One of the Most Devastating Risks for Pre-Retirees and New Retirees

One of the biggest risks facing your retirement, you need to be aware of, take proactive steps to avoid, and understand the potentially devastating consequences it could have on your retirement.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®) and host of The Retirement Income show and author of the upcoming book Core Four.

When we talk about retirement risks, a lot of times we think about market risk, the potential for stocks going down in value, some of you are aware of inflation risk, that’s the erosion of your purchasing power over time, medical risk, but one of the biggest risks that never gets discussed in mainstream media, and you’ve probably never heard of, is called sequence of returns risk. And this, I believe, is up there with maybe number one, maybe the number two potentially devastating risks that could destroy your retirement, so I want to make sure you understand what it is, what type of impact it can have on your retirement, so you don’t have to go back to work.

So when we look at the sequence of returns risk, most financial advisors when you go into see them, they talk about what’s your risk tolerance, is it low risk, medium risk, or high risk? And a lot of times you’ll get this projection that shows, well, if you earn 7% a year, every year for all of retirement, this is how much money you’re going to have left.

Well, in the real world, you don’t make 7% every single year. So what matters is the sequence in the beginning years. We call it the retirement red zone. It’s really the five years before retirement and the five years after retirement.

So if we suffer negative portfolio performance in those time periods, if we suffer it in consecutive years, we really open up the potential for this sequence of returns risk to destroy our retirement, because investment returns aren’t static, unless we’re investing in low interest paying bonds or CDs, we have some variability in outcome. This is why asset allocation, which is having the appropriate amount of stocks, bonds, CDs, real estate, annuities, etc., is so important, and ultimately really determines how long your money will last, as well as the tax plan and many of the other things we talk about on the channel.

This is very important to understand because when we talk about dynamic returns in the real world, not static returns of 7% every year, but some years it’s plus 12, plus 15, minus 10, minus 25, we have to build that portfolio with respect to your income needs, longevity, health, all the things we talk about on the channel here, with sequence of returns risk kind of front and center in our mind.

So here’s an example. First two years of retirement, if the portfolio reduces in value by 15%, and we take a 4% withdraw. So most academic studies out there right now are telling us that we should take 2 to 3% from our retirement portfolio, if we expect to make it to average life expectancy. 4% has been the rule for many, many years, but because we’re living longer, most academics through research have reduced the portfolio recommended withdrawal rate from 4% to 2 to 3.

From my experience, most of the prospective clients that I sit with, and most of the clients that we have, 2 to 3% is a pretty small withdrawal rate, and people are looking to enjoy their money, they want to spend it, they don’t want to save it and have all this money left over, so there’s a really fine balance here between determining the proper withdrawal rate for you and weighing the risks such as sequence of returns risk, longevity risk, healthcare risk, etc.

So 4%, withdrawal rate, portfolio decline of 15%, first year of retirement, and then we have a portfolio decline of 15%, again, the second year of retirement, and also another withdrawal rate of 4%.

So we want to see what happens here.

So first, let’s assume we’re starting with a million dollar portfolio. A million dollar portfolio, a 15% decline is $150,000, a 4% withdrawal rate determined at the beginning of the year, would tell us that we’re going to take about $40,000 out of our portfolio, most of us would then combine that with Social Security for an income of 70, 80, maybe $90,000 a year, depending on the amount of your Social Security benefits.

The portfolio decline plus the retirement income withdrawal totals 190,000, so that is how much is going to come out of our portfolio, or at least how much we’ll see the portfolio decline in value in that first year of retirement due to sequence of returns risk. So that 190,000 leaves us with 810.

Now, the purpose of this video is to convey the importance and the consequences of sequence of returns risk. I don’t want anyone getting hung up on the numbers being exact, because we have compound interest versus simple interest and a few other variables here, I’m just trying to convey the importance of this risk factor in retirement.

So left with $810,000. If we take another 4% withdraw, the first thing this does is this reduces our retirement income. So 4% of 810,000 is 32,400. So our income has reduced by 19%, from $40,000 per year, the first year of retirement, to $32,400 per year, the second year of retirement. And that’s because on a smaller portfolio balance, following that 4% rule means we take 4% of the account value at the beginning of the year, that means less income. If the market goes down another 15%, or our portfolio, whether it’s stocks, bonds, real estate, whatever we’re invested in, if the portfolio value declines 15%, that’s another 121,500, roughly, of portfolio value lost.

So this leaves us, after two years of retirement, taking 4% income two years in a row, and suffering portfolio losses of 15%, 15%, it leaves us with about $656,000 and we’re only two years into retirement, and we retired with a million.

So understanding the consequences of the sequence of returns risk is the first step to helping to mitigate the risks of it. I want you to be on the lookout for an upcoming video, it’s going to talk about how we mitigate sequence of returns risk, strategies that we can employ that we employ for our clients here and ways that we can make sure that once you retire, you don’t have to worry about going back to work, because that’s what it’s all about, retiring confidently, knowing how much income you can take out, knowing that it will last as long as you do, making sure your spouse is okay, and of course, reducing taxes over the course of your retirement.

As you can see, there’s a lot that goes into retirement income planning, and protecting all the money that you’ve worked your entire life for. If you want help with this, if you have questions about this, commenting down below is a great way to communicate with us, but also you can reach out to us. You can call the office, you can ask to speak to an advisor. If you leave me a message, there’s a good chance I’ll even reach back out to you. But taking care of the sequence of returns risk is one of the most important things that you can do to protect your retirement.

So make sure to subscribe to the channel and hit that little bell icon so you can be notified when we upload new content. If you know somebody who’s retiring, maybe they have recently retired, please share this video with them, help them understand this risk and get more connected to their money. It could make a huge difference for them in retirement. Make sure to comment down below and hit the like button because that lets other YouTube watchers know that this content is good and can help them be more connected to their money.