sequence of Returns Risk

December 03, 2020
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The Sequence of Returns Risk, as discussed in the book “The Bucket Plan”, in which KCA Wealth Management authored the forward. 

As many begin to prepare for retirement they learn the complexities of ensuring that their hard work during their “growth” or “working” years can be preserved throughout retirement. One of the most concerning, but often neglected, concerns for retirees is the risk regarding your sequence of returns. This risk concerns the performance of the market in regards to your withdrawal timing of investments. Although these risks cannot be completely eliminated, through proper diversification and wealth planning with a team of Wealth Managers, such as KCA Wealth Management, it can be mitigated.  

 

Timing the market is considered impossible by many, including professionals and the Random Walk Theory, but proper deposit and withdrawal strategies are highly recommended and proven to increase returns over time. 

An Example of Risk

Imagine Brian and Vince each invested $1,000,000 each, and over a ten year period, each has the same compound annual growth rate of 5%.

 

Year

Brian

Vince

2020

25%

-25%

2021

20%

-5%

2023

15%

25%

2024

-5%

15%

2025

-25%

10%

2026

10%

-25%

2027

15%

-5%

2028

25%

15%

2029

-5%

20%

2030

-25%

25%

 

In fact, the returns are simply reversed for Brian and Vince. Both having an average compound annual growth rate of 5% annual growth. However, most of us are withdrawing in retirement, so let’s now assume that both withdrew annually $40,000 (4% of the initial capital) with a 5% annual increase regardless of performance. Brian would then end up with $754,249, while Vince would be left with just $445,154. Results can be more drastic when large withdraws are taken, especially early in retirement. An 8% withdrawal could show devastating effects on your long-term financial viability in retirement. Wherein this same scenario Brian would have only $345,341 remaining, and Vince would have lost his entire investment before the end of year 8!

 

Amount Annually Withdrawn* *Includes 5% YoY increase

Brian’s 2030 Balance

Vince 2030 Balance

$20,000

$958,704

$804,156

$40,000

$754,249

$445,154

$60,000

$549,795

$86,151

$80,000

$345,341

Loses all Investment Year 8

$100,000

$140,886

Loses all Investment Year 6

 

As you can see, even when using many of the valuable techniques to mitigate risk the randomness of the market will likely always have an effect. However, a well-serving wealth management team understands the complex techniques and strategies to minimize market volatility through diversification minimizing widespread volatility at every stage of your retirement.

 

Mitigating Sequence of Returns Risk

Diversification and rebalancing are essential to minimizing risk overall, but especially in the case of the sequence of returns risk. Not just making more conservative investments, but ensuring your portfolio remains balanced, especially as you near retirement, and throughout retirement, is important to avoid financial hardships due to a downturn in the market. Financial instruments, such as Certificates of Deposit (CDs), bonds, and money market funds provide you the security and peace of mind that your nest egg will appreciate throughout retirement covering costs during recessions. However, you want to ensure as your equities grow you keep a fair balance of liquidity and stability for downturns. These fixed assets provide your portfolio long-term defense over short-term volatility.

 

At KCA Wealth Management our mission is to be there every step of the way in supporting the members of our community with the financial and educational resources they need and deserve to prosper in retirement. 

If you would like a copy of the book “ The Bucket Plan” please call our office to arrange a no obligation consultation.

 

Advisory Services offered through Investment Advisors, a division of ProEquities a Registered Investment Advisor. Securities offered through ProEquities a Registered Broker/Dealer, and member FINRA and SIPC. KCA Wealth Management is independent of ProEquities. This illustration is hypothetical and does not represent the performances of any investment product.