This was a question asked by a visitor to Investopedia.
Several other advisors responded. Here’s my contribution to the discussion.
You have gotten some good advice from the others who have responded. The only advice I would add to theirs is that the years just prior to retirement and the first few years of retirement are the most critical years for you. These are the years when significant investment losses have the biggest impact on your retirement assets.
That’s because of something referred to as “sequence of returns.” “Sequence of returns” refers to the fact that market returns are never the same from year to year. For example, here are the returns for the S&P 500 from 2000 to 2010. That was a dangerous decade for retirees.
2000 -9.1% 2001 -11.9% 2002 -22.1% 2003 28.7% 2004 10.9% 2005 4.9% 2006 15.8% 2007 5.5% 2008 -37.0% 2009 26.5% 2010 15.1%
When you are accumulating assets, the sequence of returns has no impact on the amount of money you end up with. But when you are taking money out, the sequence becomes very important. That’s because taking money out of an account exaggerates the effect of a market decline.
If you retired in the year 2000 with $100,000 and took out 4% ($4000) to live on each year, by 2010 your account would have shrunk to about $66,200 and, if you continued to withdraw the same amount each year you would now be taking out 6%. If you have another 30 years in retirement, that rate of withdrawal may not be sustainable.
For that reason, most financial advisors recommend creating a portfolio that can cushion the effect of poor market performance near your retirement date.
Tags: investment returns