Most retirement plans model one kind of sequence risk: the order in which market returns arrive. If you retire abroad, you carry a second one, and it is easy to leave out.
Why order matters once you start withdrawing
While you are saving, the order of returns does not change where you end up. Once you are withdrawing, it does.
The Government Accountability Office illustrated this in a 2011 report to Congress. Two portfolios with the same 7% average return supported withdrawals for either 18 or 24 years. The only difference was the order of the returns.
The reason is simple. If markets fall early, each withdrawal takes a bigger share of what is left, and that money is not there for the recovery.
This is not theoretical. From the end of 2005 to the end of 2009, the S&P 500’s total cumulative return was a 2.7% loss. That is four years of funding spending out of principal, with no growth to replace it.
The second sequence: currency
An American retiring in Portugal, Spain or France usually spends in euros. Their investments and their Social Security are usually in dollars.
That creates a second exposure, and at times it has been larger than the first. Using Federal Reserve monthly averages:
- From October 2000 to July 2008, the euro rose from about $0.85 to about $1.58
- Over those eight years, someone living on dollars lost about 46% of their euro purchasing power, without any market decline
- It also runs the other way. From July 2008 to March 2015, the euro fell about 31% against the dollar
A bad market year and a weak dollar arriving together, early in retirement, is the specific combination a cross-border plan faces and a domestic plan does not.
What the research supports
Flexible withdrawals. There is solid research behind rules that adjust spending, such as skipping an inflation increase after a negative year, or trimming withdrawals when they climb too high relative to the portfolio. Flexibility is one of the few tools that addresses sequence risk directly.
The “4% rule,” read carefully. The original research is often quoted as stronger than it is. It was a guideline for the early years of retirement, based on U.S. historical data, with conditions attached. It was never a guarantee, and it did not consider a household spending in another currency.
Cash “buckets.” Holding several years of spending in cash is a common suggestion. The independent academic work I have seen finds that a simply rebalanced portfolio has tended to do better on a total-return basis. The honest case for a cash reserve is behavioral: it can help people avoid selling in a panic. That is a real benefit, but it is a different argument.
What I look at
- Essential versus discretionary spending, and which currency each is in
- How much income is fixed in dollars, such as Social Security and pensions
- The timing of the first withdrawal relative to the move
- How much flexibility you actually have to reduce spending in a bad year
- Currency exposure on the asset side, and whether it matches where the spending happens
No one can choose the order of returns or the exchange rate. What a plan can do is recognize that a dollar-funded household spending euros has two separate exposures, and decide in advance how it will respond to each.
Important disclosures
Historical market returns and exchange rates are shown for illustration only. They do not predict future results.
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A longer version with full sources appears on US Expat: Sequence-of-Returns Risk Abroad.