We’ve all heard on the term “Dollar Cost Averaging” over all our years of making contributions into our retirement accounts. What it means is that you are making a continuous fixed dollar amount into your investments on regardless of what occurs in the market.
The number of shares purchased each month will vary depending on the price of those shares. In a down stock market you will buy a lot of shares and in an up stock market you will buy a lot less shares. Over time, what happens is that you reduce your average cost per share.
This strategy works very well during your accumulation phase (working years) because you are accumulating shares. The more shares you have and the higher the price of those shares rise, the more money you will have.
However, when it comes time for retirement and we switch from taking money out of these investments instead of putting money in, the rules all of a sudden change and depending on what markets are doing, could be the difference between you having enough money or running out of money. This is what is called sequence of return risk and its dollar cost averaging but in reverse.
You see, its all about those shares and the value of those shares. When you are buying those shares in a down stock market helps because you will be buying more shares regularly. However, when you are taking income, you are selling regularly, not buying. So, what occurs is that in order to generate the same income every month you have to sell more and more shares. In addition, as you sell more shares, there will be less of those shares that will be available to recover when the market goes up. This combination, especially in a drastic down stock market like we have today, will cause you a greater risk of running out of money during retirement.
You must understand that for many who are using a systematic withdraw of income for your stock market portfolio right now, your might have not caught the Coronavirus (COVID-19), but your portfolio did and for many investors it’s not going to recover. Between the stock market downturn and taking income out; combined with other downturns that have happened in years past (even in months past), there has been too much stress placed on your portfolio and your income from this stock market portfolio will probably have to be adjusted. If you are caught in this situation, now could be a good time to slowly reverse course and develop a retirement income plan that will allow you an opportunity to have a reliable income without having to worry that you will run out of money.