ChooseFI | Financial Independence Podcast

035 | Sequence of Return Risk: What Every Early Retiree Must Know

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Aug 6, 2017

In a fascinating discussion with Big Ern, a financial blogger from Early Retirement Now and an expert on safe withdrawal rates, listeners gain valuable insights into financial independence. He explains the critical concept of sequence of return risk and its impact on retirement planning. Big Ern shares his journey to early retirement, the significance of real returns, and challenges with the 4% rule. With plenty of practical examples, he emphasizes the necessity of flexible withdrawal strategies and the benefits of saving during market downturns.

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INSIGHT

Sequence of Return Risk Explained

Sequence of return risk is why retirees often run out of money despite average returns.
Poor market returns in the first 5-10 years of retirement severely damage portfolio longevity.

ADVICE

Use Big Ern’s Withdrawal Calculator

Use Big Ern's Google Sheet from part seven of his series to input personal retirement data.
This tool calculates historical safe withdrawal rates and failure probabilities tailored to individual scenarios.

ANECDOTE

Early 2000s Retiree Losses

Retiring in 2000 with $1 million and withdrawing $40,000 yearly led to portfolio depletion due to market crashes.
Withdrawing during market lows forces selling more shares at depressed prices, worsening sequence of return risk.

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The 4% rule might fail you—but not for the reason you think. Average market returns matter far less than when those returns happen, especially in your first decade of retirement. Brad and Jonathan sit down with Big Earn from Early Retirement Now to unpack sequence of return risk: the hidden danger that can derail even a well-funded retirement if you're unlucky with market timing.

Big Earn breaks down why withdrawing during a downturn compounds losses in ways the accumulation phase never prepares you for. The conversation covers how to calculate a truly safe withdrawal rate based on your specific circumstances, the critical first 5–10 years that make or break your portfolio, and flexible strategies to adapt when markets turn against you.

[00:01:20] Guest Introduction: Big Earn

Big Earn from Early Retirement Now joins to discuss sequence of return risk.

[00:11:40] What is Sequence of Return Risk?

Sequence of return risk is the potential negative impact on a retiree's portfolio caused by withdrawing funds during market downturns.

"Unlucky draws in the first 5-10 years can lead to running out of money."

"Getting unlucky with market downturns matters more than low average returns."

[00:18:00] Calculating Safe Withdrawal Rates

A common starting point is the 4% rule, but factors impacting the withdrawal rate include age, market conditions, and personal expenses.

[00:28:00] Factors Affecting Retirement Savings

Individual circumstances can alter financial plans significantly. Considerations include social security and market performance in retirement planning.

"Writing down your financial plans clarifies your understanding."

[00:37:00] Mitigating Sequence of Return Risk

Strategies include various withdrawal approaches and portfolio allocations.

"Automatically withdrawing without assessment is unwise."

"Wealth is built through consistent investments and staying the course."

Action Items

Evaluate your current withdrawal rate and assess its sustainability based on market conditions. [00:31:29]
Research and understand sequence of return risk before planning for retirement. [00:12:27]
Utilize simulation tools to create personalized financial models. [00:55:37]

Related Resources

Early Retirement Now - Safe Withdrawal Rate Series [00:50:39]
Bogleheads Investment Philosophy [00:39:00]

Key Terminology

Sequence of Return Risk [00:12:27]: The risk of receiving lower or negative returns early in retirement, which can have a detrimental effect on the overall portfolio value.
Safe Withdrawal Rate [00:18:00]: The percentage of a retirement portfolio that can be withdrawn annually without running out of money over a specific period, commonly set at 4%.
Dollar-Cost Averaging [00:57:00]: A strategy of investing a fixed amount of money at regular intervals, regardless of the asset's price, to reduce the impact of volatility.

▶ Listen Next: Ep. 038 — The Why of FI: Why Pursue Financial Independence? | Essential Listening

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