Sequence of Return, The Forgotten Risk

Posted by on Jan 5, 2015

In my last blog, I mentioned the sequence of returns risk and its importance when taking withdrawals in retirement. You have probably heard about the math when trying to recover from a down market. As a review, $100,000 invested and a 20% decline in the market would leave you with $80,000. Many folks assume that a 20% gain in the market would then bring you back to even, but 20% of $80,000 is $16,000 added to your $80,000 and you have $96,000 still $4,000 short of your original $100,000. The reality is, that if you are down 20% you’ll need a gain of 25%, $80,000 x 25% = $20,000 to get back to your original $100,000. All pretty simple when you think about it for a minute and not a big deal if you have time on your side.

So what’s my point? Now we’re getting back to the sequence of returns issue and withdrawals. Let’s say we have the same 20% negative return and we are taking a 5% withdrawal from the account, what would you estimate your necessary return need be to get back to your original $100,000? Would you believe 33%? We know that can happen, but what if we tack on another negative year of the same magnitude and take the same $5000 withdrawal? This can get pretty ugly & scary, quickly.

Annuities can represent a solution to this issue. Why? Just remember PSI when there is more pressure than you would like. What does PSI have to do with my income? An annuity can provide predictable, sustainable, and potentially increasing income throughout your lifetime, even if the market doesn’t provide the returns to sustain that income. Will they cost more than, say, a mutual fund? Of course. But they also offer something that a mutual fund cannot offer: for the cost of an insurance premium, you receive the security that you’ll never run out of income, in your lifetime or your spouse’s lifetime, even if the annuity contract value falls to zero.

Bill Driver

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

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