Quick Thoughts: Sequence of Returns Risk

Nate explains a critical, often overlooked retirement risk: sequence of returns risk—the danger of encountering poor market performance right when you begin taking withdrawals. Even when two retirees earn the same average annual return, the order in which those returns arrive can significantly change outcomes. Nate discusses how to plan for adverse early-retirement markets and presents indexed universal life insurance (IUL) as a flexible, non-market-loss-exposed income source to help mitigate this risk.

Key Discussion Points:

• Sequence of returns risk:

  • It’s not a concern until withdrawals begin, typically in retirement.

  • Losses during downturns are compounded when assets are sold to generate income at depressed prices.

  • Even if markets recover, reduced asset bases mean less participation in the rebound, potentially shortening portfolio longevity.

• Same average return, different outcomes:

  • Two retirees with identical portfolios and a 7% average annual return over 20 years can have dramatically different results depending on whether negative years occur early vs. late in retirement.

  • Early losses paired with withdrawals can rapidly erode principal, demonstrating that the sequence of returns can matter as much as the returns themselves.

• Planning with Monte Carlo simulations:

  • Nate emphasizes modeling scenarios where the first years of retirement are poor.

  • Objective: Ensure contingency plans exist for adverse sequences, because “we get one chance to get retirement income right.”

• Diversification beyond traditional assets:

  • Historical non-correlation can break down: in 2022, both stocks and bonds fell, undercutting the classic diversification benefits.

  • Relying solely on investment accounts for income in down markets may be suboptimal; alternative funds can allow portfolios time to recover.

• Role of Indexed Universal Life (IUL):

  • Properly designed and funded IULs can provide cash values protected from market loss.

  • Interest credits are linked to market indices (e.g., S&P 500) without direct exposure to downside.

  • Offers tax-advantaged access to cash values during retirement.

  • Strategy: Draw income from IUL during market volatility instead of selling investments at depressed prices, reducing sequence risk and preserving portfolio recovery potential.

  • Practical insight: Avoiding withdrawals during one or two severe downturn years over the past 25 years could materially improve a retiree’s experience and peace of mind.

• Portfolio construction idea:

  • Consider replacing some or all of a bond allocation with an IUL to add downside protection and tax advantages.

  • Nate’s backtest: A Midland National IUL paired with 60% U.S. stocks vs. a traditional 60/40 (stocks/BND bonds) over 25 years.

    • Result: 60% U.S. stock + 40% IUL outperformed 60% U.S. stock + 40% intermediate bonds (Vanguard Total Bond Market, ticker BND).

    • Additional benefits: IUL provides a death benefit and tax-free cash value growth; bond income can be taxable (outside an IRA) or subject to ordinary income tax upon IRA distribution.

Major Takeaways:

• The timing of returns can be as consequential as the returns themselves once withdrawals start.

• Traditional stock-bond diversification may not always protect against simultaneous market declines.

• Building an “off-market” income reserve—such as an IUL—can help retirees pause withdrawals from investment portfolios during downturns, improving longevity and stability of retirement income.

• Integrating IULs as part of or in place of bonds may enhance total outcomes while adding tax and estate benefits, subject to proper design, funding, and suitability.

Disclaimers and Professional Guidance:

• The podcast is informational and not direct investment advice.

• Not all investments are suitable for all individuals.

• Investing involves risk; fees and risks should be carefully considered.

• Crosby Advisory Group LLC is a registered investment entity; consult directly for personalized advice.