Many investors are aware of the risks when “saving up” towards a lump sum. Unfortunately, far fewer are aware of all the risks when “drawing down” from a lump sum, for example in retirement.
One pernicious risk is Sequence of Return risk – the risk associated with drawing an income in different market environments. In this blog we look at an example to highlight the risk.
In our Sequence of Return Risk example Mrs. Green and Mrs. Blue each start with a £100,000 portfolio at age 65.
Both average a 6% return a year so their money grows to the same value after 25 years, but the ups and downs in returns are in reverse order from each other.
But the order of returns does not impact the final value – it is the overall rate of return that determines this.
Drawing down (taking an income)
Again Mrs. Green and Mrs. Blue start with an initial £100,000 portfolio. But in this example, they start taking 5% withdrawals (of the initial value) beginning immediately at age 65.
Mrs. Green begins taking withdrawals in an “up” market (in this case three years of positive returns). Unfortunately for Mrs. Blue, she starts taking income in a “down” market (in this case three years of negative returns).
The impact of this poor start means Mrs. Blue runs out of money before reaching age 83. Mrs. Green will still have over £250,000 left 7 years later!
A Financial Adviser can assist in planning for retirement and managing these risks for the long run by using different strategies.