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by Diane Davis


Balancing the Desire for Diversification with Retirement Security


T


wo severe bear markets during the past decade have made many inves- tors wary about how


much of their portfolio should be devoted to stocks.


This is particularly true of retirees who need to depend on their savings for income. Caution is understandable, but most investors are likely unable to gen- erate sufficient income for retirement without including stocks in their port- folio. The long-term growth potential of stocks remains an important ingredient to long-term financial security, even in retirement. How can one balance the need for stocks while protecting against the risk of down markets?


Understanding Sequence Risk An important but little talked about issue that retirees should to consider is sequence risk. This concept relates to the timing of stock market returns and how it can affect a portfolio. The sequence of returns has little ef-


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fect on a portfolio that is held over an extended period of time with the goal of accumulating wealth rather than generating income.


For example, consider what happens with Bill and Betty, two individual inves- tors, who experience exactly the op- posite returns in a portfolio over two hypothetical five year periods.


Bill’s returns for five consecutive years were: +20% in year one, +6% in year two, 0% in year three, -6% in year four and -20% in year five. Betty’s investment experience was exactly the opposite: -20% in year one, -6% in year two, 0% in year three, +6% in year four and 20% in year five.


If both invested $100,000 at the outset of this five-year period and let the mon- ey continue to grow throughout the period without additional investments or any withdrawals, both would end up with $95,654 at the end of five years. While this isn’t likely the return they’d


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