Monday, October 25, 2021

The Flaw of Averages*




“What then is freedom? The power to live as one wishes.” ~ Cicero, Roman politician (106 BC – 43 BC)

Question: While I’m getting closer to retirement the markets keep making new highs. I’m concerned about what could happen to my retirement funds if there’s a big drop. What are your thoughts?

Answer: You’ve described sequence of returns risk (SOR), which is fancy jargon for the possibility of a market downturn occurring in the first few years of retirement. Although over time, returns may average out, lower returns in the early years of a plan combined with withdrawals could deplete a portfolio faster than intended. Consider someone retiring during the Fall of 2007 (pun intended) who likely experienced low or negative rates of return early in retirement, or imagine the entrepreneur retiring with a dotcom portfolio in March 2000. Their proverbial “pots of gold” likely shrunk at the worst possible time, even causing some investors to go back to work if Social Security and other income sources didn’t meet their needs. Although extreme, these examples aren’t unusual. According to the Wall Street Journal, the S&P 500 fell 33% during 1987, 28% from November 1980 to August 1982, and 48% between January 1973 and October 1974.

Some retirees aren’t able to financially or emotionally stay the course selling at inopportune times. This may reduce the value of the portfolio and limit the potential for assets to recover. Historically, investors who stay the course and don’t sell at a loss do have a greater chance of recovering.

We know that risk is part of investing, and it’s more likely to occur over shorter time periods. Over the long term, stocks are often a reliable way to accumulate wealth. The good years tend to outweigh the bad so that’s why it’s wise to start investing early and have a plan.

SOR Risk Matters Most When We Have the Most

A 20% or 30% decline on a $2 million portfolio at age 65 hurts more than the same decline on a $400,000 portfolio at age 45. SOR risk is greater in the years leading up to and just following retirement. This is when there’s the most to lose and the least amount of time to recoup a loss. Many retirees count on withdrawals to cover expenses, so depleting an asset as it’s declining is even more of a problem.

The good news is that there are ways to guard against SOR risk. What’s right for you depends on overall wealth, investment mix (stocks, bonds and cash), risk appetite, and other personal factors best discussed with your trusted advisor. That being said, here are three strategies to start the planning process: 1. Slow down. It’s customary to reduce one’s speed as we are approaching our destination while driving. This theory also holds true for investing. It may be prudent to gradually reduce exposure to equities/stocks as retirement nears. 2. Use GPS



to recalculate. Some retirees withdraw a certain percentage of their portfolio, increasing that amount every year by the inflation rate. For instance, a $1 million portfolio and 4% withdrawal rate provides pretax income of $40,000 in year one and, with 3% inflation it would increase to $41,200 in year two, $42,436 in year three and so on. If your retirement portfolio is shrinking and withdrawals are rising, be prepared to adapt. Setting a fixed percentage for withdrawals each year based on the prior year-end value of your portfolio may diminish SOR risk, although you may experience some leaner years. Another option is only taking an amount to cover your basic needs and adjust discretionary spending according to the portfolio’s performance. 3. Set it on cruise control. Building a portfolio of fixed-income assets generating income equal to expenses may help eliminate SOR risk. This usually means creating a bond “ladder” which is a series of bonds maturing in ascending years reinvesting proceeds at maturity. If there are funds left over after matching income with expenses, the surplus could be used to invest in assets with growth potential, usually stocks. This approach can be attractive when interest rates are rising because the amounts reinvested from bonds that are maturing may earn a higher rate of return. If push comes to shove, you could live more conservatively off the interest generated from your bond portfolio, leaving the principal untouched.

Hope for the best, but plan for the worst. Obviously, things could go the other way and you retire in an upward market. Ultimately it’s wise to understand your needs, goals, risk appetite and continually monitor your investment plan with your CERTIFIED FINANCIAL PLANNERTM. Stay focused and invest accordingly.

*Book title by Sam L. Savage. Past performance may not be indicative of future results. There is no assurance that any investment strategy will be successful. The market value of fixed income securities may be affected by several risks including interest rate risk, default or credit risk, and liquidity risk. The S&P 500 is an unmanaged index of 500 widely held stocks listed on U.S. market exchanges. An investment cannot be made directly in the index. The performance mentioned does not include fees and commissions which would reduce an investor’s performance. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time.

“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.”

This article provided by Darcie Guerin, CFP¨, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email darcie. Website:

Leave a Reply

Your email address will not be published. Required fields are marked *