May 11, 2018
This is how I explain to pre-retiree clients
the biggest risk they face
Unless you're brand new to investing, you've probably heard the very common investment advice that as you age, you should reduce the amount of money you have in stocks and raise the amount of money you have in bonds and cash. Generally speaking, that's true. I use the word "generally" because as people work more years and life expectancy has risen, many people may need to hold onto a greater proportion of stocks in their portfolio when they're older than they would have needed just 10 or 20 years ago.
As a result, my "pre-retirement" clients' age range has gotten a lot wider. Some still retire at 64, and some later in life. There are way too many variables to account for the reasons why for a quick Friday email, so for the sake of brevity, let's just say that isolating the correct "pre-retirement" age to start the stock reduction process requires greater depth of knowledge about each individual client's situation.
Here's how I explain this process and more importantly, why it really is such a big deal.
1) This graph shows how if you start with 100 K and you earn a 30% gain right out of the gate, and then hit a losing streak at the end of a 10 year period, you'd have an ending value of $154,764.00.*
Sequence of Returns Risk During Accumulation
Deposit: $100,000.00
2) This second one shows how you could start with the same amount and the same 10 year time horizon, but the sequence of returns are flipped upside down; the first year starts with a negative 30% return right out of the gate, but ends strong with a 30% gain for the final year. The result is the same;
$154,764.00.*
Sequence of Returns Risk During Accumulation
Deposit: $100,000.00
3) Now take a look at this third graph, which is takes graph 1; but this time you withdraw 6 K every year. You end up with about 105 K left over at the end of the 10 year period.*
Sequence of Returns Risk During Distribution
Deposit: $100,000.00
4) Last, for the fourth and last graph, we take graph 2, that starts with -30%, and we take the same annual 6 K withdrawals. But you'd end up with only 38 K this time!* Why such a low amount?
Sequence of Returns Risk During Distribution
Deposit: $100,000.00
 *Hat tip to Jason Smith for the graphs,
from his book, "The Bucket Plan"
I'll tell you why: the fourth graph, titled Mr. Unlucky, had to sell more shares (greater proportion of account) to raise the same 6 K when his account value dropped. So, when the returns improved toward the last few years, his account was already too far behind to ever catch up because he had fewer shares rising in value.
We in the industry call this "sequence of returns risk", and it means the order in which good and bad years occur in the stock market could have a huge impact on how long your retirement assets could last.
The sequence has no impact on the final portfolio value when you're saving/accumulating investments, i.e. when you're young, illustrated by the first two graphs. But when you're withdrawing/distributing money, with the same exact backdrop, starting withdrawals during negative return years early on would drastically reduce the final portfolio value compared to starting during positive years early on.
Conclusion: For the vast majority of pre-retirees, the sequence of returns risk is potentially too high because it raises the risk of running out of money during retirement. That's the real reason why it makes sense to reduce your stock exposure gradually when you're a pre-retiree. Now, all we have to do is just figure out the right age for you to retire.
See you next Friday,
Mitch
I opened ClientFirst Strategy, Inc. because I believe that the only way to help my clients potentially achieve their goals is by offering unbiased advice & investment management expertise. To my clients, thank you for your continued vote of confidence. If you are not a client but would like to explore the possibility of becoming one, I invite you to call me directly, visit my website, join my email list, and/or connect with me on social media.
Hypothetical for illustrative purposes only and is not intended to represent the past or future performance of any specific investment and should not be considered an individualized recommendation or personalized investment advice. Actual results may vary. The rates of return shown are used only to illustrate the effects of the compound growth rates and are not intended to reflect the future values of any specific investment. Investments in securities will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost, Investments differing the potential for higher rates of return also involve a higher degree of risk.
All the views expressed in this report/commentary accurately reflect our personal views about any and all of the subject securities or issuers and no part of our compensation was, is, or will be, directly or indirectly related to the specific recommendations or views we have expressed in this report. This material is not intended as an offer or solicitation for the purchase of sale of any security or other financial instrument. Securities, financial instruments, or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from securities or investments mentioned in this report may fall against your interests, and you may get back less than the amount you invested. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. You should consult with your tax adviser regarding your specific situation. Diversification is a method of managing risk and doesn't protect against loss in a down market.
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