By Boyce F. Lowery, CLU, ChFC
If you’ve been thinking about retirement beginning for you anytime soon, the COVID-19 crisis probably has you worried. As you watched the stock market freefall in March, you were probably wondering, “How is this going to impact my ability to retire and my retirement?”. That’s a very smart question—one you should be asking.
Average Returns Can Be Misleading
First of all, you need to realize that “average returns” doesn’t mean what most people think it means at all. If you read in the financial news that the S&P 500 Index (not inclusive of dividends) averaged a 5.6% annual growth rate from 2000–2019 (the last 20 years), that does not mean that the S&P 500 Index (not inclusive of dividends) had a compound growth rate of 5.6%. It did not. The compound annual growth rate was 4.25%.
When reviewing returns, it is important to understand what is actually being measured and how it is being calculated. You may be surprised to find that actual returns are lower than you expected them to be for these reasons.
How Sequence of Returns Risk Affects Retirement
Speaking of low returns, they can be devastating on a portfolio if they occur early in your retirement years. Negative returns when you first start to draw down a portfolio can have a lasting negative effect, reducing the amount of income available to you in retirement. This is known as sequence of returns risk. The timing of returns matters a lot when you are drawing down a portfolio.
Let’s look at an example. If you had $100,000 invested in the S&P 500 in 1996, 10 years later it would have grown to $238,673. However, if you were withdrawing $6,000 at the end of each year to fund your retirement, at the end of 10 years you would only have $162,548. If you add your final balance to the $60,000 you withdrew, it’s only $16,125 less. Taking withdrawals did not have a huge impact on your portfolio.
But what happens if the returns were reversed and the negative returns happened earlier? What happens if the first year’s return was 4.9%, the second was 10.9%, and so on in reverse order of the above chart?
If you simply left your money invested, you would have the same results. However, withdrawing $6,000 at the end of each year yields very different results. After 10 years you only have $125,621 left in your account. Your portfolio value drops by about a third when the negative returns come earlier in retirement. If the negative returns occur at the very time you begin withdrawals, the impact can be far worse. As you can see, the timing of adverse returns can have a huge impact on your portfolio and, therefore, the quality of your retirement. (1)
How to Protect Against Sequence of Returns Risk
So, are there financial vehicles that can be used to mitigate sequence of returns risk? Absolutely! For instance, certain products offered through life insurance companies can be used very effectively to enhance a safe money withdrawal rate during retirement, manage one’s retirement tax rate and to protect assets from potential creditors.
If you want to learn more about how we can help protect your assets and better prepare you for your retirement years, call us at 888-827-0146.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the managing partner of Suncrest Advisors, he, his partner, and their associates all aim to provide financial security and peace of mind to business owners, executives and professionals, and high net-worth individuals across the United States. Along with more than four decades of experience, Boyce is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit https://suncrestadvisors.com/ or connect with Boyce on LinkedIn.