If you’re nearing retirement or already in it, you may have decided to follow the popular 4%-plus-inflation annual withdrawal strategy1 to help your nest egg last as long as you do. But before you commit to an inflexible plan, be sure to evaluate the hazards of sequence-of-returns risk—a specific type of financial risk that could deplete your portfolio in later years.
Consider two hypothetical scenarios in the chart below—Ms. Westwood’s portfolio on the left and Ms. Eastwood’s on the right.
Both start with a $500,000 nest egg, but Ms. Westwood is retiring into a generally rising market. Though she experiences some negative returns in later years, the early momentum allows her nest egg to grow, even as she takes withdrawals from it. On the right, Ms. Eastwood experiences identical gains and losses, but in reverse order. Because Ms. Eastwood’s losses come early, her regular withdrawals are helping to starve her portfolio—already weakened from losses. Gains recouped in later years come too late to reverse the damage. By Ms. Eastwood’s 23rd year of retirement, her portfolio would have evaporated.
Sequence-of-Returns Risk: Two Hypothetical Withdrawal Scenarios for a $500,000 Retirement Nest Egg
Early market gains can provide a margin of safety for regular withdrawals, while early losses have the opposite impact.
| Early Bull Market: Ms. Westwood's Portfolio | |||
| Retirement Year | Market Gain/ Loss |
Annual Withdrawal Amount | Portfolio Market Value |
| 0 | n/a | n/a | $500,000 |
| 1 | 3% | $20,000 | $495,000 |
| 2 | 21% | $20,400 | $578,756 |
| 3 | 12% | $20,808 | $627,166 |
| 4 | 14% | $21,224 | $691,792 |
| 5 | 23% | $21,649 | $828,980 |
| 6 | 16% | $22,082 | $939,564 |
| 7 | 2% | $22,523 | $936,882 |
| 8 | -9% | $22,974 | $828,611 |
| 9 | 15% | $23,433 | $929,995 |
| 10 | 1% | $23,902 | $918,373 |
| 11 | -9% | $24,380 | $810,381 |
| 12 | 8% | $24,867 | $847,259 |
| 13 | 10% | $25,365 | $906,621 |
| 14 | -3% | $25,872 | $852,605 |
| 15 | 32% | $26,390 | $1,096,373 |
| 16 | 26% | $26,917 | $1,359,605 |
| 17 | 5% | $27,456 | $1,406,846 |
| 18 | 19% | $28,005 | $1,641,430 |
| 19 | -4% | $28,565 | $1,540,898 |
| 20 | 32% | $29,136 | $2,000,640 |
| 21 | 5% | $29,719 | $2,069,191 |
| 22 | 11% | $30,313 | $2,264,048 |
| 23 | 6% | $30,920 | $2,375,167 |
| 24 | 23% | $31,538 | $2,879,355 |
| 25 | 22% | $32,169 | $3,467,584 |
| 26 | -5% | $32,812 | $3,264,060 |
| 27 | 33% | $33,468 | $4,291,539 |
| 28 | -12% | $34,138 | $3,747,316 |
| 29 | -22% | $34,820 | $2,884,320 |
| 30 | -37% | $35,517 | $1,781,667 |
| Early Bear Market: Ms. Eastwood's Portfolio | |||
| Retirement Year | Market Gain/ Loss |
Annual Withdrawal Amount | Portfolio Market Value |
| 0 | n/a | n/a | $500,000 |
| 1 | -37% | $20,000 | $295,011 |
| 2 | -22% | $20,400 |
$209,412 |
| 3 | -12% | $20,808 |
$163,714 |
| 4 | 33% | $21,224 |
$195,703 |
| 5 | -5% | $21,649 |
$164,420 |
| 6 | 22% | $22,082 |
$177,764 |
| 7 | 23% | $22,523 |
$195,336 |
| 8 | 6% | $22,974 |
$184,618 |
| 9 | 11% | $23,433 |
$181,274 |
| 10 | 5% | $23,902 |
$166,277 |
| 11 | 32% | $24,380 |
$194,651 |
| 12 | -4% | $24,867 |
$161,249 |
| 13 | 19% | $25,365 |
$165,982 |
| 14 | 5% | $25,872 |
$149,229 |
| 15 | 26% | $26,390 |
$162,332 |
| 16 | 32% | $26,917 |
$186,851 |
| 17 | -3% | $27,456 |
$153,595 |
| 18 | 10% | $28,005 |
$140,950 |
| 19 | 8% | $28,565 |
$123,124 |
| 20 | -9% | $29,136 |
$82,778 |
| 21 | 1% | $29,719 |
$54,153 |
| 22 | 15% | $30,313 |
$31,996 |
| 23 | -9% | $30,920 |
($0) |
| 24 | 2% | ($0) |
($0) |
| 25 | 16% | ($0) |
($0) |
| 26 | 23% | ($0) |
($0) |
| 27 | 14% | ($0) |
($0) |
| 28 | 12% | ($0) |
($0) |
| 29 | 21% | ($0) |
($0) |
| 30 | 3% | ($0) |
($0) |
Source: Hartford Funds. The above chart is for illustrative purposes only. Percentage market gains and losses shown in each scenario are hypothetical and do not represent any particular asset allocation or market index strategy. Annual withdrawal amounts assume a 4% annual distribution based on a starting $500,000 retirement portfolio, plus an annual 2% inflation factor. No costs or transaction feeds were included. These costs would reduce returns.
Bottom Line: While it's impossible to predict the market's ups and downs, you can mitigate sequence-of-return risk by using a more flexible withdrawal strategy (i.e., reducing withdrawals in down years and increasing them in up years) or by withdrawing money from fixed-income investments in down years.
Your financial professional can help you tailor a withdrawal strategy to help ensure you don't outlive your portfolio.
1 The “4% rule” is a financial rule of thumb used to determine how much a retiree should withdraw from a retirement account each year. The rule calls for withdrawing 4% of your total investment during the first year of retirement while adjusting withdrawals for inflation in subsequent years.
Important Risks: Investing involves risk, including the possible loss of principal.
All information provided is for informational and educational purposes only and is not intended to provide investment, tax, accounting or legal advice. As with all matters of an investment, tax, or legal nature, you and your clients should consult with a qualified tax or legal professional regarding your or your client’s specific legal or tax situation, as applicable. The preceding is not intended to be a recommendation or advice.
This information does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice. This material may not be copied, photocopied or duplicated in any form or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.
CCWP098 220085