Why the Stock Market Can Make or Break Your Retirement

UNDERSTAND THE SEQUENCE OF RETURNS

The risk we all face is the devastating concept of sequence of returns. Sounds complicated, but it’s not. In essence, the earliest years of your retirement will define your later years. If you suffer investment losses in your early years of retirement, which is entirely a matter of luck, your odds of making it the distance have fallen off the cliff.

You can do everything right: find a fiduciary advisor, reduce your fees, invest tax efficiently, and build up a Freedom Fund. But when it’s time to ski down the backside of the mountain, when it’s time for you to take income from your portfolio, if you have one bad year early on, your retirement plan could easily go into a tailspin. A few bad years, and you will find yourself back at work and selling that vacation home.

Sound overly dramatic? Take a look at John and Susan.

John is now 65 and has accumulated $500,000 (far more than the average American) and is ready to retire. Like most Americans nearing retirement, he is in a “balanced” portfolio (60% stocks, 40% bonds). Since interest rates are so low, John decides he will need to take out 5%, or $25,000, of his nest egg each year to make his income needs for his most basic standard of living. When added to his Social Security payments, he “should” be just fine. And he must also increase his withdrawal each year (by 3%) to adjust for inflation because each year the same amount of money will buy fewer goods and services.

As John’s luck would have it, he experiences some market losses early on. In fact, three bad years kick off the beginning of his so-called golden years. And in five short years, his $500,000 has been cut in half. And withdrawing money when the market is down makes it even worse, since there is less in the account to grow if or when the market comes back. Even though John eventually has many solid positive/up years, the damage has already been done. By age 83, his account value has collapsed, and he can withdraw just $580,963 from his original $500,000 retirement account.

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