It's important to be aware of how how volatility could affect your investments and your retirement. When evaluating investments many people just consider the average rate of return. However, the volatility of investments is also very important.
In this video I show hypothetical examples of how volatility could affect you in your working years when you are still saving and investing for retirement. Then I show examples of how volatility could affect you when you are withdrawing money from your investment portfolio in retirement.
Most people are not aware of how much of a different volatility can make even when two different portfolios achieve the same same average rate of return.
Full Transcript:
How's it going, everybody? It's Ryan here. Okay, so chances are over the years you've heard that it makes sense that as you get older, you should get more conservative with your overall investment portfolio. As you approach retirement and certainly once you get into retirement and especially if you're now starting to withdraw income from that portfolio, that it makes some sense that you should get more conservative with that investment portfolio, especially more so than you were perhaps you were in your 20s, 30s, or 40s.
But what I thought I would do is share with you an actual example. So I created a spreadsheet here. I'm going to share with you in just a moment and just kind of walk you through this. So what we're going to take a look at is an example of both before retirement and then an example of after retirement. And what I want you to notice here specifically is how much of an impact volatility can have, which I know is financial jargon, but I just mean the overall ups and downs of the investment portfolio.
So let me go and share my screen and we'll get to it. Now I did this spreadsheet pretty quickly so forgive me. It's not the prettiest put together thing that you're going to look at, but I think it'll make sense as I walk you through here. So I don't know what color that is on the left. I'm just going to call that yellow. I think maybe it's a yellowish orange. Maybe one of you can tell me, but I'm just going to call it yellow for now. So we've got yellow, green, and blue. So these are three different portfolios so for three hypothetical people, so we just call them Mr. Yellow, Mr. Green, and Mr. Blue. This is all before retirement.
So hypothetically let's just say that they're all 41-years-old. So we could see that right here. They're all 41-years-old. They're all going to start investing for retirement. We could see at the top, they all have no money invested for retirement right now. They've $0 lump sum. And they're all going to end up achieving exactly the same rate of return, same average rate of return, I should say, which is 6% right here. Okay, so they're all going to have a 6% average rate of return over time.
And what's different though, is that the rates of return that they achieve. So for instance, Mr. Yellow over here. Take a look at those first three years. He has a minus 20, a positive 18 and a positive 20. And then what happens is those same three rates of return keep repeating every three years, all the way down until he's 64-years-old. And by the time he's 64-years-old, assuming he's contributing $15,000 a year, which is which all of these people are contributing. He'll have about $699, 000. Now what you'll notice Mr. Green actually ends up with more money, although he actually averages the same rate of return.
So for Mr. Green here, his rates of return are a minus 12, an 18 and a 12. So notice we've got some more volatility, some higher ups and some higher downs here. Okay? And those three rates of return keep repeating all the way through until he's 64. And then we have Mr. Blue over here on the right. And what we see with Mr Blue is we've got a minus five, an 18 and a five. So not as big of an up on the upside here and not as big of a down on the downside here. And at the end of the day, he has $747,000.
So if we just look at these hypothetical portfolios, which again are completely hypothetical, they're not based on any particular investment whatsoever, include no taxes, fees, nothing. It's just a very simple example, but all three of these are averaging exactly the same 6% average rate of return. Yet, the one that did the best was the one over here in blue that actually had less volatility. And sometimes I'll say slow and steady can win the race. And this is kind of in simple terms as to why that could possibly be.
So it definitely had an impact here in the pre-retirement years when these people are still contributing to their retirement accounts, for instance. Okay, now let's take a look at how this looks once they are actually retired. So hypothetically, they all retire when they're 65-years-old, they all retire with a million dollars. They're all going to average the same 6% average rate of return. And they all have the same rates of return that they had on the other screen.
So in other words, Mr. Yellow has the minus 20, the 18 and the 20 averaging the six. Mr. Green, minus 12, 18, and the 12th averaging the six. And Mr. Blue minus five, 18 and five, again, averaging a 6% rate of return. What's different is now that they're retired, they're no longer investing more money. Instead, what they're doing is they're withdrawing money from their portfolio in which to live on. So they're all going to withdraw this $50,000 per year. And you could see that by the time Mr. Yellow is 88 based on these hypothetical rates of return and such, he's got $381,000 in change.
Mr. Green did a heck of a lot better. He's got $869,000. And then Mr. Blue did even better than all of them. He has almost $1.2 million, so more than he even started with, more than the million bucks by the time he's 88-years-old. So what was the difference? Was it the rate of return or the average rate of return? Nope, it wasn't the average rate of return. The difference here was really the volatility. Okay? That's really the difference.
And did it have an impact before retirement? Yeah, it did. I mean, this is an extra roughly what about $48,000 difference between yellow and blue at the end year? But what's the difference here? Well, huge. Not quite three times, but that's a huge difference in the retirement years. So hopefully this was helpful. If it was, let me know. If it wasn't, let me know that too. And I look forward to talking to you soon. Take care.