What if Results Turn Out Better Than Expected in Retirement?
“The future belongs to those who believe in the beauty of their dreams.” (Eleanor Roosevelt)
A very real retirement risk
You may have heard about the dangers of retiring into a falling market, as it can have a persistent negative effect on your portfolio. This is known as sequence-of-returns risk, and it’s one of the most important risks to understand as you move from investing money to living off your savings.
While much of the discussion around sequence risk focuses on what happens when markets fall at the wrong time, the reverse can also be true: a favourable sequence of returns can leave you in a far stronger position than your original retirement plan assumed.
Let’s dig a little deeper
Consider two investors who retire with equal investments. They withdraw the same amount over a 30-year period and receive the same average return on their investments. One would expect that they end up in the same position, but the reality is that the outcomes may be quite different.
- If one investor enjoys several strong investment years early in retirement, their portfolio has an opportunity to grow before regular withdrawals begin to make a significant dent in the capital. That larger amount of capital then continues to generate returns in later years.
- The other investor may experience several weak years at the beginning of retirement. Their withdrawals are being taken from a portfolio that has already fallen in value, leaving less capital available to benefit when markets eventually recover.
The average return is only part of the story. The order in which those returns occur can have a significant effect on how much capital remains available later in retirement – and ultimately, how much can be passed on to the next generation.
When sequence risk works in your favour
Sequence risk has built up an almost entirely negative reputation. But there’s another side to the story that doesn’t get a lot of attention. What if you are very lucky with the sequence of returns and you retire into a bull market? You may end up with a lot more than expected.
A retirement plan designed primarily around avoiding the risk of running out of money can leave people psychologically stuck in protection mode. Even when their financial position has become stronger than expected, they may continue to spend cautiously, postpone experiences or keep accumulating wealth because spending still feels like a threat to their security.
The opportunity cost of not enjoying your capital once you realise you’ve lucked out is huge. Think of losing the freedom to travel (especially to family overseas), pursue other hobbies, and help your children and grandchildren financially. These are particularly valuable in the early years of retirement, when you hopefully have sufficient health/energy to live life to the full.
If you’ve always dreamed of buying a house at the beach, and the numbers show you can afford it … Do it now, before health issues kick in or the kids emigrate!
When it comes down to it, the value of your capital is not only measured by numbers, but by what the funds enable you to do. When wealth outgrows the plans, why not make intentional decisions to enjoy it rather than be shrouded in fear?
The bottom line
Sequence risk has two sides. The wrong sequence of returns can threaten a retirement plan; the right one can create opportunities that were never anticipated. Good retirement planning prepares you for both. It is not simply about protecting your capital against what might go wrong but recognising when things go right, and having the freedom to make the most of it.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact us for specific and detailed advice.
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