The Eliot Rose Blog
How to Diversify Your Portfolio as a New Retiree?
Added 06/19/2017 by Jason Siperstein, CFA, CFP
Thinking about retirement is very exciting for most people. It’s a time in life when you’re finally able to do the things you were never able to do with a nine-to-five job. You can travel the world, spend more time with friends and family, pursue your newest passion or hobby, and much more.
From a portfolio perspective, this is the biggest change to your financial life. It represents the shift from funding your lifestyle from cash flow (i.e. your salary) to assets (your investment portfolio). This is often a very strange feeling for many new retirees. And this small fact, changes everything!
Let’s look at some numbers. Assume you have a portfolio value of $1,000,000 and were able to achieve an average rate of return of 6%. While you are working and letting your portfolio grow, the sequence of returns has no impact on your portfolio value. In the table below, we see a smooth 6% return every year for the next five years. This yields an ending portfolio value of $1,323,914.
In the absence of contributions and withdrawals, your average return is all that matters. The sequence of returns has no impact on your ending portfolio value. You can see this in the table below. Here we show very choppy returns, but the average return is still 6%, yielding the same $1,323,914 ending portfolio value.
However, when you retire and start to live and draw off your investment portfolio, the sequence of returns start to impact your retirement. The table below assumes you withdraw $65,000 a year from your portfolio to help supplement your lifestyle. This portfolio has a 6% average annual return with a smooth 6% return each year. At the end of five years, your portfolio is valued at $959,165.
The table below shows the same 6% average annual return, but the sequence (only difference) was much choppier. Due to an unfavorable sequence, your ending portfolio is valued at $826,463 – almost $150,000 less than the example above!
This is called sequence of return risk. It is the risk that an unfavorable sequence of returns in retirement can adversely affect your retirement. When it comes to retirement, you want to diversify your portfolio in such a way to ensure that even if a poor sequence occurs, your retirement remains secure!
If you would like to explore the financial planning/investment management process, feel free to email me here or call me at 401-588-5122!