3 Ways to Protect Against Sequence of Return Risk in Retirement
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- čas přidán 21. 07. 2024
- James explores the concept of sequence of return risk in retirement planning. Most people are unaware of how risky this is, as it doesn’t become an issue until you begin living off your portfolio.
Responding to a listener’s inquiry about early retirement, James dives into the potential impact of market timing on retirement outcomes.
Learn three actionable strategies:
➡️ Ensure a reasonable initial withdrawal rate.
➡️ Implement a suitable withdrawal strategy.
➡️ Own a diversified mix of assets.
Questions Answered:
How does sequence of return risk impact retirement outcomes?
How can early retirees protect against sequence of return risk?
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⏱Timestamps:⏱
0:00 - Ben’s question
3:19 - Sequence of returns matters
6:48 - 3 projections to consider
11:49 - The 4% rule
16:05 - Considerations for early retirees
18:57 - 3 protective takeaways
22:15 - Summary
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James Conole has the gift of communicating complicated financial topics simply and straightforwardly; it is much appreciated!
I understand James better than anyone I listen to on the Internet with this kind of content. He is outstanding in making the information clear and applicable to anyone actually making these challenging choices. Such a blessing!
I understand the 4% rule, but it's hard to achieve a nest egg of that size. If you do, you most likely will have a large surpluses of money. That in itself is a good problem to have, but it also means you stayed on the treadmill longer than needed. Always keep in mind, you can always pick up a job, that you enjoy, to provide living expenses.
I also find it sad that spending is equated to happiness. Once I retired, I appreciated the simplest things. Freedom and security will change your perspective. I appreciate a good workout on my bike or a peaceful, long walk through a nature preserve. No matter your circumstances, I hope you find what makes YOU happy.
21 minutes to get to what I thought was the most helpful suggestion. Have a cash buffer to cushion you when returns are low and to allow you to even out your withdrawals. You'll have a portion of your portfolio that isn't earning what core assets like stocks and bonds ordinarily return but you can draw down in tough times and replenish when earnings are high. That and a CD ladder can backstop your portfolio and help minimize your draw from core assets when the market is down.
3-4 years of cash,lets u be more bold with your portfolio,avoid sequence risk,spend what u want,enjoy life,this is not hard,yes sequence is all he needed to mention,but we know people need to be cuddled.
Thanks!
Look up the bucket strategy.
if you think you can get to the specific point faster on another podcast let me know but James speaks to a wide variety of situations; he is quite thoughtful and inclusive with the scope discovery/analysis and suggestions. never know who can learn "what" from the first 21 minutes.
And the conclusion is people will need a good nest egg to to it this way
Thanks. I want to add another, less obvious one. In big market downturns, roll deferred accounts into roths. This will allow you to pay, say, half the tax you otherwise would and potentially avoid RMDs and higher SS taxation down the road, and so make your money last longer.
Cheers,
Jef
Thanks much James for this segment and all the others.
You are a great teacher.
Happy New Year!
Thank you for this detailed explanation; it was very helpful.
Thank you so much for this. This validates the retirement financial plan I came up with
thanks James, well done. I plan to retire in 3 months at 60 and needing a withdrawal strategy and spending confidence to bridge gap until Soc. Sec. income kicks in, plan to take at 62 to lesson blow on retirement funds. with close to 800k saved, be closer to 8% for 1st 2 years then drop to 4%. Much appreciated, cheers from Pennsylvania.
Well done! Excellent explanation with good detail! Thanks!
Really excellent description, including defining withdrawal strategy vs withdrawal rate. Thanks for sharing!
Yah strategy is key and bring flexible based on market returns is important
Great presentation. This was a topic to which I hadn't given enough attention. Time to go into my spreadsheet to add a dynamic variable for inflation and growth. I love numbers, but I've never exposed myself to financial modeling that contains embedded risk. So far your videos have given me two excellent planning tools. I'm early in retirement and this will be the first year I pull from my retirement account.
Nice job Jimmy.
Thanks James very helpful. Wondering if you could consider answering my question below in a different video: it seems having cash reserve is essential to ignore market corrections. Will you please discuss how cash flows should be managed to maintain that reserve across retirement years? Thanks
Definitely missing the previous format! I loved the old style much better!
Great job 👍
Best bet is to develop a plan that has plenty of cushion. If your lifestyle and monthly bills require taking that full 4% every month, do something different. You could down-size your home, move to a cheaper area, continue doing some part time work, etc.
In other words, there is a risk that a person eats too much into their capital at the early stage of their retirement (when their nest egg was largest) due to the financial markets being down.
One should note that spending in retirement is often not a fixed percentage of anything; it's often dictated by go-go/slo-go/no-go considerations, i.e., you spend more in go-go years, less in slo-go years, and even less in no-go years, although there might be other costs that do go up as you get older, such as LTC costs.
Was hoping for a bit more insight other than the 4% rule. Maybe a specific drawdown from which buckets as specific stages of the business cycle.
Thanks James. This is helpful to understand the risk and basic steps to mitigate it. I would be interested in the next step of a few examples to show how your withdrawals would change based on specific market periods. If I understand the 4% rule, you just take 4% of your starting portfolio and add inflation each year and it "always" works. This is great, but doesn't represent how most retirees want to spend their money (as you know). How about some scenarios to illustrate how you would implement the go-go, slow-go and no-go spending strategies in different market periods? Or how about illustrating how the "spending smile" behavior would be adapted to different periods? Those scenarios are more likely than a straight 4% withdrawal strategy and would be helpful to understand how corrections are made along the way. BTW, love your content and am glad you are recording the podcasts so I can watch them here.
I agree. This would be most helpful James. Thanks
That’s what I’m struggling to get my arms around. Having guaranteed $ for go go in a variety of market conditions
That would be helpful but also did Bengen consider replenishing your emergency savings after paying for a high cost home repair ie. Roof? Thx for the video
I guess I fell into this when I retired in October 2021. Moved funds in early 2022 to my control (away from Government). And now it’s Jan 2024. I’ve not fully recovered yet. Fortunately I have not needed or even have access to these funds. (Retired at 56).
You must have made some bad choices, the stock market has more than recovered.
I like investing when market down.
So, if say I need $50k a year, I keep $150k (3 yrs) in High yield money market. The market goes way down, like a reputable index fund goes from $400 to $200/ share. I take $50k (1 yr) and reinvest in it. The next year or two it goes back up to 400+.
I think this helps my sequence of return of risk. Also, I end up switching from the mutual fund index to the corresponding EFT. Basically the same thing except for just a little more expense ratio.
Attempting to wrap my head around the concept of adding rate of return on investment with inflation rate to arrive at an actual rate of return for the investment. Wouldn’t the inflation rate only affect the funds that were expended, rather than the entire portfolio? And if so, wouldn’t the inflation rate only affect the portion of the investment that was distributed as living expense? When configuring sequence of returns affect long term?
No, inflation also affects all future spending. This means the inflation is effectively costing the equivalent portion of your portfolio gains.
If you had $100, and after a year it returns 0%, and inflation is 0%, your $100 can buy $100 of stuff at the end of the year.
Or if return is 0% and inflation is 5%, now your $100 can only buy what used to be $95 of stuff - the same as negative 5% return, or 0% return - 5% inflation.
Or if return is 5% you now have $105, and if inflation is 5%, your $105 can buy $100 of stuff - the same as 0% return with 0% inflation or 5% - 5%.
My contribution… because most of the “4% rule” analysis uses 30 year periods, it leaves out recent bear markets. I used ficalc to look at 2000-2022 (using a 23 year duration). That period still survives the 4% rule (with a $600k final value), but it fails at 5.5%. I feel like the recency of that crash is more sobering than looking back 50 years.
What starting size?
@@user-ty2uz4gb7v sorry, just seeing this. starting with $1M.
@@user-ty2uz4gb7v Sorry, just seeing this now. I started with the default $1M.
I think you can’t always count the whole inflation number when doing this as it’s comprised as many dif things that all who are retired might not be hit by, like Housing inflation is included and if they own home it doesn’t effect them
James, wouldn't a pro rata withdrawal from a balanced portfolio followed by rebalancing get the same result as pulling funds from different accounts based on market conditions? Seems it would be much simpler with essentially the same result.
You're 100% correct, but he's trying to simplify for the widest audience. Perhaps he could have mentioned this, but then that's a rabbit trail he'd have to explain. Excellent point you just made.
The research you mentioned also claims that assuming 100% of your portfolio is stocks(s&p 500) and assuming 4%,you have a 100% chance of your portfolio survival after 30 years
Bill Bengen's work was no doubt a "game changer"...but he did this study, prior to the development of one the most significant investment v3hicles (IMHO) to come along, in a VERY long time: Treasury Inflation Protected Securities. It would be fascinating, if someone could do a study of how their presence in a portfolio..as opposed to intermediate, non-inflation protected intermediate treasuries (as Begen used in his model) would have weathered these very high inflation periods (as in '73-'74) conbined with significant stock market declines. I have a feeling, that a T.I.P.S position..would dramatically improve the standard 60/40 allocation "survivability", substantially!
Good thought. I'll have to look into this & do some spreadsheeting. Some of my pimco tips funds have been "meh", but those are funds that are susceptible to market fluctuations if one was to sell, rather than hold to maturity.
You've piqued my interest.
If retiring by year’s end, not knowing how the stock market will do the following year, isn’t it wise to take that 4% out from cash?
The key is that you don’t know what the market will do next year, so you would base your withdrawal on where the market is at the time you take it. So, if you are retiring at year end, take it from cash if the market is already down, or take it from stocks if the market is up (maybe wait to January 1st if selling the stock in December would put you in a higher bracket or high taxes in that last year of work).
James, if we retire early (~ 62) and delay social security until age 70, and that delayed income replaces 60% of our yearly portfolio withdrawal , could we conceivably withdraw 6% from the portfolio safely in those earlier years?
If the market is doing well you can, if not you're at risk of drawing down your principle significantly.
You are talking about a difference in SS of well over $2,000 per month for the average SS account from the age of 62 to 70. It all depends on the size of your portfolio at the time you turn 62. Do the math. My guess is likely not.
Cash buffer and dividend growth stocks… no need to sell at 4% rate … a diversified quality dividend growth stocks portfolio can easily give 4% dividend yield . It’s like living off milk without killing the cow 😂
I never heard the word annuity mentioned because those aren’t assets under management what you sign on the door that line. It’s a shame because you can get 6% in the MYGA right now and that’s 2% more than the 4% rule if I do my math right with no risk, not the whole portfolio but why not 50% secured from the market with 6% return
Key word "now", did you say this 5 years ago
That being said as long as you know the risk and have a plan it could work
Good question….The rule is 4% plus adjustment for inflation. Is the 6% annuity a flat rate?
I love MYGA's. But those 6% rates are only temporary. Canvas Annuity even has a 6.5% rate for 5 years currently. I'm expecting these kinds of rates to come back to earth sooner than later.
I am just a no one, but annuities scare the &^%# out of me due to risk of sky high inflation (34 Trillion debt.) At least stock market has a chance of keeping up with inflation.. hope some is Roth though or may lose most to tax
The 4% is an absurdly conservative withdrawal rate that 99.9% chance you'll die with a pile of money. It's better to have a cash (CD or Treasury ladder) cushion of 3-4 years, spend ~5%-6% or more and adjust spending in down markets. Plus, he updated the 4% target to 4.7% with similar results. The key is have a outsize percentage in US equities (SP500).
fial: Well, the chance is significantly lower than 99.9%, but it is highly likely you won't run out of money. That does not mean you will have "pile of money." The update to 4.7%, was with the inclusion of small cap stocks in your portfolio. Tjere was actually a study that was just released that said a 50-50 split between U.S. and foreign stocks was safer than Bengen's model portfolio.
There is no guarantee that the SP500 will continue to perform better than other indices. It's PE ratio is quite high compared to others.
I think this is the inverse of dollar cost averaging.
do you recommend annuities for growth at 63 years of age. Do you recommend annuities for income?
A lot of people on youtube try to apply the 4% rule to an all equity portfolio, ignoring the fact that the research was done using a balanced portfolio of stocks and bonds. This irritates me greatly.
1% to 4% meaning higher withdrawal near end of retirement and lower withdrawals at beginning?
Most people probably want to spend more money at the beginning
If 4% was the highest safe withdrawal rate and you withdraw less you'll probably end up with a large sum at death (if it's your goal then it's a good plan)
He left out a huge piece of the equation when it comes to protecting against sequence of returns and that is stock to bond ratio. I think Bengen’s analysis concluded the 60/40 to 70/30 range was optimal for preserving the portfolio for 30 years plus. How do you not mention that critical component?
Is it 4% withdrawals of initial total value or 4% withdrawals adjusted annually to current total value?
Adjusted for total value & also adjusted for inflation.
i don't know how to measure my sequence of returns risk. I am 61 and sill working
Your risk is 0 while you're still working if your income covers your expenses. Risk only kicks in once you retire *and* you're drawing down your portfolio. If you hang in for 2 more years, you'll be 62 & social security can mitigate the risk and allow your portfolio to grow. Only issue is healthcare until 65. Go well, you're almost there!
Does the study take into account that if your investment drops 50% your withdraw rate now becomes 8% of your portfolio?
Absolutely, that and inflation are the key variables in the analysis. If your retirement withdrawals begin at the start of a bear market, you could be screwed. Of course in the real world most people would not blindly forge ahead without making adjustments.
Should early retirees (55-60 years old) consider taking Social Security early to mitigate sequence of return risk instead of spending down retirement accounts in order to wait for full retirement age?
Depends. If wealthy yes. If not, getting a good SS check is invaluable and nearly risk free. We split the strategy, wife took at 63, I will wait till 70. My check will be over $4500/month, which is enough to live on with no debt. And that check goes to the last person living. Combined our checks will be $7000/mo. So our portfolio becomes completely purposed to discretionary spending, and we can decide to spend more or less than 4% depending on what happens.
We have a cash buffer for a down year. So no real worries except dying before we can spend our money!
4% minus 1% for advisor (which I think I probably need). 😢
🤘
Do something with your lighting to prevent the shadow changing in the background.
You’re aware that this is actually a podcast, right? This isn’t the CZcams channel (which is intended for video). Consider this a podcast with the benefit of video.
Tell this to Dave Ramsey.
Why not develop a dividend paying portfolio that pays out around 3-4%, then have a buffer account of about 1 year, in a HYSA. Then live off 4% per year.
I’ve developed a high div. Portfolio of 10 to 12% (low growth of course) it’s about 10% of my overall portfolio and I’ve been testing it the past 2 years, very nice consistant return separate from the market up and downs.
Because of inflation your spending will exceed the 3-4% on the dividends. Year 1 you spend 4% but then that spending amount needs to increase with inflation to have the same purchasing power.
Yes. Crash. That’s why use 3 bucket strategy.
3 yes Cash. 4 yrs Fixed income. Infinity Equities.
I conclude for early retirement you need a boat load of money unless you want to constantly worry, especially with the rising cost of medical and big pharma.
I’m 62 and my plan is simple, bucket 1: 4 to 5 years of cash in money market, bucket 2 social security and high dividend, low growth passive equities, bucket 3 long term high growth stocks/etf, bucket 4, crypto as a hedge. Depending on market and expenses take money from various buckets. I conclude if done correctly, very little money is taken from equities to live on. I’m sure most finance people would think I’m smoking crack buy Jm$.02
You had me until you mentioned crypto vaporware. But at least it's bucket #4 for you. :-)
Guys, trust me on this one. Go out and buy a rental property or two before you retire. Hard to beat rent from a real asset in conjunction with "ticker symbol" investments that can drop like a rock any given year.
return risk is not a risk. Most people at retirement have saved for a long time. If not, we can pretend that they did. (Your financial advisor can determine how much you could have invested each year to end up with your current balance.)
That means that they can depend on long term investment returns. Since 1929, the S&P has returned at least 9.82% annually on money invested in any year for 30 years. So if one invested at age 32, 33, 34 ... and spent what that investment had become at age 62, 63, 64 ..., they would have about 16 times as much to spend as they invested each year.
Most people would agree that 9.82% or more was a return that they would have accepted at age 32, 33, 34 ...
But people do not do math. They do not keep records. They only remember the very short term and those who support that. From 1992 thru 2022 was 30 years. The market was down. But money invested in 1992 had a return on investment of 10.0% annually. 2022 was a very good year. 20323 was a much worse year. 30 year returns were 9.84%. I was happy during both years.
I don’t think market timing will work in retirement any better than before retirement. And that’s basically what a retiree is trying to do by spending from a cash bucket in a bear market.
paul: The strategy calls for spending from the cash bucket in ALL years.
When it's raining you use an umbrella....no need to ignore circumstances and not act accordingly.
James, why does every retirement planner use the Trinity study basis the only discussion point for how to retire. Why would people plan on 4% withdrawal rate as opposed to a 3 1/2% withdrawal rate from a very stable dividend portfolio which never sells a single share and grows With a compound annual growth rate to keep up with or ahead of inflation? If someone planned and maybe bought a rental house and maybe paid off their house and factored in Social Security and factored in any kind of pensions from work, etc., as a supplement, it appears to me that Retirement shouldn’t be all that much of a question mark or a guess. I just don’t understand the 4% Trinity study as the only common sense metric for measuring Retirement and everyone uses it and discusses it as if that’s the only choice.
James the idea of Russian government assets being taken appears not to be worth commenting on with respect to no following of international law?
The best financial advice is not to use a 1% commission financial advisor like James Conole unless you want work an extra 10 years!
Well he only takes people with 2 million or more in AUM, so none of those people are going to need to work 10 more years, being that wealthy.
No graphs. No on-screen text. Quite an impoverished way of presenting information.
Actually..I find the lack of hokey set graphics, cheesy into music, and screaming and yelling; to be exceedingly REFRESHING, compared to a lot of the self-agrandizing BOZOS, on the web; who cover a topic such as serious as personal finance! I think that this young man is a FABULOUS, and well-informed presenter!
@AlanPeery - another comment mentioned this presentation was from a podcast and not his normal CZcams video with all the bells and whistles.
That was painfully long and drawn out. I’ve enjoyed some of your videos but the last few leave me feeling like I’m being talked to like a toddler.
Advisors pretty much ignore equence risk because they don't care how much risk their clients are exposed to. They get their commissions anyway.