Sequence of Returns -- A Critical Factor in Shaping Your Retirement Outlook

This article illustrates how the variation of year-to-year investment returns works together with an investor's withdrawal rate and inflation to potentially affect the longevity of a retirement portfolio.

One of the key determinants of retirement income planning is the expected rate of return on your investments. Conventional analysis typically relies on long-term performance averages to gauge a retiree's spending limits. Increasingly, however, planning experts say that for those who are withdrawing from a portfolio, it is not just the average rate of investment return that is important.

In fact, the sequence of those returns may be just as, if not more, critical to your portfolio's long-term success. In other words, over time, "average" returns will include both bull markets and bear markets. Yet once withdrawals begin, it is far better to have poor years occur later in retirement than earlier.

The timing of returns is becoming a more critical issue now as greater numbers of Americans move into retirement and begin spending down assets.

To better understand how the sequence of returns works together with your withdrawal rate and inflation to potentially affect the longevity of your retirement portfolio, consider the hypothetical example in the chart below. It illustrates three different investment scenarios, each assuming an average annualized rate of return of 6% over a 10-year period.*

sequence returns.jpg

Investor A retired at age 65 with savings worth $500,000. He plans to withdraw 7% of his starting account value each year, which is adjusted annually for 3% inflation. Investor A's investments got off to a poor start with three straight years of negative performance. When he factors in his 7% annual withdrawals, in addition to the poor performance, he will have depleted more than half of his original principal value in just 10 years.

Investor B experienced a steady 6% rate of return over 10 years. After factoring in his 7% withdrawals, his portfolio would be worth considerably more after 10 years than Investor A's -- $373,895 versus $229,109 -- but such consistent market performance over an extended time period is unrealistic.

Investor C's scenario is identical to the first two investors -- with one important exception. The investor experiences seven straight years of positive returns at the onset of retirement followed by three years of negative performance. As the chart indicates, the portfolio would have declined to $479,744 after 10 years, just $20,256 less than its original principal value, despite annual 7% withdrawals.

Since market performance and inflation are variables that cannot be controlled, it is up to individuals to be realistic and conservative in setting a distribution rate for income-producing portfolios. The consensus from financial planners and academics suggests that a "sustainable" withdrawal rate may be no more than 4% to 5% of the account's starting value, adjusted regularly for inflation.


*Standard & Poor's. This example is hypothetical and is for illustrative purposes only. It assumes a 6% annualized rate of return, rounded to the first decimal, and 7% annual withdrawal based on the first-year principal, adjusted thereafter for 3% inflation each year. Actual results will vary. Past performance does not guarantee future results.

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Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail


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