What is the Drawdown's Biggest Risk?
The forced selling of equity funds in market downturns to fund withdrawals creates the biggest risk for drawdown investors.
The more markets fall the more units must be sold to meet your income withdrawal causing irreparable damage to your drawdown account value.
This is known as ‘Return Sequencing Risk’.
To understand how this could affect your account CLICK through the TWO examples below.
This chart shows a classic stock market return delivering 8% compound return over 25 years. It also shows how much a lump sum investment of £500,000 would increase over that period. The lump sum investor reaps the average long-term compound return.
As typifies stock market returns, the returns are not smooth, with above average returns in some years and negative returns in others.
Trying to avoid such corrections by timing investments in and out of the stock market is notoriously difficult and carries the significant risk of missing out on above average return periods.
When you start to make regular withdrawals, the exact opposite happens. This chart shows someone starting with an initial investment of £500,000 into the exact same hypothetical stock market, and drawing £25,000 per year in income, escalating by 3% a year to keep pace with inflation.
In our example, the drawdown investor almost completely exhausts their account in 24 years.
In fact compared to the hypothetical return of 8%, investors who withdraw their funds receive only half of the return compared to those who invest a lump sum, averaging just 3.9% annually over a 25-year period.
