Physicians thinking of retirement in the near or distant future, picture this: You’ve been diligently saving and investing for decades, patiently waiting for the moment when you can finally enjoy the fruits of your labor during your well-deserved retirement.
But just when you’re ready to say goodbye to the daily grind and embrace a life of leisure, an insidious foe threatens to shatter your dreams – the dreaded “Sequence of Returns Risk.”
Now, you might be wondering, what in the world is this perplexing sequence of returns risk, and how does it relate to physician retirement?
Well, buckle up as we embark on a journey to demystify this concept and understand its implications on your hard-earned money. In its essence, the sequence of returns risk refers to the wild yearly fluctuations in the rate of return of your investment portfolio. It’s like a rollercoaster ride through the financial markets, with your portfolio’s value soaring to new heights one year and plummeting to terrifying depths the next. These unpredictable ups and downs can wreak havoc on your overall financial stability, particularly during the critical periods of accumulating wealth and, most importantly, withdrawing funds during retirement.
So, let’s break it down with a few engaging scenarios that will illuminate the gravity of this risk.
Scenario 1: The Accumulation Phase
During the accumulation phase of your investment journey, while you’re diligently squirreling away your savings and fervently adding to your investment portfolio, the sequence of returns risk might not seem too menacing.
A fascinating study conducted by BlackRock explored three captivating investment scenarios to demonstrate this. In all three cases, three eager investors began their financial quest with a hefty $1 million lump sum, hoping to achieve an average annual return of 7% over 25 years. In two of these scenarios, the yearly returns were as unpredictable as the weather, ranging from a scary -7% to a delightful +22%. Meanwhile, in the third scenario, the return remained a constant 7% year after year. But here’s the astonishing revelation: despite the wildly different fluctuations in annual returns, all three investors achieved the same grand total of $5,434,372 after 25 years.
How could this be, you wonder? Well, it’s all thanks to the magic of averages! The average annual return of 7% in each portfolio managed to even out the stormy seas of volatility, ensuring they all reached the same destination. (Important Reminder: Investing involves risks, and your decisions should be based on your personal goals, time horizon, and risk tolerance. The value of investments will fluctuate, and when sold, they may be worth more or less than their original cost.)
But, don’t let this seemingly harmonious outcome lull you into a false sense of security, for the real test comes when you shift from accumulation to distribution during retirement.
Scenario 2: The Distribution Phase
The moment you retire, the game changes entirely. Now, it’s no longer just about growing your wealth; it’s about sustaining it through a careful and strategic withdrawal strategy.
Enter the gripping tale of two hypothetical physician retirement portfolios, both starting with $1 million and bravely facing the tumultuous world of retirement.
Portfolio #1 kicks off its golden years with a bang, earning a jaw-dropping 22% return in the first year and an impressive 15% in the second. Despite facing a few obstacles in later years, this portfolio miraculously grows to $1.1 million over 35 years of retirement– a true financial success story.
Meanwhile, Portfolio #2 faces a more challenging fate. It encounters losses of -7% in the first year and -4% in the second, setting it on a rocky path at the start of retirement. Alas, despite an average annual return of 7% over the previous 35 years (the same as Portfolio #1), it runs out of money before reaching the finish line of 35 years of retirement.
The Enigmatic Impact of Early Losses
So, why did Portfolio #2 meet such a dismal end while both portfolios had the same average annual return in the Accumulation Phase? The answer lies in the long-lasting consequences of early losses during the Distribution Phase. While Portfolio #1 had the opportunity to thrive during its initial years of the Distribution Phase, Portfolio #2 struggled to recover from its early setbacks, leading to its unfortunate demise.
If you’re approaching retirement or already savoring its bliss, understanding the sequence of returns risk could be your ticket to safeguarding your financial future.
The window to manage this risk well typically lies within 5 to 7 years prior to your expected retirement year. Waiting any longer could make it challenging to navigate the treacherous waters of market volatility. So, arm yourself with knowledge, consult a trusted financial advisor, and embark on this thrilling adventure of securing your financial legacy. After all, with the right strategy, you can conquer the sequence of returns risk and make your retirement dreams a reality.
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David McCary, CFP, MBA, CPWA, CRI
David McCary, CFP, MBA, CPWA, CRI is a wealthcare professional who, like his fellow healthcare professionals and clients, tries to “do no harm”. Coming from a somewhat wealthy family, the Anheuser family of Budweiser Beer, unlike most advisors, Dave has honed his wealth management skills over his entire adult life. Many of his lessons learned have been with his own family’s money. He therefore brings a deep 45+ years of clinical wealthcare experience to each of his doctor client relationships. He focuses closely on his client’s needs acting as their CFO and CIO to their CEO role. And to ensure he stays well engaged with his doctor clients, his practice admits no more than 12 clients at a time, compared to most other advisors with 100 to 150+ clients. Dave gives his doctor clients a truly unique concierge-style wealth management experience. And he does it under a fee-only fiduciary business model, the model that only 1% of advisors use even though it’s the best client-first model.