As retirement draws closer for investors, it is crucial for them to understand the potential threat posed by the “sequence of returns risk.” This risk, also known as “sequence risk,” is often underestimated and overlooked by retirees. It occurs when poor investment returns are coupled with withdrawals, especially in the early stages of retirement. This combination can gradually deplete one’s retirement savings over time, leaving retirees vulnerable to financial instability in the future. According to certified financial planner Collin Lyon, wealth strategy advisor at Anderson Financial Strategies in Dayton, Ohio, the investment returns and withdrawal decisions made during the initial years of retirement can significantly impact the financial well-being of retirees over the next three decades.
Younger retirees or those on the brink of retirement face a significant risk if they encounter stock market downturns just before or as they start withdrawing funds from their retirement accounts. Selling assets in a declining market could mean disposing of more investments to generate the same amount of cash, resulting in fewer assets to benefit from future market recoveries. This poses a major challenge for retirees who need to cover several decades of living expenses from their retirement savings. Fortunately, there are several strategies recommended by financial advisors to mitigate the sequence of returns risk.
As retirement approaches, experts advise adjusting portfolio allocations to reduce exposure to high-risk assets and increase investments in less volatile options such as bonds. The appropriate mix of assets depends on various factors including risk tolerance, financial goals, and life expectancy. Diversifying investments across multiple asset classes can help alleviate the impact of market volatility, as suggested by Collin Lyon of Anderson Financial Strategies.
Building a Financial Safety Net
Maintaining a six-month emergency fund and establishing a “war chest” to cover living expenses can prevent the need to sell assets during a market downturn. Wealth advisor Jonathan Bednar II of Paradigm Wealth Partners recommends keeping five years of expenses in fixed-income assets like bonds or certificates of deposit in the “war chest” to withstand market volatility during periods of high sequence risk.
Implementing flexible withdrawal plans based on market performance can safeguard retirement portfolios from the effects of sequence risk. Instead of withdrawing a fixed percentage annually, adjustments can be made depending on how the market performs. CFP Brad Brescia of Moisand Fitzgerald Tamayo in Orlando suggests reducing withdrawals during years of negative returns to preserve the core of the portfolio. However, it is essential to be aware of required minimum distributions from certain retirement accounts eventually.
Understanding the risks associated with sequence of returns is crucial for retirees as they transition into retirement. By implementing strategic financial planning and risk management techniques, investors can protect their retirement savings from the detrimental effects of market volatility and withdrawal decisions. Planning ahead and seeking guidance from financial advisors can help retirees navigate the challenges posed by sequence of returns risk and secure a more stable financial future.