Did you know that you and a friend could put the exact same amount of money away throughout your careers, earn the exact same average annual return on your portfolio with the exact same volatility but end up with completely disparate portfolio values?
You only get one shot. No do-overs. No mulligans. You have just one life on this planet. One chance to live the life you’ve dreamed. One mistake at the wrong time could jeopardize everything while patience can afford you the opportunity to do better than you’ve imagined.
If you’re of a certain age, particularly those of you within 5-7 years before or after retirement, you are particularly vulnerable to investment mistakes.
That period around retirement is the most financially fragile point in most people’s lives. All it takes is the wrong approach for even a short while during this critical period and everything for which you’ve planned, dreamt, and saved during your life could be jeopardized.
So why is this particular age group so vulnerable? Well, it has everything to do with the sequence of returns you experience relative to when you will begin withdrawing from the portfolio. The phenomenon is called “Sequential Return Risk” or “Sequence of Return Risk.” It’s simply another type of risk of which we must be aware in addition to the more frequently discussed “Investment Risk.”
Let me illustrate using an example created by Wade Pfau.
Imagine 151 investors all working, earning, saving, and investing the same amount over the course of a 30-year career. They all earn the exact same average annual return (7%) with the exact same volatility (standard deviation = 20%). The only difference being the 30-year period in which they are participating so their respective sequence of returns are different even though they all average the same 7% annual return. So investor #1 starts at the beginning of year 1 and invests through year 30, investor #2 starts at the beginning of year 2 and invests through year 31, and so on.
Given the assumptions used in our example, which you can find in the source article linked above, each investor should expect to retire with about 10 times their final salary saved in their retirement portfolio by the end of their 30-year career.
But they don’t all end up with 10 times their final salary saved. In fact, there is a very wide dispersion between each hypothetical investor’s respective portfolio value at retirement.
See below a graphic illustrating the dispersion as a multiple of final salary between the 151 hypothetical investors (chart also from Wade Pfau).
You’ll notice that one of our investors only has about 3x his final salary accumulated at retirement while another investor has about 28x! Their respective retirements will look much different even though they both did the same thing. One may be buying a yacht cruising up and down the coast, traveling the world, paying for his grandchildren’s education while the other will be taking up part-time work and clinging to his social security check just to get by with the basics.
Remember, both these hypothetical investors were disciplined savers and both earned the exact same amount of money over their 30-year careers! The also both earned the exact same average annual return over those thirty years. So why the disparity? It seems so unjust.
Well, because the investor with only 3x saved just happened to experience a bear market towards the end of his career as he was nearing retirement age. While the 28x investor just happened to experience robust markets at the end of his career. Through no skill or fault of their own their outcomes are entirely different. But this could have been mitigated with proper, proactive risk management.
That’s what I mean when I say you only have one shot at this. Why leave your retirement up to luck? You’ve worked too hard and sacrificed too much to create a certain life for yourself. We must be proactive, thoughtful, diligent and patient when constructing and managing portfolios so we can mitigate the impact of plain bad luck on your family’s financial well-being as well as take advantage of genuine opportunities when they arise.
You only have one shot. Let’s make the most of it and leave as little up to chance as possible.
