If I could tell you right now
that I could guarantee you 7% average rates of return,
would you sign up for that deal?
Yes, you probably could.
Unfortunately, I can't guarantee you 7%,
but you might not want to sign up for that just yet.
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Hi, I'm Troy Sharpe CEO of Oak Harvest Financial Group,
host of The Retirement Income Show,
certified financial planner professional,
and certified tax specialist.
You're probably thinking, "What do you mean, Troy?
I would absolutely sign up for 7% rates of return right now
on average if I could get them
on average over the course of my retirement.
This presents an opportunity to point out a very,
very distinct difference between the accumulation phase
when we're working and earning a paycheck
and saving versus the retirement phase.
When the paychecks have stopped,
now we start distributing from our nest egg
and we have to determine how much do we take out,
which determines how much tax we pay,
which then we also have to decide Medicare,
social security,
all of this is interrelated in retirement.
When you start at that distribution phase,
one of the biggest risks is known as sequence of returns risk.
I'm going to show you how this works
and why you might not want to sign up
for the 7% average rates of return just yet.
Here we go.
This is an excellent piece.
Now I've talked to clients about this for many, many years.
I've seen multiple different marketing pieces that show
the impact of sequence of returns risk,
but yet many clients,
many of you still have not heard of this concept.
Many people come up to me and they said,
"Troy, you know what, this is the first time I ever heard of
this sequence of returns risk.
How come I've never heard of this before?"
This is if you're starting a retirement
within a few years,
this is probably the biggest risk that you face
outside of some type of Black Swan event,
a catastrophic market crash.
This is .
a great example between- or looking at the accumulation phase.
Let me make this a little bit bigger.
As I said, this is from BlackRock.
It's available on the internet. Here they do a great job.
Portfolio A, 22% returns in year 1,
15% in year 2, 12% in year 3,
and then some negative returns, negative, negative, positive.
Portfolio B,
it just averages a straight 7% across the board.
It earns a straight 7% across the board
which therefore averages 7%.
Then portfolio C has a -7%, -4%,
the same two numbers is up here,
and then 12%, 15%, 22%,
the exact opposite order of portfolio A,
which was 22%, 15%, and 12%,
12%, 15%, 22%.
What this is showing us is
all three of these ways,
portfolio A, B, and C, all three average 7%.
Starting with $1 million,
age 40, coming out to age 65,
gets us up to about $5.4 million,
excellent returns. We'd all love to average 7%.
Of course, we would, in the accumulation phase.
Now, what happens in the distribution phase?
This is where sequence of return
can kick your butt.
Same three portfolios 22%, 15%, 12%, -4%, -7%, and 7%.
I'm not going to run through them, but the same exact returns.
Portfolio A is the red line.
The one difference here,
this is a retirement portfolio so what happens in retirement?
We need to start distributing money.
That's why we call it the distribution phase.
$60,000 coming out of the portfolio adjusted for inflation because
we need to take more and more out
as time goes on to keep up with inflation.
Very simple here, portfolio A
that has the three positive years,
in the beginning sequence,
this is where the term sequence of returns risk comes from
because it's not necessarily about the average, it's about the sequence,
portfolio A
ends with 1.1 million at age 90.
We started at age 65 here.
Portfolio B is the green line.
Okay, we're fine it starts to deplete
out towards these years because of the inflation component.
Inflation erodes your purchasing power so
you need to pull more out of the nest egg
to maintain the same level of purchasing power as
you did in the initial stages of retirement.
Here's the big one, here's the whammy,
portfolio C, the yellow,
first two years of retirement
we lose 7% and 4%. That's it.
It's not a 25%, it's not a 40% catastrophic loss.
We lose 7%, we lose 4%,
that brings us down, combined with those withdrawals
60,000, 60,000,
now, our portfolios here.
When we have these good years,
we're earning high interest on lower amounts of money
so we're earning less interest.
Whereas, up here when we earned 22%, 15% and 12%
we earn that interest on a high amount of money
so the interest earned was significantly more than
when that same interest is earned on a lesser amount of money.
Long story short, here we see what happens,
the portfolio exhausts right around 87 or
so. 7% average rates of return,
all the variables other than that are identical.
The only thing that's different is the sequence.
The returns are the same,
they average the same, the numbers are the same,
the only variable is the sequence
with which we realized these returns,
combined with portfolio withdrawals.
The next question becomes how do we plan around this?
How do we make sure that we don't fall victim to
the sequence of returns risk?
Well, that's definitely another video for another day,
but the basic concept is we need to have,
one way to do it at least,
is what we call a segmented bucket strategy.
In one of those buckets is our long-term growth,
our equity positions. We want good
blue-chip dividend-paying stocks typically in retirement.
If we need those dividends we can live off the dividends.
We can have them deposited into your bank account.
If you don't need the dividends, we can reinvest those dividends and
accumulate more shares and grow that way over time.
The segmented bucket approach though, means,
we also have some money that's in a protected, secure location that
where if the market goes down, we're not losing any money.
There are secure strategies available where you can reasonably expect to
make 4%, 5%, 6% pretty consistently.
When the market is down, we don't take from there.
Maybe we take the dividends
but we go into the secure bucket and we can take some money from there.
Of course, social security plays a role
in this decision and many other factors.
Long story short, the purpose of this video
is just to educate you about the sequence of returns risk,
point out the difference between the accumulation phase and
the distribution phase,
and help you understand some of the bigger risks that are out there
if you're about to retire or you've been retired for a couple of years.
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