Sequence Risk

You worked as a plumber. The requisite butt-crack growth started when you fell in love with the non-lite Miller beer in your early 20s. And it grew as you did, in direct proportion with your savings.

You put as much as you could into your 401(k). Over time, you grew a plumbing and parts business. You owned a small building. You invested in stocks that paid a dividend. You bought bonds that matured at different times. You bought a last-to-die life insurance policy for your kids. And you paid off your home mortgage. So at the end of your working career, you have a whole mess of assets, which you will gradually sell to pay for Hawaii resort bills, mai tais with pink umbrellas, and his-and-her massages for you and your wife of 43 years.

So, where does sequence risk come alive in this otherwise beautiful American dream story?

Let’s start with the bonds. When you were 53, you put $10,000 into a 6% corporate bond coming due 20 years later. At 71 now, with only 2 years to go until that bond matures, you know you have a few more interest payments due to you, and then that bond pays $10,000 in 2 years, i.e. its original principal being returned to you. Luckily, you bought one of these bonds every two years in your 50s and 60s, such that you knew that they would come due, or rather pay back your principal of $10,000, every 2 years for a decade and change. That 10 grand buys a whole lot of mai tais and massages. You have cash coming to you from other places as well, in the form of dividends from your stocks, and the likely sale of your buildings.

For you, Joe the Plumber, you’ve done an excellent job diversifying the cash liquidity needs that you’ll have to fund the rest of your lives together. But what about Bob? Bob the Plumber made the same money you did, but now has everything in growth stocks. He owns no bonds, no buildings, no other cash-producing entities. So he has been doing just fine selling shares of Amazon, Facebook, Google, and a few other growth stocks, which performed well.

But ahhh, things never work out so well in the real world. After President Oprah decides to regulate Silicon Valley, those stocks all get cut in half. And worse. And Bob has no liquidity, i.e. even though the stocks are crazy cheap now, he still must sell them, pay taxes on whatever gains he may still have, and then use those cash proceeds to be able to fund his life. It may mean fewer mai tais for Bob.

Sequence risk is all about retirement planning so that retirees have cash to live on, because most hotels won’t take flush valves or trap vents as payment.