Finance: What is sequence risk, and how can it derail retirement?

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Transcript

00:19

direct proportion With your savings you put as much as

00:22

you could into your four Oh one k overtime You

00:25

grew a plumbing in parts business nicely You owned a

00:27

small building you invested in stocks that paid a dividend

00:31

If you bought bonds that matured at different times you

00:34

bought a last to die life insurance policy for your

00:37

kids and you paid off your home mortgage Yeah So

00:40

at the end of your working career you have a

00:41

whole mess of assets which you will gradually sell off

00:45

the hey for Hawaii resort bills to pay from my

00:47

ties with pink umbrellas in him And you know to

00:50

pay for his and her massages for you and your

00:52

wife of forty three years So where does sequence risk

00:56

come alive in this otherwise beautiful American dream story Well

01:00

let's start with the bonds When you were fifty three

01:02

you put ten grand into a six percent corporate fund

01:04

coming do twenty years later at seventy one Now with

01:07

only two years ago until that bond matures Well you

01:09

know you have a few more interest payments due coming

01:12

to you And then that bond pays ten grand in

01:14

two years It's original principles being returned to you Luckily

01:18

you bought one of these bonds every two years in

01:21

your fifties and sixties such that you knew they would

01:23

come to our rather pay back your original principle of

01:26

ten grand every two years for a decade in change

01:30

You have all this cash cash Ola coming to you

01:33

from other places as well It comes in the form

01:35

of dividends from your stocks and the likely sale of

01:38

your building and a whole bunch of other little assets

01:41

that you'll slowly pull out of Your four Oh one

01:43

k pay taxes on it So where does sequence risk

01:46

then Come in Like what's wrong with all this Well

01:48

for you Joe the plumber you've done an excellent job

01:51

diversifying the cash liquidity needs that you'll have to fund

01:55

the rest of your life together You know with your

01:57

wife The cash comes in waves gentle waves of ten

02:01

grand here twenty grand there of stream of dividends So

02:04

you always have cash handy to pay your bills It's

02:07

really easy right Well what about Bob Bob the plumber

02:10

not the builder He made the same money you did

02:13

but has everything in growth stocks and one big fat

02:17

building He owns no bonds no other cash producing entities

02:20

That's it So he's been doing just fine selling shares

02:23

Obama's on Facebook Google Netflix And if you have a

02:25

growth stocks would performed well But things never work out

02:28

so well in the real world After President Oprah decided

02:31

to regulate Silicon Valley those stocks all got cut in

02:35

half and then worse and kept falling and falling and

02:37

falling And well now Bob has no liquidity because he

02:40

depended on selling growth stocks to fund his life Even

02:44

though the stocks are crazy cheap now he still has

02:46

to keep selling them Pay taxes on well any gains

02:49

he may still have left from when he bottom a

02:51

while ago and then use those cash proceeds to hopefully

02:55

be able to fund his life He also has that

02:57

building which is in a bear market now and it

02:59

can't really sell so he'll get only a third for

03:02

it If he has to sell it right now can

03:04

he borrow against it Kenny margin against his stocks Really

03:08

risky If you start doing that because of stocks keep

03:10

going down then your margin executes a call provisions and

03:14

basically you lose all of your stocks meaning if stocks

03:17

go down and your margin rates are more than fifty

03:19

percent the broker's likely will force you to sell even

03:22

more stocks And so you lose even more money and

03:24

it means probably a lot fewer mai tais for Bob

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So sequence risk is all about retirement planning so that

03:31

retirees have oodles of cash coming in regularly safely to

03:35

fund the lives they want you know in their golden

03:38

years there Why Well because most hotels won't take flush

03:42

valves or trap vents or toilet seats as payment eh