Why long term Average Returns can be Misleading in Retirement
When looking at investment performance, focus is often on the average annual return of a portfolio, for example 7% return every year might sound fantastic - but in retirement, this average can be misleading.
The issue lies in sequencing risk - the risk that poor market returns early in retirement can have a compounding negative effect on portfolio longevity.
Smooth Consistent Returns Can be Better in Retirement
Imagine two portfolios with the same average return: one with less volatility, and another with large investment returns, but also negative investment returns.
Let’s assume:
a retiree has $1,000,000 in super at retirement
they withdraw $60,000 each year as their pension
retirement duration is 20 years
Two portfolios:
Portfolio A: Higher average return (7%) with significant volatility
Portfolio B: Lower average return (6%) with reduced volatility
What is the Outcome?
Portfolio B is around $265,000 higher in value after 20 years. Despite having a lower average return, Portfolio B’s smoother ride - especially in the early years - meant fewer losses when withdrawals were made. Portfolio A’s early losses resulted in withdrawing at depressed values, compounding the problem!
In accumulation (savings) phase, average returns are more reliable indicators
In retirement, sequence matters - early negative returns can do lasting damage
Reducing downside exposure, especially in early retirement is more beneficial than chasing higher average returns
“The first rule of investment is: don’t lose money. The second rule is: don’t forget the first rule.”
To understand Sequencing Risk and how it can impact your retirement savings,
contact Anthony on anthony.walker@cambridgeprivate.com.au or 0481 554 415