Even a small slit in your money bag will destroy your wealth. A lot of what you pour into the top flows out the bottom. You may fill it up if you pour enough in fast enough. But repairing or preventing that slit at the bottom makes a huge difference.
SLIT: a long narrow cut or opening
SLIT can also help you remember the major threats that eat away at your financial success.
S. Sequence of Returns Risk.
L. Longevity Risk.
S is for SoR
The Sequence of Returns risk is sometimes called SoR. It relates to the order of your variable investment returns. Some simplified calculations show stocks returning 8% or 10% per year for every year. The average return of the stock market over the last century was 10.5%.
What this ignores is that the return is never fixed and consistent. It varies from year to year. It might go more like (+32%, +4%, +8%, -2%, -42%).
In our early careers, we are in the accumulation phase. When contributing to retirement funds the order of the returns doesn’t matter much.
The rules are different in the decumulations phase. Once retired and withdrawing funds the sequence of returns matters a lot. If you enter retirement after a protracted bear market with plenty of funds, then you will likely be fine. The initial returns are likely to be positive. Early positive returns will grow your wealth and protect you against future loss.
If you have just enough to retire and a protracted bear starts after you retire, things will not go well for you. Negative returns at the start can devastate your funds. So, the sequence above would go better than if it were in a different order: (say -42%, -2%, +4%, +8%, +32%).
L is for Longevity Risk.
We tend to underestimate our own longevity when calculating retirement income needs. If you exercise and avoid overeating or smoking you may live longer than average. What will happen if you live past 95? How about age 105. You may run out of money. Have your models projected that long?
I is for Inflation.
Inflation has been in check for quite some time in the U.S. That doesn’t mean that will continue. Especially with central banks around the world printing money. Even a 3-4% inflation rate erodes purchasing power over decades.
Are you old enough to remember the 1970’s? How about those WIN buttons? (Whip Inflation Now). I remember those difficult times. Inflation seems to affect the retired elderly even more than the rest of the population.
When working and receiving a steady paycheck, you have built-in inflation protection. It is harder to get such protection when drawing down a financial portfolio.
T is for Taxes.
Many financial plans don’t account for taxes upon withdrawal of retirement funds. When we are young and adding into our retirement accounts we get a wonderful tax deduction. What a sweet deal the government is giving us, eh?
But come time to withdrawal the money we realize that tax-advantaged is not tax-free. Uncle Sam gets his cut whenever we withdrawal funds (unless they come from a ROTH). In fact, you must withdraw your funds early and often. The government has waited long enough and they would like their part of your money
SLIT doesn’t have to prevent your comfortable retirement. But it should remind you to prepare for those powerful forces.
You may have a SLIT in the bottom of your money bag. Are you concerned about returns, running out of money, inflation, or taxes? Do you have a strategy to combat these threats?