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REVERSE DOLLAR COST AVERAGING
PART 3 of 7 Series:
THE ROAD OF RETIREMENT
The Process of Managing Retirement Income
The effect on a retirement portfolio under the stress of systematic withdrawals can be quite dramatic.
Sequence of returns is simply the order in which returns are realized by a retiree. The consequences of a bad sequence of returns, especially early in retirement, can mean premature depletion of the portfolio.
Retirees need to avoid being in the position of having to sell during inopportune market environments. Being forced to sell at the wrong time can result in "reverse dollar cost averaging".
Reverse Dollar Cost Averaging
PLAN TO ALLEVIATE REVERSE DOLLAR COST AVERAGING
During the pre-retirement or accumulation stage, investors making systematic deposits into an investment portfolio will typically benefit from "dollar cost averaging". This benefit results from nothing more than taking advantage of periodic drops in the price of an investment being systematically purchased. During these periods of share price decline, the investor is getting more shares for the dollars being invested.
Once an investor retires and begins to receive systematic withdrawals from their retirement portfolio, these periodic declines in the price of these shares, now being sold to cover expenses, becomes detrimental. Retirees look to generate a certain amount of dollars to pay expenses so when the share prices of the investments in the portfolio decline, the retiree has to sell more shares to raise the dollars needed. This is "reverse" dollar cost averaging.
Best Practices for Retirement Income Planning
RETAIN CONTROL OVER YOUR RETIREMENT ASSETS
To help alleviate the effects of the sequence of returns and reverse dollar cost averaging, there are four very simple best practices that can be incorporated into your retirement income planning.
1. Diversify Your Portfolio by staying invested in cash, fixed income and stocks.
2. Use a Cash Flow Reserve Ladder when structuring the portfolio to provide allocations to cash and short-term, highly liquid investments, which is optimal. The retiree is not under duress to have to sell.
3. Develop a Growing Income Stream using high and growing dividend paying stocks for the equity portion of the portfolio can provide a growing income stream that should reduce the dependency on capital appreciation to achieve the retirement plan.
4. Use a Trusted Financial Advisor who can help thoughtfully develop and manage your retirement income plan. They can provide a line of defense during times of market turbulence.
While there is no way to adequately predict the sequence of returns you will experience during your retirement, you can control the timing of when you sell your assets to support expenses. Using the strategies outlined in this article can provide a framework that will help alleviate the negative effects of reverse dollar cost averaging and should be appropriate for the majority of retirees looking to retain control over their retirement assets.
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Following these strategies does not assure or guarantee sustainability of a retirement portfolio or better performance nor do they protect against investment losses.
Investments carry risks, including possible loss of principal. Bonds are subject to certain risks, including interest rate risk, credit risk, and inflation risk. The principal value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. Investments in equity securities are subject to additional risks, such as greater market fluctuations. Investments in stocks and bonds are not FDIC insured, nor are they deposits of or guaranteed by a bank or any other entity.
The views expressed in this article are subject to change.
Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.