401(k)s and IRAs are Easy Choices but they Increase Market Risk
In another one of my favorite quant geek research papers about dealing with market risk, the US Government Accounting Office (GAO) explains why sequence of return risks dramatically increase the risks for retirees reliant upon traditional plans such as 401(k)s and IRAs. Since everything we do is based on reducing the three big risks to your retirement, we talk about sequence of return risks a lot.
Sequence of return risks are how the returns of a stock market portfolio are affected by the timing of the returns.
For example, imagine that two retirees – Ms. Redondo and Ms. Hermosa – both started with a $1m investment portfolio at age 65.
Both portfolios deliver an AVERAGE return of 6% Annually for 25 years. But the order of their market returns occurs in reverse order from each other.
They each begin taking $50k withdrawals annually beginning at age 66.
Assume Ms. Redondo begins taking withdrawals in an up market and Ms. Hermosa begins her withdrawals in a down market.
After 18 years, when they are both 83, Ms. Redondo has $3.8 Million left, and Ms. Hermosa has $0.
