New and soon-to-be retirees can reduce their “risk-return cascade” by adjusting both their portfolio and their investment mindset. Investors who do not manage this risk may wish to have paid more attention to the old Aesop’s tale about a farmer who had a goose that laid one golden egg each day.
If you don’t remember it, I’m going to hunt: Instead of considering how best to protect his goose–and the comfortable lifestyle it provided for him–the farmer decided he wanted to get more eggs, faster. So he ends up chopping up the goose… and a retirement plan.
The moral of the story—”those who have a lot want more, and therefore lose all they have”—could serve as a cautionary tale for anyone, young or old, who chooses to invest aggressively despite the potential for big losses. But it’s especially relevant, I think, for recent and soon-to-be retirees, who are more vulnerable to something called “risk-of-return cascades.”
participation in Kiplinger’s Personal Finance
Become a smarter, better-informed investor.
Save up to 74%
This is because once you retire and start making regular withdrawals from your investment portfolio, annual market returns become key to maintaining a reliable income stream. If your shares experience a significant loss in value due to a correction or crash, and you find yourself having to sell more shares to generate the income you need, this could affect how long your retirement savings will last.
And if that loss occurs early in your retirement, or just before retirement, the unfortunate timing could end up killing the goose you depend on for a steady stream of golden eggs – even if your portfolio’s “average” rate of return is adequate.
How the sequence of returns may affect retirement outcome
Below is a hypothetical example of how the sequence of returns may affect the outcome of retirement. Let’s say we have two investors, both starting retirement with $1 million and a plan to withdraw $50,000 annually. Over the next 30 years, they experience exactly the same average rate of return (6.3%), but their annual returns occur in exactly the opposite order.
Investor A lives three years into retirement, and has nearly halved his savings. Despite several good years after that, he never really recovered and eventually ran out of money.
Investor B gets off to a much better start. And though he’s going through some tough times ahead, three decades later, he’s doubling his money to over $2 million.
If they don’t take the distributions, Investor A and Investor B will have the same balance of big dollars at the end of 30 years, regardless of their return sequence. But because they were withdrawing $50,000 a year, their real rates of return were much different than their average rates of return.
Of course, you can’t control the markets, so you can’t control the amount or demand of your returns. But you can adjust your portfolio (and your investment mindset) to help reduce the risk-return cascade.
Have a plan that minimizes the risky return continuum
The investment you made in your 20s, 30s, and 40s–and even your 50s–is different from what you should do as you approach retirement. (Think 10 or at least five years.) With continued contributions and the power of compounding, you had a chance to bounce back if you experienced a market crash in your younger years. That rebound may not be a given, unfortunately, when you have a decade or less left until your retirement date.
You must have a plan that prioritizes protecting the wealth you have accumulated.
That likely means reducing your exposure to volatility with a more conservative mix of bonds and stocks. You can also choose to add some trusted income producers (such as annuities or dividend-paying stocks). And you may find it makes sense to create a flexible withdrawal plan so that you don’t have to sell shares at a low price to maintain your lifestyle in a bad year.
You can still keep some growth in your portfolio to generate income in the future. Just don’t let greed, fear, or complacency cook your goose. Talk to your financial advisor about how to maintain a steady stream of golden eggs during your golden years.
Kim Frankie Volstad contributed to this article.
Appearances at Kiplinger were obtained through PR software. The columnist received assistance from a public relations firm in preparing this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Investment advisory products and services are provided by AE Wealth Management, LLC (AEWM), a registered investment advisor. Ted Thatcher License No.: 0L09326 Pinebrook License No.: 0M84694 Insurance products are offered by the insurance business of Pine Brook Financial. Pine Brook Financial is also an investment advisory practice that provides products and services through AE Wealth Management, LLC (AEWM), a registered investment advisor. AEWM does not offer insurance products. Insurance products offered by Pine Brook Financial are not subject to investment advisor requirements. This article is for informational purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. Insurance products are sold based on the suitability standard at the country level and the insurance company level; This means that product recommendations must meet the specific needs and financial goals of the customer. It is required to provide advisory services in the field of investment in accordance with a fiduciary standard; This means that the advice must be in the best interest of the client with full disclosure of any conflicts of interest to the client. 1,539,974 – 11/22
This article was written by and presents the opinions of our contributing advisor, not the Kiplinger editorial staff. You can check the advisor’s records with the SEC (Opens in a new tab) or with FINRA (Opens in a new tab).