Sequencing of Returns – When 6% Is Less/More Than 6%

The typical retiree needs to pursue a rate of return of 6% for the duration of their retirement, to make ends meet.  This has been accomplished by deploying a portfolio of 60% stock and 40% bonds, in recent years.


Most financial professionals will illustrate a 6% fixed rate of return on assets, when asked to do the math for you.  The smart ones will tell you something along the lines of: “The moment I print this scenario for you, it’s wrong.”  We will encourage you to keep close contact and review the numbers regularly, understanding the almost non-existent prospects of getting a stable return while making use of variable markets.


Below, you will find why it is important to check in with your planner on a regular basis.  I will illustrate a 6% average rate of return in 5 different manners with the assumption that monthly withdrawals on a $500,000 portfolio of $3k gross (inflation not factored) are withdrawn like clockwork.


First: 6% Per Year, Steady

Remaining Balance, Year 5 = $465,115

Remaining Balance, Year 10 = $418,060

Remaining Balance, Year 15 = $354,590

Remaining Balance, Year 20 = $268,980

Remaining Balance, Year 25 = $153,505

Remaining Balance, Year 30 = $0


Second: 6% Per Year, Deviation Up To 9%, Starting with Losses

Order = (-3, -3, 7, 5, 12, 8, 14, 10, 12, -1, 15, -2, 12, 8, 3, 8, 11, -2, 10, 0, 6, 9, 13, -3, 8, -1, 11, -1, 5, 9)

Remaining Balance, Year 5 = $385,565

Remaining Balance, Year 10 = $418,060

Remaining Balance, Year 15 = $327,630

Remaining Balance, Year 20 = $229,435

Remaining Balance, Year 25 = $109,395

Remaining Balance, Year 30 = negative balance


Third: 6% Per Year, Deviation Up To 9%, Starting with Gains

Reverse Order of #2 = (9, 5, -1, 11, -1, 8, -3, 13, 9, 6, 0, 10, -2, 11, 8, 3, 8, 12, -2, 15, -1, 12, 10, 14, 8, 12, 5, 7, -3, -3)

Remaining Balance, Year 5 = $423,370

Remaining Balance, Year 10 = $384,450

Remaining Balance, Year 15 = $289,800

Remaining Balance, Year 20 = $192,775

Remaining Balance, Year 25 = $62,020

Remaining Balance, Year 30 = negative balance


Fourth: 6% Per Year, Deviation Up To 15%, Starting with Losses

Order = (-7, -4, 10, 3, 0, 15, 4, -3, 14, 19, -5, 6, 9, 13, -2, 5, 21, 14, 8, 0, 4, -1, 3, 5, 18, 2, 12, -9, 11, 16)

Remaining Balance, Year 5 = $320,025

Remaining Balance, Year 10 = $282,230

Remaining Balance, Year 15 = $142,000

Remaining Balance, Year 20 = $8,005

Remaining Balance, Year 25 = negative balance

Remaining Balance, Year 30 = negative balance


Fifth: 6% Per Year, Deviation Up To 15%, Starting with Gains

Reverse Order of #4 = (16, 11, -9, 12, 2, 18, 5, 3, -1, 4, 0, 8, 14, 21, 5, -2, 13, 9, 6, -5, 19, 14, -3, 4, 15, 0, 3, 10, -4, -7)

Remaining Balance, Year 5 = $486,775

Remaining Balance, Year 10 = $455,190

Remaining Balance, Year 15 = $491,595

Remaining Balance, Year 20 = $410.345

Remaining Balance, Year 25 = $445,560

Remaining Balance, Year 30 = $279,840


As stated earlier, the first illustration is the most common.  It’s also the most bogus … there is virtually no chance of realizing exactly a 6% rate of return year in and year out.  It is a decent guide to determine if 6% is ‘in the ballpark’ of returns we’ll need to pursue together.


The second and third illustrate why your asset manager would like to take less risk in retirement than prior to it.  -3 to +15 is a pretty tight range of returns.  As you can see, even with averaging a 6% rate of return, the variations of the market still left the portfolio empty later in life.  Even when the portfolio started with gains, the amount didn’t last like the primary illustration.


The fourth and fifth scenarios show a more aggressive investor; returns used range from -9 to +21.  Engendering a more aggressive portfolio clearly has its effect on the balances.  Taking the losses up front had the portfolio run out of money a decade earlier than it was required to last.  Meanwhile, seeing sharp turns to the upside in the early going leaves a legacy with the assets after 30 years.


Before discussing the point of this exercise, I’d like to make mention of several caveats:

  • Inflation cuts into the buying power of the $3k monthly distributions. After 20 years of 2.5% inflation, $3k will spend like $1,830 does now.  For many, it makes sense to start with lower withdrawals and increase to keep pace with inflation over time.
  • Expenses tend to get more focused over time. Travel, clothing, home improvement, and food expenses tend to fade as medically related costs and gifts tend to increase.  It has been my experience that most retirees have less net outflow in the later years.  This could allow balances to last longer
  • This is only one randomization of returns. It was pulled from thin air, not reality.  However, I would not be working with these numbers, if I found them unrealistic.
  • It is not a good idea to retire if your money lasts exactly to the year of life expectancy. We want the goal to be overfunded, not scraping by, in our illustrations.


It is just as important to check the risk metrics of your portfolio as it is to target a certain return.  While we are all shopping in the same supermarket for investments and many people tend to purchase the same staples (Amazon, Apple, Google, Chevron, Walmart, etc.), your portfolio can be tailored to pursue a narrow range of returns or cast a much wider net.  I have seen instances when a 70/30 portfolio was at the same level of risk as a 60/40.  Neither of these approaches are wrong, if the clients’ best interests are being prioritized.


What the above makes clear is: The more risk you take, the more that your immediate success or bumps in the road dictate what you’ll be able to accomplish with the portfolio later in life.  When you retire fully and have no intention of making more money, it might not be the right time to ‘chase returns.’  Many portfolio managers tend to try to limit risk in the early going, not just because they know clients are watching them more closely but, also because they do not wish to be playing catch-up with the stock market and trying for more return as the clients age.


If the market has been on an obvious tear right before you retire, I urge you to keep 2008 in mind.  Those who retired and/or took lump sums from their pensions only had the 2004 – 2007 surge in mind when they allocated their portfolios.  Many took risks more appropriate for their 40 – 50 year old selves and the market(s) wiped out a third of their portfolio value in swift fashion.  Those who didn’t tap too much into their funds regained their initial footing by late 2012 and started pulling ahead in projected value in 2013.  If you don’t want to wait 4 to 5 years to spend major portions of your assets, retirement is a great time to leave behind the concept of “Missing Out.”  FOMO (fear of) has been prevalent in recent days and people have been asking me, and my friends in the industry, to load up on individual stock issues or dabble in unestablished firms / penny stocks.  I don’t want to be your parent but, if everyone was jumping off a bridge, would you?


Money is great and we should all want to be able to secure more goods and services.  This casino holds many games.  Some offer bigger wins than others.  When you have finite resources, you have to learn to ignore the glitzy games that seldom pay out and learn to love the machines that help you print money.


‘But, I like to gamble, Ross’ … an adequately funded portfolio may have some money set aside for higher upside plays.  Ideally, there is an understanding this portion is not to be counted upon to meet financial objectives.  If you rely on every dollar and increase risk on a portion of assets, a corresponding reduction of risk somewhere else in the portfolio is warranted.  In the end, losses from outsized risks may offset the benefit of tried-and-true income sources needed to meet goals.


If the numbers above have made you question your retirement preparedness, please know there are more complicated tools out there to help relieve your stress.  One tool many advisors like to employ is called “Monte Carlo” analysis.  Basically, it takes your financial goals / resources and associates real returns from the various asset classes to be used in a randomized order.  It will run 500, 1000, or 5000 simulations putting the years of returns in random order.  It may start with 1999, then go to 2004, back to 1991, up to 2010, back to 2007, and back to 1998 in one scenario and have 2003, 2006, 1994, 1997, 1995, 2001, etc. next.  In essence, this service does what I did by hand, mechanically, and with verified, historical numbers.  If your portfolio lasts 85%+ of the time, it is deemed highly likely that your assets will last in keeping with the goals entered.  I have had access to this tool for the better part of two decades and I have not seen anyone with greater than an 85% score get close to a point of concern with remaining dollars.  Though, to be fair, we’ve been on a pretty bullish tear for over a decade and the only people who should be falling behind on their goals are those who consistently overspent their budgets.


Whoever you choose, your advisor does not have a crystal ball.  We try to keep your risk appropriate for your personality and goals.  However, there is no way of telling when the next 1987, 2000, 2007, or even 2018 is coming for us.  With all the money being made in this market by those who took outsized risks against the logic of the situation, it’s almost impossible for a client not to want to take part in further growth opportunities.  Advancing the risk metrics (Standard Deviation being one of them) while in distribution mode is one clear manner of putting retirement goals in jeopardy.  Don’t get preoccupied with not making a killing, the real secret of portfolio management is not that you can possibly get double-digit returns from risks taken it’s that a $500k portfolio paying $3k per month for 30 years could actually pay you out $1,080,000, if you don’t play too many games!