Over the years, I have had two groups of clients that had the biggest struggle to overcome in the early years of their retirement. The first group of clients retired in late 1999 or early 2000, right as the dot.com bubble was starting to burst and shortly before the events of 9/11. These clients watched the stock market drop over 45% in their first 2 1/2 years of retirement. The second group of clients retired in late 2007 or early 2008, as the subprime mortgage crisis appeared, leading into government bailouts and the failure of AIG and Lehman brothers. This group of clients watched the S&P 500 drop in excess of 55% in their first 18 months of retirement. While history does not always repeat itself, people are concerned that it could rhyme.
The risk of retiring when markets are high, and then watching your account values fall precipitously right as you start needing income from it is known as "Sequence of Return" risk. It is very dangerous for a number of reasons. Not surprisingly, with markets near all-time highs, an aging economic cycle, lots of political uncertainty and signs that the economy is slowing due to the trade/tariff war with China, we are getting questions about how to manage this risk more often.
One of the biggest issues we face is that when markets fall and clients need to take income from their portfolios, they need to sell more shares when markets are low to create the financial resources they need to maintain standard of living. As we have all heard Warren Buffett say over the years, you make money in the market by buying low and selling high. Markets dropping significantly in the early years of retirement causes us to do the opposite. This makes it difficult for portfolios to regain lost ground during your retirement years, especially if you have longevity on your side, which would lead to many years of withdrawals.
A second factor that is often even more difficult to manage is the behavioral aspects of this process. Market downturns can be alarming, and with the media screaming that the end of the financial world is coming, it is emotionally difficult for clients to stay the course and keep their portfolios appropriately allocated and diversified. This can sometimes cause people to deviate from their sound and well-reasoned long-term investment and financial plans...at exactly the wrong point in time. This makes it incredibly difficult for portfolios and financial resources to recover as markets rebound.
Our friends at Jackson National recently put out a two-page chart that we have attached via the link below that shows the impact of a negative sequence of returns early in your retirement life. They say that a picture is worth 1000 words and we think this illustration makes that point.
It is normal in human nature to want things that sometimes conflict, a desire for predictable income and portfolio growth being just one of them. If you, or your friends or family are heading into retirement in the near future and have questions about how these issues could impact you, please give us a call. There are a number of strategies for managing this risk. As with any tailor-made strategy, one size does not fit all. We believe it is beneficial to have a plan to help you continue "Moving Life Forward" and we are look forward to discussing these with you.
*Investments in securities do not offer a fix rate of return. Principal, yield, and/or share price will fluctuate with changes in market conditions and, when sold or redeemed, you may receive more or less than originally invested. No system or financial planning strategy can guarantee future results. *