|The dangers of market volatility
Though a market downturn generally isn't fun for most people, its timing can have a greater impact on some investors than on others.
For example, a market downturn can have greater significance for retirees than for those who are still accumulating assets. And it has the most impact if it occurs early in retirement. Why? Because of something known as the "sequence of returns." Basically, it’s the order in which events affect a portfolio.
For retirees, timing is everything
To understand the importance of the sequence of returns, let's look at two hypothetical retirees (see graphic), both of whom start retirement with a $200,000 portfolio. Each year on Jan. 1, Jim withdraws $10,000 for living expenses; so does Pam. During the first 10 years, each earns an average annualized 6 percent return (though the actual yearly returns fluctuate), and both experience a three-year bear market. With the same average annual returns, the same withdrawals, and the same bear market, both should end up with the same balance, right?
They don't, and here's why: though both portfolios earned the same annual returns, the order in which those returns were received was reversed. The three-year decline hit Jim in the first three years; Pam went through the bear market at the end of her 10 years.
As you can see, Pam's account balance at the end of 10 years is more than $47,000 higher than Jim's. That means that even if both portfolios earned no return at all in the future, Pam would be able to continue to withdraw her $10,000 a year for almost five years longer than Jim. This is a hypothetical example for illustrative purposes only, of course, and doesn't represent the results of any actual investment, but it demonstrates the timing challenge new retirees can face.
Weighing income and longevity
If you're in or near retirement, you have to think both short term and long term. You need to consider not only your own longevity, but also whether your portfolio will last as long as you do. To do that requires balancing portfolio longevity with the need for immediate income.
The math involved in the sequence of returns dictates that if you're either withdrawing money from your portfolio or about to start, you'll want to pay especially close attention to the level of risk you face. After the 2008 market crash, many individual investors fled equities and invested instead in bonds. Along with actions by the Federal Reserve, that demand helped push interest rates to all-time lows.
However, when interest rates begin to rise, investors will face falling bond prices. And yet if you avoid both stocks and bonds entirely, current super-low interest rates might not provide enough income. Achieving the right combination of safety, income, and growth is one of the key tasks of retirement investing.
This article was provided by Ken Weise, an LPL Financial Advisor. He can be reached at 707-584-6690. Securities offered through LPL Financial. Member FINRA/SIPC. The opinions of this material are for information purposes only.