Boost Your Retirement Account by Weighing Your Sequence of Return Risk
The “Slap in the Face” Award this week comes compliments of something called “sequence risk.”
And if you’re trying to plan for retirement, this is a real wrench in the works.
Simply put, sequence risk means you can do everything right, like execute and fund your retirement plan exactly as designed… but depending on how the unavoidable mix of good and bad stock market years line up, you could still retire with significantly less (or more) than another person who simply started saving and investing on a different date.
You can even have the same long-term return, but if you happen to get hit with a series of bad years at the wrong time, your outcome could be a lot less.
Take the following hypothetical example from a study by a money management firm in Boston…
It looked at a person who started saving and investing in 1954 versus a person who started in 1967. Both continued for 40 years. They experienced nearly identical long-term market returns but had radically different outcomes.
The one who started in 1967 ended up with 50% more money in his 401(k) than the other guy.
Yet the amount of time was the same. Their salary growth was the same. And they experienced the same deferral rate and company match.
But the investor who started in 1967 produced 50% more than the one who started in ‘54.
The only difference was the 1987 crash; the younger person had less equity at risk.
And that’s the crux of the issue I’m talking about today…
Not many money managers talk about sequence risk, but it’s real. And according to some fund managers, it’s an act of God that mere mortals have no control over.
There’s only one way to limit the potential damage: Decrease your exposure to equities as you age.
Leave too much exposed – for too long – to the risks of the market, and you increase your chances of a big surprise. And it’s not a nice one.
I have been pounding the table about this for years!
A helpful guide? Your age. It’s equal to the percentage you should have in less risky investments, like bonds and cash.
The more predictable your returns, the lower your sequence risk.
The fixed model of 60% stock and 40% bonds most planners throw out there is a bunch of hooey! It does not go far enough! You need annual adjustments to limit the damage that can be done.
Stay on top of the changes necessary to hold on to your money as you age, or be prepared for a not-so-nice outcome.
“An act of God”…
Well, we finally have an accurate description of stock market losses!