The Money Trailhead

Welcome to the beginning of a new monthly newsletter from PLC Wealth.  The hope is that this content is quick, relevant and helpful to you as you pursue your best life right now and like any start to a trail (aka, the trailhead), it is the beginning of an adventure.  The newsletter will include a custom article on a variety of financial and life topics but be sure to scroll to the bottom where you will find links to other writers that I have found interesting.

So here we go….

Retirement’s greatest danger

It is time for a deep dive in to one of the most important topics for a retiree that is rarely discussed.  Clearly, there is a lot to think about when planning for retirement. While we have a degree of control over many of the choices involved, there is one big wild card called sequence risk.  For the retiree looking to turn their assets in to a systematic paycheck, the sequence in which you get your returns is far more important that your average rate of return.  Read further to find out what I mean by this.

Sequence risk is the risk that you will encounter negative investment returns in early retirement. This is an important consideration, because the random sequence – or order – in which you earn your returns, particularly early in retirement, can have a significant impact on your lasting wealth. Simply put, a retirement portfolio that happens to experience positive returns early in retirement will outlast an identical portfolio that must endure negative returns early in retirement … even if their long-term average rates of return end up the same.

Since nobody can predict which return sequence they will experience early in their retirement, every family should prepare for a range of possibilities in their realistic retirement planning. One possible way to do this is to use one of the many tools available to stress test your financial plan.

The Significance of Sequence Risk

It is no secret that global stock markets are volatile. While long-term average annual returns may be in the range of 7%, markets rarely deliver this exact average any given year. In fact, you should expect that you will rarely, if ever, have an annual rate of return that is exactly equal to the long-term average.  Soaring one year, plummeting the next; we never know for sure how far above or below average each year will be.

During your career, you are mostly spending earned income, while adding to your retirement reserves as aggressively as your plans call for. If you stay the course – benefiting from the upswings and enduring the downturns – tolerating market volatility is just part of the plan.

When you are still growing your wealth, market downturns give you the opportunity to buy more shares than you otherwise could when prices are higher. Who doesn’t want to buy stuff that they need when it goes on sale?  When the market recovers, you then have more shares to recover with, which ultimately strengthens your portfolio.

But then, you stop working, and start spending your reserves. This has an opposite effect. Now, when stock markets decline, you may need to sell shares at low prices, which means you will have to sell more of them to withdraw the same amount of cash. Even though the market is expected to eventually recover and continue upward, your portfolio will have fewer shares with which to participate in the recovery. This hurts your portfolio’s staying power. It will not be able to bounce back as readily as when you were adding shares to it, or at least not taking them away.

In our newsletter next month, we will look at a couple examples to illustration the impact of sequence of returns.  Until then, please do not hesitate to let us know if there is anything that we can help with.

What I am reading…