The stock market doesn’t care for what you want or need. It’s a cold and heartless beast – I know, it’s unfair.
Some things don’t make me happy to say, but there is a lottery aspect to all of this: when you were born, when you retire, and when your children go to college. And you have no control over that.
The lottery that Mr Bogle is referring to is the luck of the draw: What will the financial markets be doing when you retire? If you retired in the early 2000’s, you we’re ‘in luck’. If you retired in 2007, you were ‘out of luck’.
One of the biggest risks that isn’t spoken about in the financial world, is sequencing risk. Although it may sound complicated, it’s probably one of the most simplest, yet underrated risks. The risk that you suffer investment losses early in your retirement years, which is a matter of luck, your odds of making it over the long run fade very quickly. In essence, the earliest years of your retirement will define your later years.
Don’t believe me? Let’s take a look at two retirees, David and Carol.
David, age 65, has accumulated $1,000,000 and is about to retire. His portfolio is invested in line with a ‘balanced’ portfolio, that is 60% in stocks, and 40% in bonds. David draws $50,000 (indexed by 3% each year) from his portfolio each year to help fund his retirement.
David experiences some losses early on in his retirement – three years in a row in fact. And within five years, his portfolio has been cut in half. Withdrawing funds when the market is down makes it even worse. Although David’s portfolio makes up ground in the following years, the damage has been done. By the time he reaches 85 years of age, his portfolio has collapsed. he withdrew a total of $1,255,843 from his original investment of $1,000,000.
Let’s now consider Carol. Carol also retires at the age of 65 with $1,000,000 in the kitty. Carol experiences the exact same market returns as David, however in reverse order. Here’s what her portfolio looks like:
By simply reversing the order, or sequence of returns, Carol has a vastly different retirement experience. In fact, by the time she is 88 years of age, she has withdrawn $1,721,323 and still has over $2,485,000 in her retirement portfolio.
It’s mind boggling. Two retirees with the same investment balance, same withdrawal rate, same investment time frame, same average returns. Yet one penniless, the other living a completely financial free retirement.
You can do all the things right, but if you, just for one second, need to start drawing on your funds when the market is spiraling out of control, there can be a devastating impact on your nest egg. For some, this may mean not being able to care for their loved ones, or fund the retirement they’ve always dreamed of. For others, it means not being able to send their grandchildren to an independent school.
The market doesn’t care for what you want or need. For this reason, your personal life and balance sheet have never needed to be been more connected. Be clear on what you want and why. Then make investment decisions accordingly.
It certainly helps when you have a life and financial plan mapped out. Sure, it’s unlikely to go to plan, but like every pilot has a route mapped to their destination, and when the whether changes, they know exactly where they need to go, how far they deviated, and what to do to get back on track.
Sequencing risk is real. And investors deserve risk management strategies that will help give them the financial freedom they deserve.