Retirement Roadblocks: The Sequence of Returns Risk
TIMING IS EVERYTHING. Sometimes, your timing is just off. You hit every red light or have to wait for that long train to pass. This typically amounts to little more than an inconvenience. With retirement income planning, however, timing issues can sometimes lead to major financial detours!
Market pullbacks will often have a minor impact on retirement savings strategies because savers can simply wait for the market to recover. While Bill and Jill have done a nice job saving for
retirement, neither of them could have predicted when a pullback would take place, nor the impact those pullbacks would have.
That same market pullback may pose a major challenge when withdrawing money from certain retirement assets. Why? When withdrawals are used for purchases, that money is no longer in the account waiting for the market to recover.
POTENTIAL IMPACT OF MARKET CYCLES
Bill and Jill have both saved $1 million for retirement. Bill elects to retire in 1996. Jill retires three years later in 1999. Both will withdraw $40,000 a year, increasing it by 3% each year to account for inflation.
With Bill retiring in 1996, he had four years of market growth prior to Bear Market 1. Jill only had one year of retirement prior to the Bear Market. Although they had both saved $1 million and had a common strategy, their different sequence of returns had a dramatic impact on their retirement savings.
Having some retirement income sources that are not impacted by market pullbacks is one way to address this risk. These income sources can allow a nest egg to recover from a market pullback, easing the pressure on the portfolio during times of volatility and unpredictability.