Why isn’t 7% the same as 7%?
If you’re not withdrawing money from your portfolio, volatility doesn’t matter if the return is the same in the end. But if you’re a retiree taking money out, it can make a big difference.
With a $1 million portfolio, the difference could be up to $337,100 over 20 years.
Consider four hypothetical $1 million portfolios modeled by Financial Advantage. All produce a 7% annual average return, and they’ll be spent down to practically zero after 20 years. Yearly withdrawals start out in the 5.2% to 6.6% range, with the dollar amounts gradually increasing because of inflation.
The steadiest portfolio produces annual returns that range from -1% to 10%, while the second-steadiest portfolio’s returns range from -10% to 12%. The portfolio with the second-highest volatility has returns that range from -7% to 21%, while the most volatile portfolio careens from -25% to 20% annually.
Over 20 years, the total amounts withdrawn from the four portfolios stack up like this:
$1,774,520 (least volatile)
$1,640,436
$1,556,869
$1,401,424 (most volatile)
Different assumptions would produce different numbers, but the lesson is clear: Volatility punishes retirees. When you must withdraw funds during a big down year—especially early on—your portfolio takes a disproportionate hit. CDs and Treasuries aren’t the answer, because they won’t beat inflation.
Bonds, High-Yield Stocks Lower Volatility
Retirees can both lower volatility and get good rates of return with an actively managed basket of assets, including high-quality corporate bonds, agency bonds, high-yield stocks like utilities Duke and Spectra (6.5% yields), Canadian Royalty trusts such as Enerplus, and gold.
While you need to get growth and income, when you’re retired, protecting what you have is the top priority. It’s a different game than it is for someone who’s working and saving.
Lyn Dippel is an advisor with Financial Advantage, which provides personal financial planning and investment-management services to retirees and aspiring retirees on a fee-only basis. Wealth Manager magazine has named Financial Advantage as one of the top 200 independent financial advisory firms in the country. Web: www.financialadvantageinc.com
