When you’re saving for retirement, you may hear a lot about investment returns, market volatility, and portfolio risk. But there is another type of risk that can be especially important once you begin taking money out of your retirement savings: sequence of returns risk.
The good news is that the concept is fairly simple.
What Is Sequence of Returns Risk?
Sequence of returns risk refers to when your investment gains and losses occur, particularly during the early years of retirement.
Imagine two retirees who each have the same amount of savings and experience the exact same average investment return over a 10-year period. You might assume they would end up in the same financial position. Not necessarily.
If one retiree experiences several years of significant losses right after retirement, while the other experiences those losses later, their outcomes can be dramatically different.
Why? The first retiree is withdrawing money while the portfolio is declining. Those withdrawals can leave fewer assets available to participate in a future market recovery.
Why It Matters During Retirement
When you are working, a market downturn can be frustrating, but you may have years or decades to wait for your investments to recover. You are also potentially continuing to contribute money to your accounts.
Retirement changes the equation.
Once you begin relying on your investments for income, you may need to sell assets even when markets are down. Taking withdrawals from a declining portfolio can make it harder for your savings to recover.
For example, suppose the market drops significantly during the first few years of your retirement. If you need to sell investments to pay your living expenses, you may permanently reduce the amount of money remaining in your portfolio. If strong returns occur later, you have less money invested to benefit from that recovery.
How Can You Manage the Risk?
Sequence of returns risk is one reason your retirement income strategy deserves careful consideration. Depending on your circumstances, strategies may include maintaining an appropriate cash reserve, diversifying your investments, adjusting withdrawals during market downturns, or using other sources of retirement income.
The right approach depends on your financial situation, goals, expenses, risk tolerance, and other sources of income. There is no universal solution.
Retirement planning is not simply about determining how much you need to save. It is also about developing a strategy for turning those savings into sustainable income.
If you have questions about sequence of returns risk or your retirement income plan, make an appointment with us. We can review your situation, answer your questions, and help you explore strategies designed to support your financial goals throughout retirement.
