Most retirement calculators use average returns for various assets (like U.S. Equities, bonds, etc.) in order to calculate future values for investments. It's common to project investments for 30 years or more when doing retirement planning. This can lead to a huge mistake. It's one thing to conclude from a thousand simulations that a particular strategy will be successful, and another to recognize that the retiring person only gets one shot at their life in retirement.
That's why it's important to understand that there are risks in the sequence of market returns over that retirement lifespan. Actually, there are two risks. One is called sequence of consumption risk, excessive spending early in retirement. The other is called sequence of returns risk, poor returns early in retirement. Both have the effect of decreasing the retirement savings with long term detrimental consequences.
It turns out that sequence of return risk is particularly onerous for retirees. You see, that's when you've accumulated a lot of money. So, a major market downturn at or near retirement has a big effect on you. Not so for the young who hasn't been accumulating for 30 plus years. Incurring a major market downturn early in retirement dramatically reduces the probability that your savings will meet your retirement projections.
The point is to be aware that the use of average returns is often misleading for individuals. The strategy of just buy and hold regardless of what happens in the market is fine if you're young. But, can have grave consequences if you're a retiree. BTW, a target date retirement fund doesn't do a very good job protecting you from sequence risks. Just ask those retirees with a 2010 fund.
There are good ideas for addressing this risk. These include being tactical, not fixed in your investment mix. Having alternative sources of income outside of investment accounts. Consideration for pension like annuities that don't rely on the market. Of course, being willing and able to cut your consumption makes a difference.
That's why it's important to understand that there are risks in the sequence of market returns over that retirement lifespan. Actually, there are two risks. One is called sequence of consumption risk, excessive spending early in retirement. The other is called sequence of returns risk, poor returns early in retirement. Both have the effect of decreasing the retirement savings with long term detrimental consequences.
It turns out that sequence of return risk is particularly onerous for retirees. You see, that's when you've accumulated a lot of money. So, a major market downturn at or near retirement has a big effect on you. Not so for the young who hasn't been accumulating for 30 plus years. Incurring a major market downturn early in retirement dramatically reduces the probability that your savings will meet your retirement projections.
The point is to be aware that the use of average returns is often misleading for individuals. The strategy of just buy and hold regardless of what happens in the market is fine if you're young. But, can have grave consequences if you're a retiree. BTW, a target date retirement fund doesn't do a very good job protecting you from sequence risks. Just ask those retirees with a 2010 fund.
There are good ideas for addressing this risk. These include being tactical, not fixed in your investment mix. Having alternative sources of income outside of investment accounts. Consideration for pension like annuities that don't rely on the market. Of course, being willing and able to cut your consumption makes a difference.
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