If you were guaranteed an average rate of return of 7% over the next 30 years would you take it? The simple answer for most retirees would be “Absolutely!” but the order in which those returns are achieved and the withdrawals taken from the portfolio can have an outsize effect on overall plan success rates. Baird defines sequencing risk as “The risk of lower or negative returns early in a period when withdrawals are made from an investment portfolio”. Specifically, let’s examine a scenario in which negative returns are achieved early in retirement.
Consider the following example in which a client retires with $1,000,000, gets an average arithmetic return of 7%, and wants to withdraw 4%, inflated at 3%, from their portfolio for 30 years. Various rules of thumb would approve of this spending plan; 4% is a fairly common withdrawal rate and we already know that the portfolio’s average return is higher than the planned withdrawals.