External

Retiring retirement

Source: Retiring retirement

Advertisements
Research Articles

Sequence-of-returns risk and its amplified effect on retirees’ returns

Sequence-of-returns risk, or sequence risk, refers to the specific order how returns, good and bad, accrue during investors’ life cycles, and it is especially relevant for living annuity investors, or investors that are making regular withdrawals from their investment portfolios.

Source: SOR_impact

Research Articles

Living annuities and (much) less-than-expected portfolio returns: Do I really have enough capital?

Any financial plan is subject to core assumptions – one such make-and-break assumption in retirement planning is the expected portfolio return one will experience in a retirement portfolio in the long run.  That is key because it will determine whether the retiree will have enough capital to retire comfortably, as well as the appropriate drawdown rate required at retirement, and the long-term sustainability of the retirement plan in the post-retirement period.

Very often financial planners plug in an expected portfolio return of about 5% above the inflation rate over the long term, which is not wrong per se as it is based on the historical precedent of market returns through multiple decades, even though it is biased towards more recent history. That is to say, if the retiree’s investment portfolio will mimic more or less the market portfolio on which the assumption is premised, typically a medium-to-high equity, multi-asset class investment portfolio.

Are there any reasons to doubt the validity of these numbers, going forward? While it is easy to succumb to current political and economic concerns of the day, often backed and highlighted by popular columnists (I would not use the term “experts”) why this time around it should be very different than the past, the long history of financial markets have shown that it survived deep crises before, both political and economic in the past and yielded the desired returns to brave and patient investors that weathered those storms.

Thus, I for one, do not deviate from the numbers too much, I might use a bit more conservative return assumptions in my planning exercises, but I do not radically change my assumptions because I might feel at a particular point in time less optimistic, or conversely, very optimistic about the future, akin to participants’ behaviour on the stock market. That, to me, is a very bad starting point in the planning process.

Yet, what’s wrong playing devil’s advocate with the expected return numbers? What if the market will yield substantially lower numbers than what we’ve witnessed in recent memories. Let’s call it a stress-test exercise. How sound is my plan under (much) lower-than-expected returns, going forward. What alternative plans and options should I keep in mind when things really do go south?

Source: Retirement_bad returns