Three Paths

Most investors wish that they could be on a merry-go-round, not a roller coaster. Of course we know that it is not possible, but consider three different portfolios that are invested over an eight-year period.

Path #1 Path #2 Path #3
YR 1 10% 38% (22%)
YR 2 10% 23% (12%)
YR 3 10% 33% (9%)
YR 4 10% 29% 21%
YR 5 10% 21% 29%
YR 6 10% (9%) 33%
YR 7 10% (12%) 23%
YR 8 10% (22%) 38%

It’s hard to believe, but the compound annual return of each portfolio is exactly the same --- 10% for all three portfolios! Obviously Path #1 would be nice, but again, just not going to happen. Yet people consistently set themselves up for disappointment by expecting the historic “10% return” to occur year after year, only to discover that most years it’s not 10% on the nose.

Considering that we all have to endure variability of returns, which is better, Path #2 or #3? You may think that Path #2 isn’t so bad, but if you have retired at the end of year 6, it’s pretty darned painful, and it is similarly difficult to begin retirement with three nasty, down years. The one nice thing is that if you are still saving for retirement, the three down years allow you to invest in your retirement account at lower levels.

But what would happen if you were already retired in all three paths? In that case, most people would be withdrawing money from their accounts. So if the portfolio in each path is worth $1,000,000 and you are planning to withdraw an inflation-adjusted $50,000 each year, you may be surprised to see what would happen over the course of the eight years. In Path #1, after eight years, the $1million portfolio would be worth $1.6 million, in Path #2, it would be worth $1.8 million and in Path #3 it would total $1.2 million. A $600,000 differential is pretty major!

The reason that I bring this up is that when you are about to retire, rarely do results move in a straight line. Your job is to ensure that regardless of market performance, you are taking into account the various outcomes that would impact your life.