Debunking “Sequence of Returns Risk”

What is the actual risk of running out of money if you start retirement when the market crashes?

This is a question on the minds of many retirees.

Especially because a lot of financial advisors talk about “Sequence of Returns Risk”.

But worrying about this can lead to worse results for many retirees, as well as inferior portfolios, lower returns and a less reliable retirement.

In this blog post I’m going to debunk the “Sequence of Returns Risk” and give you solutions, including a dynamic spending rule that I give my clients.

What you will learn:

• What is “Sequence of Returns Risk”?
• What solutions are typically recommended?\
• What is the actual risk of running out of money with a bad sequence of returns?
• Do the typical solutions work?
• Why don’t the typical solutions work?
• How can you get the maximum reliable retirement income?
• What should you do if your risk tolerance is lower?
• What is “Your Personal Rule” for you to use instead of the “4% Rule”?
• What solution to “Sequence of Returns Risk” actually works?
•  What dynamic spending rules are suggested by actuaries & advisors?
•  What is Ed’s dynamic spending rule?
• How is it customized for you?

What is “Sequence of Returns Risk”?

• The risk that you run out of money if you start retirement with a market crash.
• “Sequence risk is the danger that the timing of withdrawals from a retirement account will damage the investor’s overall return. Account withdrawals during a bear market are more costly than the same withdrawals in a bull market. A diversified portfolio can protect your savings against sequence risk.”

What solutions are typically recommended?

• Diversified portfolio – Bonds.
• Bucketing strategy – Bonds.
• Annuities – Fixed income.

What is the actual risk of running out of money with a bad sequence of returns?

• 4% Rule 100% equities graph – 96-97% success rate.
• Only one market crash that didn’t support a 30-year retirement – 1929
• Fed did not know how to manage the economy. They didn’t support the run on the banks and reduced the money supply by 30%. Fed would not make that mistake today.
• Not just the last 100 years. (Equity returns after inflation similar in the 1800s.)
• Risk to your retirement is inflation, not a market crash.
• Most retirements with 100% equities end with 3-4 times more.

Do the typical solutions work?

• Typical solution is to add bonds to reduce volatility.
• This is more risky.
• 100% bonds chart – 53% failure rate.
• Failure rate nearly 100% except when interest fall for many years, like 1982-2020.

100% Bonds/0% Equities = 53% Failure

70% Bonds/30% Equities = 14% Failure

Why don’t the typical solutions work?

• Stocks are more consistent than bonds after 20 years – Chart
• 70-88% of your 30-year retirement is investment growth AFTER you retire.

The more bonds, the lower the success rate of a 30-year retirement

Success Rates of Retirement Income Withdrawals chart

Ed’s advice:

How can you get the maximum reliable retirement income?

• Growth-focused investors: Keep pre-retirement portfolio.
• If you invest 70% or more in stocks, the “4% Rule has been safe in history.
• Effective management of your withdrawal rate.

What should you do if your risk tolerance is lower?

• Invest within your risk tolerance.
• Lower risk = Lower retirement income.
• Use “Your Personal Rule” instead of the “4% Rule.

Risk tolerance is a learned skill. You can learn it.

• The ability to do nothing when your investments go down.

What is “Your Personal Rule” for you to use instead of the “4% Rule”?

• Ed’s retirement rule: Replace the “4% Rule” with “Your Personal Rule:
• “2.5% +.2% for every 10% in stocks Rule”.
• For example, with 10% in stocks, use a “2.7% Rule”.Highest Success rate chart“
• Age Rule” – Your age in bonds – 3% Rule
• Not a rule – It’s a guideline.

What solution to “Sequence of Returns Risk” actually works?

• Protect 4% Rule with dynamic spending rules.
• What dynamic spending rules are suggested by actuaries & advisors?
• Actuarial studies & advisor formulas – Automatic formulas.
• Guyton-Klinger strategy
• Hebeler Autopilot
• T-SWP funds – T4
• Income automatically adjusted every year.
• 100% effective for any retirement.
• Can be hard to reduce spending by 30% after a big market decline.

Active management of withdrawal rate – Ed’s method.

• Client specific – Depends on ability to reduce spending.
• 100% success rate in history.
• Experience in 2008 – Worst case scenario. Quick recovery.
• Worst market crash in 90 years & 4% Rule worked fine.

Ed