The Pattern of Returns: How They Might Affect You

Post Written by: Paul B. Elfner, CFP®, MSFS | Matthew M. Gavel, CFA

Up one day and down the next. The market is constantly moving and focusing on these daily fluctuations can raise many questions in your mind.

Will your portfolio help you meet your long-term goals amid the market ups and downs? What if you are taking withdrawals from your portfolio? How does a down market affect your overall financial plan?

These are natural questions and below we discuss things you can do to ensure financial success given swings in the markets.

 Same Ending Point, Different Paths

We all know that the market is up and down to varying degrees year by year. One year may see positive returns and the next could see negative returns. But how does this pattern of returns affect your portfolio outcome?

Let us look at an example. The table below shows annual returns for two different portfolios over 25 years beginning when the investor is 65 years old.

Both portfolios start with $750,000 and experience the same annual returns but in a different order. Portfolio A starts out with several years of positive returns and Portfolio B starts out with some negative returns.

Despite these differences, both portfolios are valued at $2,889,770 in 25 years and have the same average annual return of about 5.3 percent.

Pattern of Returns chart 1

But look at the graph below. This shows the value of both portfolios every year over the 25-year time horizon. The two lines look very different.

Portfolio B (orange line) starts out flat and even negative at some points, and then has a fairly upward trend at the end of the 25 years.

Compare this to Portfolio A (blue line) which grows much faster at the beginning, but has some pretty big ups and downs along the way. This investor had a pretty bumpy ride.

You can see the pattern of returns matters in the experience of these two investors.

Pattern of returns chart 2

The Impact of Withdrawals

The sequence of returns becomes an even bigger factor when you consider withdrawals from the portfolio as we will see in the example below.

Both Portfolio A and Portfolio B start with $750,000 and withdrawal $30,000 each year, which represents a 4% withdrawal rate.

The pattern of returns in this example is the same as the previous example. Portfolio A starts out with a few years of positive returns, and Portfolio B starts out with some negative returns.

Now, look at the ending value of both portfolios. After 25 years, Portfolio A is valued at $1,871,117, while Portfolio B is valued at $364,600. This is a difference of over $1,500,000.

pattern of returns chart 3

Why are these outcomes so different? The first few years of returns are vital as the investor pulls funds from their portfolio. One of the worst times to encounter a down market is when you are withdrawing funds from your portfolio because you have less money left in your portfolio to recover from the negative returns.

Take a look at the portfolio values after one year when the investor is 66 years old. Portfolio A is withdrawing $30,000 or 4% of its portfolio value. Portfolio B is also withdrawing $30,000 but this is 5.5% of their portfolio value because of the loss sustained that year.

Portfolio B never truly recovers from those lower returns at the beginning of the portfolio withdrawal period.

You can see in the line graph below how the pattern of returns makes a big difference in the outcomes.

Pattern of returns chart 4

 

What Can You Do?

We don’t have control over the pattern of stock market returns, but we do have control over some things that can make a big difference in helping you weather periods of volatility.

Cash Reserve

Consider keeping a cash reserve to weather down markets and not be forced to sell at inopportune times. This will allow your portfolio time to recover before you need to replenish your cash reserves. Consider building your cash reserves over time if you have large upcoming expenses like purchasing a new car or replacing your roof. We recommend working with your financial advisor to develop a cash flow plan that fits your unique situation.

Your Financial Plan Is Fluid

It may be a good time to revisit your financial plan. Have your financial goals or risk tolerance changed? Do you have any new goals? Has your time horizon changed? Remember that your financial plan is fluid and it is imperative to revise your roadmap as things change.

Diversified Portfolio

One of the goals of portfolio management is to avoid sustaining a large loss that could derail you from reaching your longer-term goals. We do this by constructing a portfolio that includes different areas of the market such as stocks and bonds. This helps to preserve the portfolio value when one area of the market may be experiencing a pullback.

As you can see, the pattern of returns can make a difference in portfolio results over time. Managing this risk in retirement is crucial by establishing and maintaining a strategic asset allocation that aligns with your risk tolerance. If you’re asking yourself what this means or how do I know if I have the proper allocation, perhaps it’s best to speak with one of our trusted Wealth Advisors to discuss your portfolio and how best to achieve your financial goals. Our advisors and investment professionals are always ready to have a conversation about how we can help with your financial situation. Connect with us anytime at 717-393-9721 or info@domaniwealth.com.

 

Important Disclosure

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Domani. A copy of Domani’s current written disclosure brochure discussing our advisory services and fees continues to remain available upon request.

PLEASE SEE ADDITIONAL IMPORTANT DISCLOSURE INFORMATION

 

 

 

 

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