Are we nearing the retirement danger zone? After 13 years of incredible gains in stocks, we may be due for a significant correction. A bad year right before or early in your retirement could create a problem. It has to do with a concept called sequence of returns risk.
Watch Now: Are We Nearing The Retirement Danger Zone?
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Are You Concerned About Your Retirement?
Nobody knows what the future holds. This could be the worst time to retire. It could also be a good time to retire from an investor's perspective.
Sequence of Returns risk is real. It creates real challenges, especially if those bad returns happen right before or early in your retirement journey.
But there are ways to plan so you can address that risk. If you would like to discuss your situation with one of our financial advisors, please complete the form. We will contact you to arrange a time to talk about your concerns.
Something Interesting: Emotional Mistakes
It's Buy Low, Sell High...
When stock and bond prices fall for a few weeks, many investors get a queasy feeling. Seeing your accounts decrease is hard. The longer it goes, the greater the challenge to stick with your long-term plans.
It can lead to the emotional Investment cycle. Our brains are hard-wired to want to protect what we have. The combination of dire news and decreasing account values can lead to significant mistakes, like selling low and buying higher.
Getting The Timing Wrong...
Many investors will get the timing wrong. If you only buy when things look and feel great, how would that impact your future returns? What about if you did as investing legend Warren Buffet says? You know, "Buy when there is blood in the streets?"
Here is an interesting chart we found from BlackRock investments.
It shows what future stock market returns were three years after inflows (purchases) were their highest levels. It also shows what future stock market returns were three years after outflows were at their highest levels.
Are We Entering the Retirement Danger Zone?
Same Returns, Different Order
In this graph, the returns are exactly the same. The starting value is exactly the same. The annual withdrawals are, likewise, identical. The difference is the order in which they happen.
The yellow line represents the annual returns of the S&P 500 (using the ETF SPY as a proxy) from 2000-2019. The blue line is the same annual returns in random order.
"Timing" Can Be Everything
This chart represents 5 different people. Each began with the same initial investment and each one took the same amount of income.
The first person retired on December 31, 1999. The next retired on March 31, 2000, and then every 90 days.
(This assumes a 100% investment in stocks)
Distributions Amplify Negative Years
Any distribution you take from your account will amplify the impact of a negative return. In this example, you begin with $100,000. You take 4%, or $4,000, of your account balance as income. Unfortunately, the return you experienced was -12%. This means your account is now 16% lower than where you began.
Now, if you happen to have back-to-back years where your account drops, it can make things very interesting.
Returns are not a function of addition. It is multiplication. If you lose 10% in the first year and gain 10% in the second year, your return isn't 0%. It is -1%.
When you are taking income from your account, this makes recovering from a downturn a bigger challenge.
When you're relying on your investments to create an income stream, it may take several years to recover from a significant downturn.