Sequence of Returns (SOR) Risk

Here we are again… the market is at all time record highs. One client recently told me, “We are spending the money like you told us to when our investments are making money. And they are making money." Sounds good right? While I am always happy when the market performs favorably for my clients, it is always wise to keep the big picture in perspective.  

One thing that I spend a lot of time with clients on is designing an Income Plan for retirement. Most clients do not realize how to utilize the funds they have amassed over a working career once they are retired. While there are a lot of 'products' out there that give the allure of an Income Plan, there is no substitute for an actual distribution plan.

When you retire can have a big impact on how long your savings last. How the stock market performs in the years directly preceding and shortly after retirement can have a disproportionate impact on how quickly or slowly your money is consumed.

If the value of a new retiree’s investments have increased around the time of retirement, necessary withdrawals to cover their fixed costs will amount to a smaller percentage of their retirement assets, leaving more in their accounts to grow in coming years. The reverse also applies. If the new retiree’s investments have recently decreased in value, they will need to withdraw a greater percentage of assets for living expenses, and they’ll have fewer assets left to grow.

Imagine how much more a 30 percent drop would hurt a 65-year-old with a $2 million portfolio than it would hit a 45-year-old with $400,000 in investments. The 65-year-old loses more immediately while they are withdrawing living expenses from their portfolio at the same time, plus they have less time to recover their losses.

Consequently, two different individuals with the same portfolios who retire at the same age and spend the same amount but retire at different times could have dramatically different situations 20 years into retirement – even if the long-term market averages are similar.

There are several approaches to minimize SOR (perhaps explain what SOR is) risk. One is to consider withdrawing a constant percentage from your nest egg, regardless of inflation or whether the portfolio has shrunk due to falling stock prices. You could also insert an annual set amount, indexed for inflation in lieu of a set percentage. Yet another is to reduce volatility on assets you’ll need to tap in the early years. One analyst suggests starting retirement with 20 percent in stocks and gradually increasing the percentage to 40 or 50 percent over time. The rest of your portfolio might be in fixed-income investments, like an annuity or a bond ladder (a series of bonds that mature in ascending years).

Whether you’re already retired, you’re approaching retirement or it’s a long way off, you need to have a financial plan that includes a spend-down strategy or Income Plan.

We are always here to answer questions and help guide you through the planning process.  

Until next time....

Darin