Understanding Sequence of Returns Risk

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By Kevin Engbers, Founder, CEO, and Wealth Advisor

One of the biggest risks facing retirement income planning is sequence of returns. When you retire, you go from accumulation (saving for retirement) to decumulation (spending for retirement needs). If you experience a down market early in the decumulation phase, it greatly increases the chances of you running out of money in retirement.

 

A Case Study
Consider the S&P 500 from 2000 through 2019, which averaged a 7.681% positive return. If someone would have retired in 2000 with $500,000 invested in the S&P 500 and they withdrew $30,000 every year, they would have run out of money in less than 20 years. However, if you invert the annual returns (2019’s returns in 2000, 2018’s return in 2001, etc.), the account will have over $780,000 with the same amount of withdrawals*.

This is the power of sequence of returns risk.

 

The first five years of retirement are very important

The hypothetical situation above is a great illustration highlighting the importance of market performance during the onset of retirement. Depending on the direction of the markets, especially during the first five years of retirement, the financial future of a retiree could be in jeopardy.

Managing risk needs to be a top priority

While we never claim to know exactly what the market is going to do during your retirement, there are strategies you can implement as your start nearing retirement to offset the unknown. Sitting down with a professional to assess and manage your risk profile well before retirement, is a must.

You must retire with a spending plan

In our office, we talk to our clients about risk tolerance versus risk capacity. Rick tolerance is how much risk you can stomach. Risk capacity is the amount of risk you can afford. Two different families with the same amount of risk tolerance may have different financial plans because their spending needs are different. This is yet another reason developing a spending plan with your financial advisor is vital.

Plan to prevent sequence of returns risk. Don’t go into retirement alone. We can help you avoid sequence of returns risk, and many other risks associated with retirement income planning. Give us a call today at (605) 271-6032 or visit us online at www.pinnaclewealth.com.

 

 

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