(Complete Show Notes Below)
In the 53rd episode of the Financial Procast:
Is Timing Risk All About The Whims of the Stock Market?
Most of us think that timing risk has everything to do with a buy low, sell high sort of discussion and our goal is to maximize our overall rate of return. But truthfully there's more to it than that. Timing risk is applicable to more than just rate of return, it really pertains to the fluctuation or variability of your assets. Think about this for a second, if you buy assets at a set price and the market (whatever market it may be) has a correction or adjustment, think 2000-2001 or more recently 2008. The markets typically come back but there was, in both cases, a significant depreciation of your assets.
This poses a problem.
There may be things that you want or need to do with your money during that time but you are hesitant to do so for obvious reasons. Unfortunately, the advice that most financial advisers will give their clients (even us in a past life) is “Well, you have lost anything unless you sell, it's just a paper loss”. True…kind of.
That line of thinking works if you don't actually believe in mark to market asset valuation. But for the rest of us that live in the real world where the market value of our assets is all that really matters, watching our assets lose value in a particular market is a very real thing.
Think about the real estate crash of the past several years. If you went to your banker and wanted any kind of equity loan on your house, what would he look at to determine if the loan makes sense? Well, of course he's going to look at your credit, your earnings, and finally he's going to look at the market value of your property. You can argue all day that you paid $300,000 for your property but if the market value is $250,000 that's the number he's going to use to determine your eligibility.
The variability of markets can significantly alter your ability to seize opportunities as they arise. And it becomes even more important when you are looking at your retirement assets.
You Can't Control the Order of Returns
Averages are fine to look at but please make sure you understand the difference between average annual rate of return and compound annual growth rate. A good starting point is to look at this post to make sure you fully understand the difference:
After you've looked at that you should go back and look at this post:
Which is the basis for the analysis discussed in this episode. You'll notice that depending on the order of returns, you run out of money before you planned despite the fact that the rate of return is identical. If you get hit with a huge decline in the early years of your retirement withdrawals, timing risk becomes very real to you.
As you can see, that rate of return will not do anything for you if you don't mitigate your losses or control the order of returns you receive. Hopefully, you just grasped the absurdity of the second part of that statement.
What market sensitive investment gives you control over the order of your returns? If you could predict market returns, you probably wouldn't care less about anything that we have to say. Can you place your rate of return exactly where you want it over the next 20 years? That would be a useful skill.
You'd always stack your best returns at the beginning of the period in descending order. But you can't control that obviously so the only thing you can control is the ability to mitigate the loss.
So what about savings bonds…could that be the answer? hahahahahahaha…funny right? You definitely mitigate losses but the rates are a bit too low to even consider them a viable alternative.
What about life insurance? Could it work?
Well, Brandon proved that whole life insurance could work for sure but we had a reader write us with a question about using universal life? And more specifically indexed universal life insurance (IUL).
With IUL you have a miniumum (0%) and a maximum (10%) as an example. Without getting too deep in the weeds here in show notes, just know that your credited interest rate in an IUL is tied to the movement of an index. If you want more detail on how it all works…listen to the podcast!