The following is an excerpt from

Big Picture Retirement Planning

Les Goldstein, M.B.A.

Personal Financial Strategies, Inc. PARK RIDGE, ILLINOIS

Copyright © 2018 by Les Goldstein.

The following content is for non-commercial educational use only. All rights reserved. No part of this publication may be reproduced, distributed or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other non-commercial uses permitted by copyright law. For permission requests, write to the publisher at the address below.
Les Goldstein/Personal Financial Strategies, Inc.
626 Busse Highway
Park Ridge, IL 60068
Book layout ©2013
Big Picture Retirement Planning/ Les Goldstein. —1st ed.
ISBN 978-0-0000000-0-0


The Sequence of Returns


It seems as if almost no one talks about sequence of returns risk. Keeping in mind my goal of adding value to your life from your reading and taking to heart the content in this book, let’s explore this right now. Why? Because in the world of retirement planning, the timing of positive and negative returns can be just as impactful as the amount of losses and gains. Interestingly enough, sequence of returns does not matter during the accumulation phase of life, only during the distribution phase.

Let’s see if I can prove this to you right now. I have seen many cases where clients come to us after firing their previous advisor, where losses in the early years of retirement were incredibly detrimental to their successful retirement. Why do losses early on potentially matter much more than losses later in life? Let’s explore this right now.

Here is a hypothetical example of two investors with the same initial $250,000 portfolio. The average annual rate of return for each investor is identical. However, the sequence of returns for Investor A is “flipped on its head” for Investor B. The 5 percent per year annual withdrawal (for retirement income generation) is increased 3 percent per year to account for inflation.

Now, lets flip those returns in reverse:


Investors A and B had the same annual returns over 19 years, with each portfolio earning an average annual return of 4.71 percent. The only difference is that Investor A’s annual returns were inverted to create Investor B’s annual returns. This hypothetical example is for illustrative purposes only and is not intended to represent the performance of any particular investment product or actual stock or bond market performance. In this hypothetical example, Investor A exhausted his portfolio in only 19 years, while Investor B still had approximately 80 percent of his original principal intact. I hope you can now see that losses early on can potentially hurt more than losses later in your retirement life.

This is why we often like investments with safety nets, such as annuities with minimum income benefit riders. Riders of this type are designed to provide a minimum guaranteed income stream for life, regardless of the performance (or lack thereof) of the investment to which the rider is attached. As always, you need to remember that these riders are built by insurance companies and are not FDIC insured or guaranteed by the US government. You can lose money.

Here are even more examples of sequence of returns and the potential impact of retirement income withdrawals. As always, please remember that these are illustrations only. Your results will vary.
The first two following charts are based upon the actual prior performance of the unmanaged S&P 500. For simplicity of illustration, we assume that the initial investment in 2006 was $700,000, all in the unmanaged S&P 500.

For illustration purposes only. Assumes 100 percent of money is invested in the S&P 500 Index. Your results will vary. Based upon the prior performance of the S&P 500 Index, an unmanaged index. You cannot invest directly into an index. Also assumes 5 percent annual withdrawals of the beginning of the year value, increasing by 3 percent per year for inflation.

Now, what if you retired in 2008, just two years later?

If this was your situation, you would have worked two years more than the first investor and received over $70,000 less in income distributions from your portfolio. Your portfolio value would have been almost $80,000 less than the value of the first investor’s portfolio. Finally, your nest egg would have decreased by almost $140,000 from your original $700,000. This is after only seven years of retirement!
Prior to retirement, the sequence of returns is not nearly as impactful as it becomes after retirement. This is because withdrawals of income and principal are not taking place during the accumulation phase of your investment life.

Here’s proof: Suppose you invested $500,000 into a hypothetical investment. You need $30,000 per year from this investment to live on. You realize that there is always inflation, so you wisely increase your annual withdrawal by 3 percent to keep up with rising costs. Here is what Scenario #1 looks like.

Scenario #1

Source: Securities America, Inc. NextPhase Workshop. 2015.

Scenario #1 looks pretty good. Every year, your income increased to keep up with inflation. At the end of 20 years, you ended up with more than you started with. Your actual returns and income looked like this:

  • 6 percent annual distribution, increasing by 3 percent per year for inflation
  • 8.27 percent average annual return (this does not include taxes, investment management fees, etc.)

Now, let’s turn the numbers upside down and see what happens to this investor’s lifestyle.

Scenario #2

Again, your actual returns and income looked like this:

  • 6 percent annual distribution, increasing by 3 percent per year for inflation
  • 8.27 percent average annual return (this does not include taxes, investment management fees, etc.)

If income was not taken out of the preceding portfolio, the two investors would have ended up in the same place. Why? Because sequence of returns does not matter during the accumulation phase of life. But when income is taken out of a portfolio, early negative returns can be extremely detrimental to long-term retirement health. In Scenario #2, after only 14 years, this second investor is out of money. This is one of the reasons we often consider using a strategy that includes annuities with income benefit riders that are designed to create a certain level of minimum annual income for soon-to-retire and already-retired clients.

PFS Pearl of Wisdom: Withdrawing a fixed dollar amount from a declining portfolio results in a higher withdrawal rate and hastens the decline of your portfolio. If you insist upon taking out a fixed dollar amount all the time, regardless of the value of your investments, you may need to sell investments periodically to support your income needs. You will then have fewer shares, thereby reducing the number of shares you own that will be available to participate in any future stock market rally. Potentially, you are creating a downward spiral from which there is no escape.

One of the large Wall Street investment firms calls the first few years before and after retirement the “Retirement Red Zone.” I agree. If you suffer negative returns early on in retirement, the impact can be devastating to your retirement lifestyle. Negative returns later on, after (hopefully) some years of solid returns, are not nearly so negatively impactful. Also, as discussed earlier in this book, depending on your specific objectives and risk tolerance, you may want to consider including low-correlated non-stock-market assets in your retirement portfolio. In addition, consider investments with safety nets, such as annuities with income benefit riders. Please remember that adding low-correlated or non-correlated investments and annuities with safety nets does not guarantee positive results.

When you own annuities with income benefit riders during retirement, your goal should be to secure the income you will need to meet your basic retirement income needs. The account value can decrease (with a variable annuity), but your minimum guaranteed lifetime income will not decrease if you follow the withdrawal terms of the income benefit rider. With some variable and fixed index annuities, your account value can even decrease to $0 and your lifetime income will continue for your entire life, as long as you follow the annuity rider contract rules. Yes, there is always an additional cost for an income benefit rider. But it can be a valuable tool, especially during bad times, and always when you are trying to fill your retirement income gap. Please see the section on risks at the end of this chapter for a more in-depth review of the risks associated with variable annuities.

Important Disclosures for This Chapter

It is important to understand that everyone’s situation is unique and not all strategies and methods mentioned in this book may be appropriate or suitable for every individual. We suggest that you consult fully with your financial, tax, and legal advisors on pursuing a strategy that is uniquely tailored to your particular needs.
Sequence of return reviews and Monte Carlo simulations illustrate how your future finances might look based on the assumptions you provide. Though a projection might show a very high probability that you may reach your financial goals, it can’t guarantee that outcome. However, a Monte Carlo simulation can illustrate how changes to your plan could affect your odds of achieving your goals. Combined with periodic progress reviews and plan updates, Monte Carlo financial forecasts could help you make better-informed investment decisions.
Variable annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax, and, if taken prior to age 59½, a 10 percent federal tax penalty may apply. Withdrawals will reduce the living benefits, death benefits, and account values. Early withdrawals may be subject to withdrawal charges. An investment in the securities underlying a variable annuity involves investment risk, including possible loss of principal. The contract, when redeemed, may be worth more or less than the original investment. Optional riders have limitations and come at an additional cost through the purchase of a variable annuity contract. Guarantees are backed by the claims-paying ability of the issuer.
Annuity contracts and life insurance policies are guaranteed as to payment of principal and interest by the issuing insurance company.
Variable annuities are sold by prospectus only. Investors should carefully consider objectives, risks, charges, and expenses before investing. The contract prospectus and the underlying fund prospectus contain this and other important information. Investors should read the prospectus carefully before investing. For a copy of the prospectus, contact your financial advisor.
Equity indexed annuities are long-term investments subject to possible surrender charges and the 10 percent IRS early withdrawal penalty prior to age 59½. Current minimum return, principal value, and prior earnings guaranteed by the issuing insurance company are subject to their claims-paying ability and contract provisions.
Income benefit riders are offered for an additional cost by issuers of variable and equity index annuities. Income benefit riders do not guarantee the principal or original premium invested in the variable or equity index annuity; they are typically designed to provide lifetime income to the annuitant(s) and/or spousal beneficiary. Income benefit rider guarantees are backed by the claims-paying ability of the issuing insurance companies. Review all the benefits, limitations, and costs of the income benefit rider before selecting. Not FDIC insured. You can lose money.