Transcript

00:00:00

Voiceover

Welcome to Retirement Unlocked with Larry Heller, your life your way, unlimited possibilities. Join us as we explore how tailored financial planning and investments can help you navigate life transitions with confidence. Let’s dive into this week’s episode.

00:00:23

Matt Halloran

Welcome to The Retirement Unlocked Podcast with Larry Heller, your life Your Way, unlimited possibilities. Join us as we explore how tailored financial planning and investments can help you navigate life transitions with confidence. Let’s dive into this week’s episode. Today, Larry, we’re talking about sequence of returns, but for your longtime listeners, they’re probably saying, wait a second here. This was the Life Unlimited podcast. And now it is Retirement Unlock. So we’ve renamed the show. You want to tell everybody a little bit about why we did this before we get into sequence of returns?

00:00:56

Larry Heller

Yeah. So there was a little bit of confusion with Life Unlimited. People sometimes thought it might be religiously oriented. We wanted to be more specific that this is really geared towards retirement investing and financial advice. We will have guests that may not relate to retirement, but we wanted to be more focused. So when people are looking for us on podcasts and seeking retirement help and financial planning, they can find us more easily than with Life Unlimited.

00:01:33

Matt Halloran

Well, and what a perfect transition into a huge aspect of retirement planning, which is the sequence of return risks. So, where do we even begin here?

00:01:43

Larry Heller

A lot of times when we start to run financial planning software and retirement projections, we use an expected rate of return based on their portfolio and life expectancy. However, one of the things that can really come into play is when you retire and the amount of money you’re going to earn, especially in the first few years. The sequence comes into play, and if you retire in a year with some down years, it can have a major impact on what you are withdrawing and whether your retirement plan is going to work. Coming off 2024 and 2023, where the S&P 500 had its combined best two years in a hundred years, if you’re retiring now and looking at projections based on your current portfolio, we want to caution that the sequence of your returns could impact that based on what they earn. Let me back up a second. Let’s really talk about what the sequence of return risk is. It refers to the order of the investment returns you’re going to get. For example, if your first sequence was 9% the first year, 9% the second year, 2% the third year, and minus 4% in year four, and you just flip them, so now if the first year you had minus four, then two, and then nine and nine, you’ve made the same rate of return in four years. But because of the sequence, your portfolio is going to look different if you had a negative in your first year versus if you had a positive nine in the first year. If you are retiring and have some bigger numbers, we’re going to talk about history in a few minutes. It could mean running out of money faster due to early losses. It’s not just about how much you earn over time, but when you earn those during your retirement.

00:04:02

Matt Halloran

I think I need a little bit more clarity on why the sequence of return risk is so important if you have a down year right at the beginning of retiring. Can you expand on that just a little bit more?

00:04:22

Larry Heller

Let’s say your portfolio had one of those really bad years right from the start, and you lost 20% in the first year. Maybe you were a little too aggressive in your portfolio. But even if you were in a 60/40, it’s not unheard of to have a double-digit year, and what’s been happening in the last few years, we’re having some big swings. If you lost 20% in the first year, you need to make 25% just to break even again. If you had even bigger losses, like a 40% loss, you would have to make 66% just to break even again. Recouping those losses and trying to avoid those losses in the first year of retirement, although you’re not planning on it, could impact how that looks in your specific retirement, especially in the first few years. Let’s talk about some real historical numbers and how this actually played out. If you were retiring in the worst possible scenario, the Great Depression, and you retired right before 1929, for the next 24 years, if you had a million dollars, the returns in the first four years were minus 12, minus 16, minus 29. Over the 25 years, this portfolio produced an annual withdrawal amount of about $37,000. That’s based on a 5% withdrawal on the year-end balance. But if you were lucky enough to retire in 1975, right after a major recession for two years, the same 24 years, the same 5% over 25 years, you achieved an average annual withdrawal of $160,000. Two retirees, two different timeframes, two different sequences of returns. One was able to withdraw a lot more money and live a lot differently than the other. Of course, we hope we’re not going to go through another depression with four negative years, but you definitely could.

00:06:50

Matt Halloran

We’ve had podcasts before talking about some of the strategies that you guys have, and you’ve used the word reservoir before. Is that applicable here?

00:07:07

Larry Heller

Reservoir. So let’s now open people’s eyes that it’s very important to make sure you have a really good strategy in case you get negative returns right when you retire. What are some of the things you can do to help mitigate that risk and hopefully make it so that it isn’t so impactful? There are a couple of different strategies you can use. One of them, and one of the things we like to do, is our reservoir strategy. Basically, part of the reservoir strategy is keeping two to three years of your expenses in short-term cash. What does that allow you to do? If you had one of those sequences where you had some negatives in the first year, you’re not selling from those years. It’s still going to impact your overall retirement, but by not having to sell during those years, historically, it has shown that after those three years, the portfolio has rebounded to what it was before. It gives time to at least accumulate that. But if you don’t have the cash in the short term and you’re now withdrawing during those years, that’s going to deplete your portfolio even more and have a major impact. We did a full episode on other reservoir strategies in episode 119. Take a look into that and see how that could help when we talk about mitigating sequence of return risk.

00:08:49

Matt Halloran

I want you to dive in if you don’t mind. I know we did a whole episode on that. I don’t know why I thought it was called moat, but reservoir’s way better. With the reservoir strategy specifically, are there other planning implications besides the fact that you’re not taking withdrawals and selling aspects of your portfolio for cash? We talked about this in episode 119. There is a feeling that your clients have when it comes to this. Do you want to talk a little bit about that or maybe share an example of you guys implementing the reservoir strategy and how that has helped people feel more comfortable in retirement?

00:09:26

Larry Heller

Absolutely. I don’t care how much money you have when you retire. When you no longer have that spigot of income coming in, you’re really concerned about your portfolio. Just imagine you retired with $3 million and the first year out, you’re down 20%. So now you’re down to $600,000 on that portfolio. If you’re not withdrawing from it because you need to live on that, that portfolio is even less. Suddenly, after one year, your $3 million portfolio could be less than $2.5 million. Now you start worrying and think, “I have to stop the bleeding. I have to stop it from going down,” because they’re worried about it going down even more. They’re like, “I can’t afford more.” Now they’re tempted to sell out of some things in equities that are there for their long-term growth, and that just compounds the problem. By having this short-term reservoir strategy, we can say it doesn’t make a difference what happens in the market in years one, two, and three. The money in the market is geared for 10-plus years. We also have a secondary reservoir, which is more fixed income, really geared for years three to ten. We have plenty of time to let the cycles go through what they need to do and get back to the equity side. In someone’s head, it’s a lot of behavioral thinking. If they know, “Okay, that’s my long-term bucket, it’s down 20%, but I’m not touching that for 10 years,” they’re not happy, but they can wait the timeframe out because they have these other reservoirs. Versus if you don’t think of it that way and just look at your overall portfolio being down, you have much more lack of conviction and a lot more worry. By doing this, we’re able to get people to live their lives, not worry about a downturn right when they start. That’s what the reservoir strategy will provide, and it’s definitely worked because we’ve used it for many, many years with our clients.

00:11:49

Matt Halloran

I love the fact that when you’re working with somebody with your qualifications, when you are turning off that spigot of income coming in and you know you’re good for 10 years, that’s got to be a huge stress reliever for your clients to make it so that they know they don’t have to be looking at the market every single day because that’s 10-year money, right? I’m good for the next 10. What are some of the other things we need to be paying attention to with the percentage-based withdrawals? You just began that, and we talked about the reservoir strategy. Anything else we want to go there before we wrap up?

00:12:30

Larry Heller

There are some other strategies and percentage-based withdrawals that I’ve seen out there, not reservoir strategy, but basically, it means you adjust your withdrawals based on how your portfolio has done each year. If the portfolio is down, you drop the amount of withdrawals. If you had some very good up years, you could increase withdrawals. We prefer the reservoir strategy, but that’s another way of looking at this. That’s one thing to look at. We do talk about 25-year timeframes. We talked about the Great Depression and 1975 right after a bear market. Historically, even before the depression through 2023, a 60/40 model, 60% equities and 40% bonds, based on a 4% withdrawal rate, you’ve never run out of money during those 25-year timeframes. It doesn’t mean your portfolio hasn’t gone way down. It doesn’t mean there won’t be a time going forward for 25 years that it will happen, but that’s just an idea. That’s on a 60/40 plan, and that’s going to zero. Of course, if you start seeing your portfolio going down a lot, you’re not going to be happy as well. That’s kind of where we start as far as what the withdrawal rates are. Depending on now, if you’re 60 years old and you’re retiring, 25 years may not be sufficient because that only brings you to the mid-eighties, and people are living longer. You have to be a little bit careful in just looking at the historical data and what that tells you and what the withdrawal rate you want to factor in. A lot of other things, your longevity history, what inflation is, kind of what’s been happening the last few years, and look at that withdrawal rate. As you get older, we talk about people when they’re older, and they don’t want to take the money with them. Can they have a higher withdrawal rate than 4%? Sure. It’s a good guideline to start with, but everyone is different. Everyone is unique. Some people want to plan to age 100, so you’re planning for almost 40 years. Some people say, “I’m not going to live past 85 no matter what, my no-good family history.” So everyone is customizable as we go.

00:15:08

Matt Halloran

Alright. Let’s talk about some of the key tips and the big takeaways for our audience today to manage the sequence of return risk.

00:15:19

Larry Heller

We mentioned a couple of them, but one of them is obviously to stay balanced with your mix of stocks, equities, and bonds as well as cash, our reservoir strategy. In other words, don’t panic when that’s going through. We’ve had a couple of times during my career where we’ve had some major downturns. 2000 is one of them, and we have clients who are retired and they’re thinking about stopping the bleeding because they’ve seen some big downturns, and that’s kind of the worst thing you want to do. I’ve even seen some people that I know just entirely get out of the stock market because they couldn’t live with the swings, and they adjusted their life and expenses to live on a lot less because they wanted to stop the downturns on that. That’s kind of the worst thing you can really do, and that’s why we talked about the reservoir strategy. Another tip is to rebalance the portfolio back to your target allocation regularly. What does that mean? If you have 40% in equities and the stock market has had two great years, like we just talked about, your allocation to equities has gone up. We want to rebalance that back down. What are we actually doing now? We’re selling high and replenishing the money you took out of your reservoir, your short-term reservoir, when the market is up higher. The same thing on the flip side. Even if you’re retired and there’s been some years where the stock market is down and maybe your bond portfolio is up, we may want to take some money from the bonds and move that into equities even in retirement. Rebalancing regularly, we look at it quarterly just to see what your allocation is. Maybe we’ll rebalance once or twice a year. But we’re constantly looking at it, and it’s a hard concept because people are like, “Why are you selling this? This is doing great. It’s making a lot of money. Why are we getting into this? And then why are we going into this? Because this fund did nothing this year.” Again, behavioral sell high, buy low. Avoid panic selling during the market downturns. Again, harder to do when you’re retired and you don’t have more money coming in, but you really want to avoid panic selling during the market downturns, and that’s one of the big reasons that a lot of people hire us because we’re looking at it a lot more objectively than someone doing it on their own, and it’s your own money. We can guide you through avoiding these panic selling at the wrong time. Also, focus on long-term outcomes. Don’t focus on the short-term volatility. A lot of times when we have new clients or we’ve set them up, we’ve put the reservoir strategy in, and we’re talking about long-term. We basically tell them, “Don’t watch the news. Don’t watch CNBC,” because they’re focusing on literally what are the earnings of these companies for the last quarter, and they’re talking about, “Oh, the market was down a thousand points today.” That’s not going to do you any good. Focus on long-term outcomes rather than the short-term volatility. Overall, the sequence of return risk is a real risk, but retirees don’t need to live by fear. By understanding the concepts and making informed adjustments to the withdrawal strategy, they can significantly improve their chances of maintaining their current retirement income and lifestyle throughout retirement.

00:19:22

Matt Halloran

I love the fact that you brought up the whole psychological component of this because, well, one, that’s very near and dear to my heart, but it is so vitally important when you actually hire an objective third person who does this and is paying attention to it so that you can really pay attention to what you should be paying attention to, which, by the way, is living your retirement dreams. I think that’s really important. I just want to recall, or for the audience to think about a couple of episodes that we’ve done previously that will accentuate a lot of the stuff that Larry has just been talking about today, episode 136, which is, “Are You Spending Enough?” which is an interesting partner podcast to this one because, again, if you know what your sequence of return risks are, there can be adjustments, and sometimes they can actually be in your favor. Let’s just talk about that for one second.

00:20:13

Larry Heller

That’s a great episode because, believe it or not, most people, when we run these game plans, run retirement plans for them and show them, they’re spending less than they can, and more often than not, we’re telling people, “You can spend more money.” So listen to that episode if you think you’re one of those people that may not be spending enough during retirement.

00:20:36

Matt Halloran

And again, I think this is one of the difference makers with you, Larry, is you have those conversations with your clients, which I think there are many advisors who don’t. Then there’s episode 164, which is “Why Distribution Strategy Demands More Attention in Retirement.” You touched on a little bit of that with the reallocation of the portfolio. Is there anything you want to add there before we wrap up?

00:20:58

Larry Heller

Not only reallocation of the portfolio but where you’re taking the money out. If you have, let’s say, your fixed income, your income distributions or income sources such as Social Security and maybe a pension, but then you have your qualified assets, so you have retirement assets you haven’t paid taxes on, and then you have your non-qualified assets, and maybe you have a Roth account, which is an account that you would draw on, can also have an impact on your retirement success. We have a whole podcast that talks about the distribution strategy.

00:21:35

Matt Halloran

Alright, Larry, final thoughts before we wrap up?

00:21:35

Larry Heller

Again, the sequence of return risk is real, so you should be aware of that when you retire. But there are definitely strategies you can put in place to minimize that risk and live your life unlimited and enjoy your retirement.

00:21:55

Matt Halloran

Thanks for listening to The Retirement Unlocked with Larry Heller. Ready to take the next step to your retirement possibilities? Subscribe to the podcast, share the episode, and of course, visit hellerwealthmanagement.com for so many more resources. For Larry and everybody at Heller Wealth Management, this is Matt Halloran. We’ll see you on the other side of the mic very soon.