Step 97: Sequence of Return

Step 97 of the 100 Steps mission to financial independence: Sequence of Return
Step 97: Sequence of Return

Sequence of return – or sequence risk -can pose a serious threat to you portfolio and is a factor to be very aware of and take measures against when you are planning your retirement. Sequence of return can hamper a secure retirement, whether you plan to retire when you are 40, 65 or 80 and it can seriously increase your chances of outliving your portfolio, meaning you might be left with no income towards the end of your retirement.

So what is sequence of return?

Sequence of return is the risk of your portfolio being hit by bad market returns early on in retirement when you start making withdrawals from your portfolio. Like for anybody a bad market return affects the value of your portfolio, but whereas you have time to recover from a few bad years if you are still building up your portfolio, once you start withdrawing you no longer have this time to recover. The value of the portfolio can be affected (i.e. decreasing) by it so much that it threatens its own chances of survival. Not only does your portfolio reduce in value from your withdrawal but also from the market drop.

Let’s have a look at how devastating this effect can be by looking at the portfolio of a retiree who is hit by this phenomenon Let’s say they have $1,000,000 and that the market returns an average of 8% over the first 20 years. This retiree takes out $40,000 (4%) in their first year and then adjust for inflation by 3% each year. Below is the chart with how well they do.

market returns start portfolio take out Total left over
-10% $              1.000.000 $           40.000 $         864.000
-15% $                  864.000 $           41.200 $         699.380
-25% $                  699.380 $           42.436 $         492.708
5% $                  492.708 $           43.709 $         471.449
0% $                  471.449 $           45.020 $         426.429
-15% $                  426.429 $           46.371 $         323.049
5% $                  323.049 $           47.762 $         289.051
20% $                  289.051 $           49.195 $         287.827
10% $                  287.827 $           50.671 $         260.872
25% $                  260.872 $           52.191 $         260.852
30% $                  260.852 $           53.757 $         269.224
15% $                  269.224 $           55.369 $         245.932
-10% $                  245.932 $           57.030 $         170.012
15% $                  170.012 $           58.741 $         127.961
25% $                  127.961 $           60.504 $           84.322
30% $                    84.322 $           62.319 $           28.604
-15% $                    28.604 $            28.604 $                     0
15% $                              0 $                     0 $                     0
30% $                              0 $                     0 $                     0
25% $                              0 $                     0 $                     0

Despite the average 8% return, as you can see, this portfolio takes a big hit at the start of retirement with big negative returns and therefore a big decrease of value early on. Unfortunately after 16 years this person has run out of money and is no longer able to draw anything out of their portfolio. Of the $1,000,000 they started with, they were only able to take out just over $806,000. Continue reading

Step 80: Your Savings Rate

Step 80 of the 100 steps mission to financial independence: Your Savings Rate
Step 80: Your Savings Rate

Now that you’ve got a bigger picture of your long-term financial goals, it is equally important to identify ways to achieve those goals. Hopefully by now you’ve set yourself some big financial goals to work towards to in the near future. These could range from earning some extra cash, becoming debt-free and paying off your mortgage, to reducing your work hours or retiring early.

Why exactly do so many people still have debt or no financial or pension plan for their future? Ask anybody in your environment and a vast majority will say that they just don’t have enough money to pay off their debt or to throw at their pension fund. They’ll tell you that they might plan to pay off their debt as soon as they get that promotion and accompanying pay raise. But by now you probably know that even when they get that increase in income, they still most likely won’t be using that money to pay off their debt, nor will they tuck it away and use it to invest in their pension. They’ll simply spend it on new things and without them even realizing it, their lifestyle will gradually inflate to a new level.

And are you maybe still telling yourself a version of this story as well?

Let’s think about how you can speed up your savings goals. Simply speaking and as we have already discussed in earlier steps, there are generally two ways to increase your savings:

  • increasing your income
  • decreasing your expenses

The disadvantages of looking at achieving your savings goals in this way however is that it is easy to focus on the finding excuses for not saving more: “I don’t make enough money”, “If only I earned another $1000 a month”, “It’s so much easier for my neighbor, he earns a lot more than me”, or: “I wish I didn’t have a mortgage for 30 years, it’s a big expense each month”, “It’s easy for you to say, I came out of university with a $50,000 debt”, “I have two young children, do you know how expensive they are?”…. And the list goes on and on and on. Continue reading

Step 79: The 4% Rule

Ste 79 of the 100 steps mission to financial independence: The 4% Rule
Step 79: The 4% Rule

“This whole financial independence story might sound nice and dandy, but how will I ever get there?” I hear you think. “How much money do I need to retire?” and most importantly: “What can I do NOW to make sure I get (and stay) on track to reaching my financial goals?”. Well, I am glad you asked as it is about time that we start looking at putting together a lifetime plan for your financial journey that will make sure you reach your financial dreams and that will give you the motivation and blueprint towards achieving those goals.

In order to get that plan together we will first discuss the 4% rule, a hugely popular and helpful guideline to planning for retirement.

The Trinity Study

In the late 90s and then again in 2009, three professors from Trinity University conducted a now famous study on how different withdrawal percentages affected various retirement portfolios over a 30 year period.

What they calculated in particular was how the portfolios stood up against various withdrawal rates, i.e. whether the portfolios would stand the test of time and outlive the withdrawals. If a withdrawal rate succeeded it meant there was still money left over in the portfolio after the time period of withdrawals ended. Their studies included: Continue reading

Step 44: Personal pensions

Step 44 of the 100 steps to financial independence: Personal Pensions
Step 44: Personal Pensions

If you aren’t enrolled in a workplace pension and don’t have the option to join one, it is worth considering setting up your own personal pension. And even if you have an occupational pension, you might still want to look into personal pensions either as an alternative, or in addition to your workplace pension. Of course, you don’t have to if your workplace pension offers you exactly what you need and how much you need anyway., but as with anything it is worth considering the different options, to know for sure you have chosen the option(s) that are most relevant to you.

A personal pension works in very much the same way as a workplace pension, with the exception that your employer usually won’t be required to make a contribution. Another difference is that you need to make more decisions. Not only do you have to choose a pension provider (whereas in the case of occupational pensions your employer would have already done this for you), you often also need to choose from different packages, conditions and investment options.  Continue reading

Step 43: Workplace Pensions

Step 43 of the 100 steps mission to financial independence: Workplace pensions
Step 43: Workplace pensions

As we saw before, a workplace pension is often offered by your employer or work sector and contributions are usually made monthly directly from your paycheck. Although many of the characteristics discussed in step 42 on state pensions are also applicable to workplace pensions, the latter often have many additional advantages or characteristics, including some of the following:

Automatic

It is often (though not always!) automatic, meaning in many workplace pensions employees are automatically enrolled. If you don’t take action to opt-out you are systematically making monthly payments into your pension scheme.

Monthly contribution

You can determine your monthly contribution. There is usually both a minimum and maximum contribution you are allowed to make, and although many people might just pay the bare minimum, if you budget well and set aside enough money, you can obviously pay in more. The more you contribute (i.e. save) now, the more you’ll again have by the time you retire, not just from your monthly paymentsbut also from the compounded interest.  Continue reading

Step 42: State Pensions

Step 42 of the 100 steps mission to financial independence: State Pensions
Step 42 of the 100 steps mission: State Pensions

In the previous step we looked at the different types of pensions that exist. In this step we look at state pensions in detail, although many of the characteristics of state pensions also apply to other types of pensions. Pensions vary greatly from one country to the next, if they even exist at all, as not all countries offer state pensions, so make sure to do your homework well and read up on the details of the state pension for your country.

If you are entitled to a state pension this is normally regardless of the height of your salary and of any workplace or private pensions you might or might not have. Bear in mind that most state pensions tend to be far from generous and designed mainly to just provide for your basic needs.  Continue reading

Step 41: An Introduction to Pensions

Step 41 of the 100 steps mission to financial independence: An introduction to pensions
Step 41: An introduction to pensions

Pension… a word dreaded by many, not just because they might not like the idea of being old, or – on the contrary – are worried it’ll be way too long before they can finally retire. Many simply don’t have a clue what their pension might look like and fear that they might never be able to retire properly, due to a (nearly) empty pension pot or the absence of a decent pension plan altogether.

Or maybe you just hate the idea of talking about pensions as it sounds like the most BORING topic in the world to you.

Be that as it is, ignoring your pension is not going to do you any good and considering the many changes that pensions are going through at the moment in many countries, it is wise to learn more about them and especially to understand your own pension projection better and to put together your own pension plan. So you are going to take the bull by the horns here and set up or review your current pension scheme. It might be tough, unpleasant or tedious at first, but once the bulk of the work has been done, you can sit back with a comfortable feeling, knowing you might still be a long way away from where you want to be, or from your retirement in general, but that you’ve put in a plan to get you back on track or closer to your end goal. Continue reading