While you accumulate wealth during your working years, you can withstand a considerable amount of investment volatility because any losses you sustain are only "paper losses." This means they aren't locked in until you sell the asset or start withdrawing funds from your retirement account. However, once you retire, these losses are realized, and market volatility can reduce your nest egg more quickly than you'd hoped. Modern Woodmen | Scott S. Paterick CLU CHFC, an experienced investment counselor and estate planning expert in Wisconsin Rapids, WI, explains below how your sequence of returns can affect your retirement savings.
What Is a Sequence of Returns?
Your investment portfolio's sequence of returns is simply the measure of how well or how poorly it performed year by year over a particular sequence of years. For instance, imagine your investments did very well your first year of retirement, fairly well the next two years, and poorly during the fourth year. Your sequence of returns over the period might look like this:
- Year 1: +27%
- Year 2: +9%
- Year 3: +7%
- Year 4: -15%
Now imagine a different sequence of returns, in which you achieve the same results, but in a different order. It might look like this:
- Year 1: -15%
- Year 2: +7%
- Year 3: +9%
- Year 4: +27%
Finally, imagine each of these sequences repeats over and over for the entire period of your retirement as you're withdrawing funds from your investment accounts. You might think that, because the returns are the same except for the order, each sequence would provide a similar number of retirement dollars. Unfortunately, because you're locking in losses and these come first, the second sequence cannot fund your retirement for nearly as long. In fact, if you start with $1 million and withdraw 5% of the balance (adjusted +3.5% for inflation each year), the second sequence of returns will run out 13 years earlier!
Limiting Volatility With Annuities
To address this problem, many investors prefer to limit the amount of volatility in their investment accounts during their withdrawal years. An annuity is a good way to reduce sequence-of-returns risk. It provides a guaranteed lifetime income in return for an up-front payment and gives investors peace of mind.
If you are concerned your retirement savings could be diminished by sequence of returns volatility, Modern Woodmen | Scott S. Paterick CLU CHFC in Wisconsin Rapids, WI, can offer solutions. Visit their website for directions and hours of operation, or call (715) 424-1873 to schedule an appointment.
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