For investors saving up for a comfortable retirement, there may be no stretch of time more consequential than the Fragile Decade.
This is the critical period leading up to and immediately following the point where they turn their assets into income – or in other words, retire. Getting through the Fragile Decade unscathed takes a great deal of luck. But proper planning can greatly improve your odds.
There are two dangerous forces at play: (1) the Arithmetic of Loss and (2) the Sequence of Investment Returns. A third potential threat lurks in the IRS-mandated Required Minimum Distribution from traditional qualified accounts.
Let’s examine these dynamics and propose some solutions.
The Arithmetic of Loss
A loss hurts more than an equal gain helps. To put that in mathematical terms, if your portfolio loses 5%, it will need a subsequent 5.26% gain to return to break even. A 50% loss requires a subsequent 100% gain. Fortunately, the stock market tends to notch far more gains than losses in the long run. But the closer you get to retirement, the less time your portfolio has to recover. And a bad year followed by a few merely decent years could mean starting your retirement withdrawals from a smaller asset base than you had a few years prior.
If your portfolio loses… | …you need this subsequent return to break even. |
5% | 5.26% |
10% | 11.11% |
15% | 17.65% |
20% | 25% |
25% | 33.33% |
30% | 42.86% |
35% | 53.85% |
40% | 66.67% |
45% | 81.82% |
50% | 100% |
Sowing vs. Reaping: Why Sequence of Returns Matters
While you are working and accumulating savings, the average return on your investments matters much more than the sequence those returns come in. But once you retire and start withdrawing, the sequence of returns matters a great deal. This is because when you withdraw from your retirement savings, you must realize a gain or loss in your portfolio. A realized loss requires an even greater subsequent gain to return to break even than an unrealized loss, creating a compounding loss effect.
So if the market is down early in retirement, you must sell more asset units (e.g. shares of stock) to meet your income needs. The fewer assets left in your portfolio, the smaller the base available to benefit from a market recovery.
The IRS Doesn’t Care About Your Sequence of Returns
Even if you can correctly predict when your portfolio will be up or down (in which case, please tell me your secret), you may not always be able to choose when you realize gains or losses.
Under current law, Required Minimum Distributions (RMDs) from traditional retirement accounts begin at age 73 (rising to 75 in 2032 under the SECURE 2.0 Act). These mandatory withdrawals force retirees to take money out—even if they don’t need it—potentially selling assets during a downturn.
Withdrawals from traditional IRAs and 401(k)s are taxed as ordinary income, unlike taxable investment accounts taxed at lower capital gains rates. Without proper planning, retirees may be forced to sell assets at a loss just to meet RMD obligations.
The Leadup: Preparing for the Fragile Decade
The years leading up to retirement are just as important as those which immediately follow. If your portfolio takes a significant hit a year or two before you planned to retire, you will begin withdrawals from a smaller asset base than you may have planned for. It is therefore prudent to start repositioning your retirement portfolio from “high-return, high-volatility” assets to more stable assets well in advance of your target retirement date.
But how can retirees protect themselves from sequence of returns risk during the Fragile Decade? In a word: diversification. You can use inverse-correlated, non-correlated or downside-protected assets to generate income from gains as opposed to losses in your portfolio.
The Inverse-Correlated Option
Traditionally, retirement savers start to balance their stocks with bonds as they approach retirement. This is because historically when stock values are down, bond values tend to be up. Bonds also generate a fixed yield regardless of equity market conditions. Some commodities, such as gold or crypto currencies, may also be inverse-correlated to equities.
The problem with these types of assets is that while they may be typically inverse-correlated, they are not always inverse-correlated. For example, in 2022, the Russell 1000 Growth Index was down 29.14% and the Bloomberg US Aggregate Bond Index was down 13.01%. In a scenario like that, you might have no choice but to realize and compound losses in your portfolio.
Non-Correlated Guaranteed Growth
There are a few asset class that promise minimum-guaranteed growth with additional upside potential that is wholly unrelated to stock market swings. One such asset is the cash value of Whole Life insurance. While the expected long-term return potential of Whole Life cash value may be lower than that of equities, it does offer the guarantees and predictability that help retirees sleep at night when the stock market is facing headwinds.
Another is a fixed income annuity. These annuities come in many flavors, so to speak, but they share a common feature which is a minimum guaranteed annual income. Some contracts also provide set annually increasing income, and some have income increases based on prevailing interest rates or carrier profitability. Either way, knowing that at least of portion of your retirement income is guaranteed and totally unrelated to stock market swings will allow you to plan your lifestyle accordingly. It may also give you the confidence to invest your other assets more aggressively, longer into retirement.
Downside Protection
Retirement savers looking to capture more of the market’s upside while limiting downside loss may find a buffered annuity to be an attractive solution. These are essentially an index options collar packaged in an off-the-shelf product that can be tailored to your individual risk and return needs.
For example, a 10% downside buffer protects you from the first 10% of loss in the index tied to your annuity. That means if the index drops 7%, your annuity will be credited at 0%, avoiding a loss completely. If the index drops 15%, your credited loss is only 5%. Looking back at the Arithmetic of Loss, that means the index will only need a subsequent 5.26% gain to break even as opposed to a 17.65% gain. By avoiding or limiting losses in bad years and reaping gains in good years, these annuities help maintain a stable withdrawal base that grows in line with the market index.
Plan Now for Later
The right strategy to offset sequence of returns risk varies for every investor. My experience teaches me that there is no single correct solution to the Fragile Decade. Rather, a combination of tactics and techniques is most likely to yield sustainable results.
Regardless of the approach, the key takeaway is this: the Fragile Decade is real, and planning ahead is essential. Once losses start compounding, recovery becomes much harder.
If you’re approaching retirement, now is the time to take action. Protecting your assets today determines your financial security for the years ahead.