Eric: Hi David, and thanks for joining us today.
David: Thank you, Eric.
Eric: We've heard that sequencing risk is important and should be taken into consideration by retirees. Could you explain why this is the case?
David: You're absolutely right. Regular withdrawals from your portfolio combined with a loss in the market can have a significant impact on the lifespan of your assets during retirement. For example, let's say you have a principal of $1 million, and you withdraw $60,000 a year with an expected return of 5%. In this case, your portfolio should mathematically last about 36 years. However, if you experience a decline of 15% in the first year of your retirement, your assets will only last about 25 years. That's 10 years less than expected.
So, it's important to consider the potential risks and work with a financial advisor to develop a plan that takes those risks into account. They can help you create a retirement plan that takes into account potential market downturns and withdrawals, so you can enjoy a secure and comfortable retirement for as long as possible.
Eric: That's quite an impact. Why does this happen?
David: Many retirees are unaware that their retirement payout is a critical factor in determining whether their assets will last throughout their retirement. Since no one can predict how much volatility they might encounter in the next 10 years, it's important to practice prudent risk management from the outset. This means creating a retirement plan that takes into account potential market fluctuations and other factors that could impact your finances. In financial planning, this concept is often referred to as the "luck factor" because the way the market behaves is largely beyond our control.
By working with a financial advisor and creating a solid retirement plan, you will help increase your chances of enjoying a comfortable and secure retirement, no matter when you decide to retire. To ensure that your retirement portfolio lasts as long as you need it to, one strategy you can implement is to create an income portfolio. This means building a diversified portfolio of assets that generates the cash flow you need to support your retirement lifestyle without having to dip into your savings.
Eric: What can retirees and their advisors do to manage volatility to reduce the possibility of running out of assets?
David: To answer your question, think along the lines of planting a garden that produces the fruits and vegetables you need to sustain you throughout the year, rather than constantly raiding your pantry. By building a portfolio that generates sustainable cash flow, you will help protect yourself against the risk of outliving your savings in retirement. Your advisor can work with you to create a customized plan that takes into account your individual needs and goals, just like a chef creating a custom menu for a particular client. With the right mix of assets, you can create a steady stream of income that provides a solid foundation for your retirement.
Eric: What are the things you need to consider to make sure you have the right assets to generate an income stream?
David: When building a retirement income portfolio, three key elements need to be considered: consistency, sustainability, and tax efficiency. Consistency is important because it ensures that the frequency of our cash flows matches our needs. By aligning our income stream with our expenses, we make sure we have a solid foundation for our retirement lifestyle. Sustainability is crucial when we want to ensure that cash flow can be maintained over a long time.
By building a diversified portfolio of assets that can withstand market fluctuations, we will ensure that our retirement income remains secure and reliable. Finally, it's important to consider tax efficiency as different types of income are taxed at different rates. For example, interest income is often taxed at the highest rates, while capital gains are taxed at a lower rate. By managing our cash flow in a tax-efficient way, we can help keep more of our hard-earned money in our pockets.
Your financial advisor and tax specialist can work with you to create a customized plan that takes these three factors into account so you can build an income portfolio that suits your individual needs and goals and provides a solid foundation for your retirement.
Eric: David, thank you for this valuable information and for your time.
David: Thank you, Eric.
