The risk of losing money in the markets and the critical impact that the sequence of returns have on your portfolio is also referred to as “Reverse Dollar Cost Averaging.”
When systematically buying stocks, or dollar cost averaging, you sometimes buy high and sometimes low and do well because your gains mitigate your higher basis purchases. This is ‘Dollar Cost Averaging.”
But in reverse, when selling low, you realize the loss, but when the market bounces back, you are no longer invested and can’t recapture the gain. The reverse effect of having sold, then missing out on gains, magnifies overall portfolio loss, and is a key risk in retirement.
This timing or ‘sequence of returns’ risk is demonstrated best by retirement expert Moshe Milevsky in his paper “Retirement Ruin And The Sequencing Of Returns” and the data from that paper is shown below.
Sequence Of Returns Risk
- Average Returns Mean Nothing
- Timing Is Everything
- Risk Is Running Out Of Money
- Why Carry That Risk?
- Sequence Of Returns Risk Can Be Insured Around
The timing of good and bad years is everything. If you are exposed to market fluctuations you must be prepared to stop taking withdrawals if you want to make your portfolio last.
Portfolio ruin is defined as running out of money. When you combine longevity risk with the sequence of returns risk, you could be facing a future of limited means, long lifespan, and no income.
That is a bleak prospect, and one that is completely avoidable with proper planning.
Frankly, annuities are made for this situation. If life insurance tackles the risk that you die too early, an annuity offsets the risk that you die too late and run out of money. They are two sides of the same coin
Sequence of Returns Risks In Retirement
Sequence of returns risks and portfolio volatility in retirement is a portfolio killer.
How Long Will Your Portfolio Last?
The most graphic illustration of the ‘sequence of returns risk‘ or ‘reverse dollar cost averaging’ is this illustration by Moshe Milevsky.
The smooth light blue line in the middle is the 7% per year and 7% average return. If you started with $100,000 at age 65, your portfolio would last until age 86 ½ with withdrawals of $9000 per year.
It is fascinating to look at the purple line- if you take out your $9000 per year and you suffer a bad year on the first year of retirement, your portfolio will only last until age 81.
The dark blue line at the top on the other hand shows your portfolio lasting until age 95 if you have good years in your first year of retirement.
Clearly, the sequence of returns has a much greater effect than the rate of return on how long a portfolio lasts. The data used for this chart is shown below.
Sequence Risk Summary
Portfolio losses early in retirement can have devastating effects on the viability of your portfolio, especially so if you are also carrying your longevity risk.
Mitigate longevity risk (risk of outliving your money) and sequence of return risks (hitting a bad year early on and needing to sell when you are down) by investing in a guaranteed income stream.
Need any more reasons to avoid market volatility and sequence of returns risk?
- Past performance is no guarantee of future results
- The markets are choppier and more volatile than ever
- Many investment managers are steeped in bull market offense, and may not have any bear market defense strategies.
- If you’re approaching retirement, you do not have time to recover if you sustain losses
Sequence of Returns Risk Conclusion:
If you are carrying longevity risk AND market risk, you are doubly exposed…. Add in demographic risk pressures, withdrawal rate risk, and sequence of returns risk, and the retirement investment landscape is a veritable minefield.
Ahem…. Guarantees (Annuities) Mitigate All These Risks!
Moshe Milevsky: Academic Expert on Sequence of Returns Risk
Moshe Milevsky is a modern day economist and prolific writer well versed in Annuities, efficient portfolios, and is a scholar of sequence of returns risk. His books are approachable and he is a terrific writer.
Highly Recommended Works:
1)“Are You A Stock Or A Bond?”
2)“7 Most Important Equations For Your Retirement”
3)“Pensionize Your Nest Egg”
4)“Your Money Milestones”
Greatest Idea: Your Human Capital (Earnings Ability) Is A Key Component Part Of Your Risk Allocation Calculation