Why the sequence of returns matter
A downturn when you’re in the withdrawal stage can have a critical impact.
Earlier this year, the federal government reduced the 2020 RRIF minimum withdrawal by 25%. You may be wondering why they would take this extraordinary step.
This change helps to address one of the key risks retirees face with their investment portfolios – “sequence of returns” risk or the order in which you experience market returns.
When investing for the long term, downturns in the market are less important because your portfolio has a chance to recover.
But, when you start withdrawing, experiencing a downturn in the early years can have a critical impact on your portfolio.
Let’s look at an example to see how much of an impact the sequence of returns can have.
Both the scenarios and portfolios in this example are hypothetical and do not reflect actual investment performances.
Scenario #1 – Accumulation Phase
Both Investor A and B invested $100,000 into their respective portfolios
Neither withdraw any money
At the end of 15 years, both investors have the same amount of money
Scenario #2 – Withdrawal Phase
Investors C and D each invested $100,000 into the same portfolios as Investors A and B respectively
They each withdraw $7,000 annual withdrawal at the end of the year
Investor D runs out of money in year 11 – they never recovered from the early negative returns
The key take-away here is that – even though Investor C and D withdrew the same amount, because Investor D had the negative returns at the beginning, those returns had a much more serious impact on their net worth.