Volatility-proofing your client’s retirement nest egg

Investors have experienced higher than normal volatility with their investment portfolios recently. As such, the topic of “sequence of returns” has started once again to come to the forefront of discussions between clients and their investment advisors.

It is no surprise that a significant risk to retirement portfolios occurs when distributions that are taken from those portfolios in down years. Withdrawals from a portfolio during a temporary dip in markets can lead to adverse effects which leave clients at risk of running out of money prematurely.   

To highlight this problem, we evaluated the 20-year time period from 2000 to 2019. Our hypothetical client invested $1,000,000 in 2000 and took out $50,000 annual distributions during that 20-year time period. You will see that the investor ended 2019 with $271,000 in their account. 

Now, imagine we simply flip-flopped the sequence of returns by reversing the order -- starting in 2019 and then working our way backward to 2000.  Amazingly, under that same withdrawal rate, the retiree saw an ending balance of $1,800,000.  That is 7 times more than in the first example.

A simple way for advisors to help clients mitigate that risk is to ensure their clients will have an alternative source of funds to draw from in years where the markets have a pullback.   

 

Years such as 2000, 2001, 2002 and 2008 are great examples of years in which a client would be well served by not withdrawing from their equity portfolios and instead drawing from one of their alternative sources of funds.   

Herein lies the problem. We are starting to see current retirees that haven’t quite thought this through and, as such, find themselves limited to alternative sources that combine low volatility with low returns. The typical asset classes that fall into this category include: 

1. Money markets
2. Savings
3. Certificates of deposit.
4. Short-term bond funds.

Advisors who are thinking ahead for their clients can improve upon those choices for clients allowing them to “have their cake and eat it too.” Advisors who help their clients to prepare for this early and construct a whole life insurance component to complement their other asset classes and provide an alternative source of funds at retirement. This alternative source includes guaranteed cash value with strong tax advantages. This gives their clients the low volatility asset class they need, with a potentially more robust overall return in comparison to the other alternatives mentioned previously. 

A client planned to include whole life insurance as a bucket from which to withdraw funds, can find an excellent source of funds to use in a year such as 2008. This allows the retiree’s portfolio time to rebound from what is historically a temporary pullback moving towards a permanent advance.  And when markets eventually rebound, clients can choose to reallocate money from their now recovered equities and replenish the money they borrowed from their cash value life insurance policy in anticipation for the next rainy day. 

Not only will this significantly enhance the aggregate return of a client’s retirement nest egg, but it also provides the retiree a less stressful journey and the calmness that retirement was meant to be. 

 

Tom Henske of The Affluent Insurance Advisor works exclusively with financial advisors, accountants, attorneys and investment advisors to design life insurance portfolios which integrate with their clients’ financial and estate plans. He may be contacted at [email protected].

 

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