“The entirety of the US-based asset systems, from stocks to Treasuries and the dollar,
are still at risk of collapse”
John Authers, Bloomberg
In more than three decades of explaining “risk” to clients we pointed out that sometimes you are just unlucky. Today I wanted to discuss the role of luck, and one very big risk which our industry invariably under-estimates, but which can decimate your financial plan, particularly through retirement.
One of my favourite lines from our TopFunds Guide (now in its 45th edition) and a multitude of commentaries and client reports stretching back to the 1990’s:
“Sometimes you are just unlucky. Could our parents or grandparents have predicted that they would live through the Great Depression, the Wall Street Crash, and two World Wars?”
The textbooks call this Sequence Risk. To a point such a sequence of events such as these is just bad luck or random. Yet the risks prior to the Wall Street Crash were absolutely clear at the time based on financial history to that point. Bubble valuations, manic investor behaviour, huge volumes of debt. Sound familiar? I get ahead of myself now, as Brian will come back to this in more detail in the days ahead. Right now, bear this in mind…
Never has a single UK generation been so dangerously exposed to a prolonged downturn in financial markets.
If you are aged over 60 you are part of that generation, the Baby Boomers.
The Trump unravelling of a 40 year uptrend in financial markets, and of global institutions built over 80 years, has spawned some great research to come across our desks. But there have also been the usual trite and complacent commentaries, usually from within our industry. You know the stuff – the market always recovers – sit it out – risks come and go. These people are dangerous to more than your wealth. Why?
The financial services industry is dependent on the wealth of the Baby Boomers which has been accumulated over the last 40 years. The problem is that the Baby Boomers are horribly dependent on they or their advisers knowing how to defend their life savings – those on which many intend to rely on through a long retirement.
The problem is that most of our industry has no defence in place to protect the assets of the Baby Boomers, a generation which doesn’t have the luxury of time to rebuild their wealth.
The Sequence Risk that I mentioned above is about the order in which investment returns occur. In a nutshell, the risk is that your SIPP and ISA and other assets take a big hit at exactly the wrong time for you, and your life plans are up in flames.
Lip service might be paid to this risk by our peers, but it is rare for them to have a process to protect you from what we call catastrophic risks, falls which are deep and prolonged. For example:
- It took 16 years for the US stock market to recover its 1966 peak.
- It took 16 years for the technology index to return to its high of 2000.
- It took 34 years for the Japan market to recover after 1989 peak.
The falls ranged from approximately 50% to 80%.
That seems tough enough, but now imagine you also need to withdraw 4% every year to meet your income needs. The Dennehy Wealth financial planning team can model such periods and the outcomes – without boring you with the detail, there is a very good chance you might run out of money, and this period can become very stressful for the investor and their family at this most vulnerable stage of their life.
If anyone tells you there is such a thing as a “Safe Withdrawal Rate”, 4% or otherwise, do give them a wide berth – there is no such thing. Why? Because there are two big variables. The precise order of investment returns on your investments is unknown (sequencing risk), and how long you will live (mortality risk).
Thankfully most of you have contingency funds and some flexibility, so that together we can cope with the more extreme periods for financial markets. Plus we have a defence built into our discretionary portfolios, the stop-loss.
But if you don’t feel you have those contingency funds, and that flexibility, please do get in touch with us. Great care will need to be taken, and pretending these risks do not exist is not a solution, and quite dangerous.
More from Brian in coming days on the range of historical precedents, for financial markets and beyond.
