Did you know there is a latent risk that could put your retirement in jeopardy, even if you’ve worked tirelessly through the years to reach your financial goals? Even if you’ve considered long-term care, health care, inflation, and other potential dangers to your portfolio, you could still be at risk of not having enough to carry you through your retirement years.
What is Sequence-Of-Returns Risk?
This risk is called sequence-of-returns risk and it occurs when the beginning of your retirement falls during a bear period. When you begin to withdraw from your savings, unfortunately you may suffer from low or negative returns. Negative returns in the first few years of retirement can significantly add to the possibility of portfolio failure.
There will always be uncertainty related to investment returns, whether pre or post-retirement, but the timing of your retirement plays a more critical role than you may realize. If your retirement date correlates with the onset of a bear market, your savings can be depleted quite quickly as you continue to withdraw from your portfolio and leave less wealth remaining to benefit from a future market upswing.
What Does This Risk Look Like?
Here’s a hypothetical picture of what sequence-of-returns risk looks like and how it can affect your savings in a significant way:
Peggy has a portfolio worth $10,000. At the end of each period, she withdraws $1,100. In years one through five, she receives the following returns: 40%, 20%, 0%, -20%, and -40%. As a result, Peggy has a 0% average rate of return.
Let’s flip those numbers around and look at Gregg’s situation. He starts with the same amount and makes the same withdrawals, but because the negative returns transpire when cash outflows are occurring, he will not have enough for the returns to average out in the long run and he runs the risk of his portfolio becoming depleted while he is still alive.
Here we have two retirees with the exact same amount of savings but with completely divergent financial results, all dependent on when they started their retirement. Since we can’t predict the markets, what can we do to protect ourselves from Gregg’s situation?
Steps to Protect Yourself
Thankfully, there are some steps you can take to mitigate the risk that sequence-of-returns will ruin your retirement portfolio. These steps include reducing volatility, examining your withdrawal strategy, and finding different market options to protect your money.
Sequence-of-returns risk is tied, in part, to portfolio volatility. If you take measures to reduce volatility in your retirement portfolio, you will subsequently reduce sequence-of-returns risk. There are multiple options to make this happen, such as purchasing life annuities or buying bonds and holding them to maturity to build an income stream in retirement.
The less risk in your portfolio, the less your portfolio will be affected by market downturns. As you near retirement, look less at stocks and more at options that will provide for basic retirement expenses. Once your expenses are covered, anything extra can be invested in higher risk assets.
Choose a Wise Withdrawal Strategy
Carefully examine your withdrawal strategy and talk to your financial advisor about what will work best for your portfolio. Don’t just assume that you can withdraw the same amount every year, adjusted for inflation, and have enough wealth to last your lifetime.
Consider withdrawing a constant amount, not adjusted for inflation. If your portfolio is at risk, increasing your withdrawal rates based on upwards inflation will only put you in greater danger of running out of money. To ensure that you will have enough to withstand inflation, employ some tips mentioned here (link to inflation post).
Investigate Downside Protection
One way to limit losses due to sequence-of-returns risk is to provide for downside protection. Downside protection can come in the form of using derivatives and purchasing deferred annuities with living benefit riders. These options provide minimum income benefits.
Once you reach retirement, you are still not safe from market uncertainties. Reach out to me to discuss your options and make decisions today that will protect your retirement future. To learn more, download our free report, 12 Keys to a Successful Retirement Strategy today. Call my office at 770.249.7424 or email me today at firstname.lastname@example.org.