Though counter-intuitive, the years immediately before and after retirement can be one of higher risk for your portfolio. Your portfolio is even more vulnerable than later in life. A portfolio downturn at this time can be very unpleasant for retirement planning. Consider the following chart:
As noted by the dark red shaded areas entitled “Retirement Date Risk,” the portfolio is highly dependent upon returns during the last 10 years of working. The percentage change on your portfolio, in gross dollars, is obviously greater the larger your portfolio.
The lighter shaded red area is titled “Sequence of Returns Risk.” The timing of returns is extremely important, not just the average.
Riddle: Is it possible to drown in a body of water that is, on average, 3 inches deep?
Yes if the water is 1 inch deep except for a 7 foot deep hole. The average may still be 3 inches, but you must watch for the hole.
In much the same way, a portfolio can return an average of 6% per annum, but if lower or negative returns occur early, the overall size of the portfolio can be greatly reduced (when taking withdrawals.)
Source: Investment News
The above chart shows that though both retirees experience an average 6% return, and both take $72,000 (6%) in annual withdrawals, the remaining balance in year 10 is significantly different depending upon the timing of the returns (in this case, they just occur in a reverse order.)
Since bonds usually carry less risk than equities, increasing the fixed income (i.e. bonds) percentage can be a good strategy. The bond portion (sometimes called a “bond tent”) decrease susceptibility to the aforementioned retirement date risk and sequence of return risks. The potential rising interest rate environment that we find ourselves in does present problems with this strategy. If you will remember-as interest rates rise, bonds fall in value.
Our challenge is finding ways to de-risk the portfolio in a rising rate environment. We are constantly searching for new tools to help accomplish this goal. If you are in the Retirement Danger Zone, contact us to discuss ways to make it through this exciting period of life safely.
If you are in the Retirement Danger Zone, contact us to discuss ways to make it through this exciting period of life safely.