Order-of-returns: A widely overlooked variable is the order in which you receive your returns while you take income in retirement. One might call this the “half-million” dollar mistake. For example, consider two retirees long term portfolios, each with a 7% average rate-of-return over their retirement years. Let’s assume an inflating $80,000 yearly withdrawal rate from assets and a $1,100,000 initial portfolio value.
Consider Bill, who has a lower rate of return in his early retirement years:
+5%, -4%, +8%, -6%, +14%, +16%, +7%, +16%, +7%, etc…
vs. Debra who has a higher rate of return in her early retirement years:
+16%, +7%, +16%, +14%, -6%, +8%, -4%, +5%, +7%, etc…
Bill would run out of money after 23 years, 5 years earlier than Debra who would run out of money after 28 years all while averaging the same long term average rate-of-return!
Bill’s total income will be about $600,000 less than Debra’s over her retirement. The order in which you receive your returns matters greatly given poor early returns will cause additional principal to be spent early in retirement. Further, recognize that the order in which you receive returns can be more important than your average rate-of-return is!
Asset segmentation can mitigate the effect that order-of-returns can have on a retirement. You can learn more about asset segmentation and other retirement planning terms by reading my Retirement Planning Terms Explained post here.