One of the biggest risks with a typical retirement portfolio is the stock market performing negatively or taking a nosedive in the early years of retirement.
The impact this has on the portfolio may not be recoverable for some. This is called the sequence of returns risk.
Many would agree that the stock market has grown over the long term, despite short-term volatility. We don’t know from year to year if the market will be up or down.
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If your retirement strategy includes withdrawing income from investment accounts that are going through a down cycle or a volatile period, especially in the early years of your retirement, that could become a big problem. A structured income plan helps mitigate this risk.
Invest for the long term, right?
Investment institutions across the land educate us to invest in stock and bond portfolios for the long term. We’re taught that the further we are from retirement, the larger the percentage we should allocate to equities and the smaller the percentage we should put in bonds.
As we get closer to or begin retirement, we’re taught to allocate less to equity holdings and increase bond or fixed income holdings. The theory is that this reduces your investment risk. But it also reduces your growth potential.
What if you need income on day one of retirement and your portfolio is in negative territory for the year and the market is volatile? Your portfolio is losing value and you’re told to withdraw income anyway.
Isn’t that the opposite of what we’ve been taught about buying low and selling high and investing for the long term?
The issue is that retirees need income this year and next year, and for the rest of their lives. Will the stock market be up when you retire and need income? Or down?
Somehow, the sequence of returns risk doesn’t get much attention. Being primarily invested in stocks and bonds is great when you have years for your accounts to grow and overcome short-term dips and market downturns.
However, problems tend to emerge when you have to rely on these investments to generate income early on in retirement.
Maybe you'll get lucky
If the markets zoom up during your first few years of retirement, consider yourself fortunate — you’ve most likely avoided the sequence of returns risk.
If, on the other hand, the markets are negative early on in your retirement years, that could spell trouble for your retirement income strategy.
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It’s important to ensure that you not only have a retirement income strategy, but the strategy is structured in such a way that it mitigates the sequence of returns risk.
Our firm uses a structured income plan to help our clients avoid this risk. Essentially, we split client assets into multiple accounts and assign job descriptions to those accounts.
Here is an example of a structured income plan:
Account No. 1
This account is designed to provide the client with dependable and predictable income during the first five years of retirement.
We typically use low-risk or protected savings vehicles that are designed to achieve this goal.
Savings, CDs, Treasuries, certain types of bonds and income annuities are options to help achieve this account’s goal.
Account No. 2
This account is designed to grow for five years and then provide income for the next five years. We could use bonds or fixed annuities with or without an income rider to help achieve this account’s goal.
Account No. 3
We have now accounted for the first 10 years of income in retirement with low or no stock market risk, so this next account’s job is to grow for 10 years then provide income.
We could use a wide variety of securities instruments in this account and allow these investments to perform over a long period while mitigating client emotions of short-term volatility inherent when invested in the market.
It also helps some clients avoid knee-jerk reactions of wanting to move to cash during volatile times.
Also, we could consider a fixed index annuity with an income rider that grows for 10 years, then begins income for life.
Account No. 4
Given that we have provided for the first 15 years of income in retirement, this account’s job is to grow for 15 years then provide income.
Similar to bucket No. 3, we could use a wide variety of securities instruments in this account and allow these investments to perform over a long period while providing clients with income, mitigating their emotions and allowing this account to be invested long term without concerns about the daily gyrations of the markets.
Even more accounts
I’ve illustrated four accounts that make up a structured income plan. But there are times where we use five, six or seven buckets.
The concept is the same, but each plan design is unique to the needs and preferences of the client. The purpose of this retirement income strategy is to generate income without market risk for 10 to15 years of life, without market volatility.
Structured income planning provides the client with steady and predictable income while allowing the stock market to do what it has historically done long term, thus helping to avoid the potential negative impact of the sequence of returns risk.
Insurance products and services offered by Jim Sloan and Associates, LLC. Investment advisory services offered through MariPau Wealth Management, LLC an SEC Registered Investment Advisor. Please note that the use of the term “registered” to refer to our firm and/or our associated persons does not imply any particular level of skill or training. Jim Sloan and Associates, LLC and MariPau Wealth Management, LLC are not affiliated entities. While the processes mentioned in this article have been designed with care, financial outcomes can never be guaranteed as investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. None of the information contained in this article shall constitute an offer to sell or solicit any offer to buy a security or any insurance product. Insurance may be subject to fees, surrender charges and holding periods which vary by insurance company. The information and opinions contained in this article are provided by the author and have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. They are given for informational purposes only and are not a solicitation to buy or sell any of the products mentioned. This article is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. Jim Sloan and Jim Sloan and Associates, LLC do not give tax or legal advice. Tax laws are subject to change and can affect results. The firm is not affiliated with the U.S. government or any governmental agency. Hypothetical examples have been provided for illustrative purposes only and should not be construed as advice designed to meet the particular needs of an individual’s situation.
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