Clear Idea #4

38 www.acasociety.com | info@acasociety.com T hese are some of the comments I get from dentist friends when asked about their retirement dreams. I believe they resonate with many and I am certain there are many more varied dreams out there waiting to be met. Retirement fromany profession is now no longer a function of age. Retirement from one could be the beginning of another. No matter the age nor what the dream is of a post professional or clinical life, one key input into realising that dream is to have sufficient resources to pursue that next goal. Wealth releases one and gives one the freedom to do so. Hence, wealth creation during one’s professional life informs how well and how soon one is able to realise those post professional life dreams and goals. There are indeed numerous strategies and ways to create wealth but no matter which route one chooses, there is one principle that we can’t escape from, if not careful, could derail any well-planned wealth creation strategies. When matters There is an old adage that says: “It’s not about timing the market but the time in the market.” It can’t be more wrong. Firstly timing is important; no one wants to buy at the peak now sell at the trough. But more importantly, many investors fail to consider when they may lose in the market. Many like to talk about their winnings and bury their losses. It’s actually not the losses themselves per se. It is when one loses in the journey of their wealth creation and at which stage of their professional life that matters a lot more. Asimilar amount of losses, taken early in one’s wealth creation journey versus later, can have a great impact on the amount that one would retire on, when professional life ceases. Let’s take a look at this hidden risk called Sequencing Risk, which is basically the risk of losing a large chuck of one’s wealth due to the sequence or order of negative returns in a portfolio. It is not as much about the negative returns as it is about the timing that it happened. This is a risk for those nearing retirement or close to ceasing professional earning capacity. This is due to the happenstance of three events at the same time: i) Peak portfolio value ii) significant drawdown or negative returns iii) no further contribution into the Portfolio and worst if adding the forth element iv) starting to drawdown from the portfolio. These are the covalence of events happening at the wrong time creating the greatest impact (negatively) on the value of one’s wealth at retirement. Worst returns at the wrong time Sequence of significant events How big can this impact be? Can we quantify it? Should we bother? Let’s take a significant event that is top of mind for most - that is the GFC period in 2008 where the Australian S&P/ ASX200 Index fell by 41%. We will simulate the returns of two portfolios, both with an inception amount of $100,000 for a 12-and-a-half-year period from 2008 to June 2020, but from two different starting point and under two scenarios, one with static value (Diagram 1) and the other (Diagram 2) with yearly contributions into both portfolios. Portfolio A depicts the GFC event happening early in the investment period (2008) as how it was whilst Portfolio B simulates a reverse situation, where the GFC event happened at the end of the 12.5 year investment period (in June 2020), with all other variables remaining stable. Scenario 1, Diagram 1 – Significant event at different times and no new contributions Result: No impact. No Sequencing Risk. Scenario 1 demonstrates that where there had been no new contributions made to a portfolio investment returns i.e. how well you invest matters. There is no Sequencing Risk. Maximising wealth for the dreamed retirement By Wai-Yee Chen Wai-Yee Chen We a lt h C r e at i on “I want to… drive a nice car, live by the ocean, write a book.” “I want freedom… from financial stress and worrying about my practice.” Scenario 2, Diagram 2 – Significant event at different times with yearly contributions Result: Portfolio B suffered from Sequencing Risk and was 26% worse off.