Sequence of returns risk refers to the impact that the order of your investment returns can have on the longevity of your retirement savings. This risk becomes particularly significant if poor market performance occurs in the early years of retirement, as it can accelerate the depletion of your savings when combined with regular withdrawals.
Imagine a retiree who withdraws $50,000 each year from their portfolio. If the market suffers losses early on (say, -20%, -15%, and -5%), the portfolio’s value may decline sharply. Even if the market recovers later, those early losses could leave the retiree with less money than expected and in some instances, impossible to recover.
To illustrate this risk, consider these two scenarios:
Scenario A: Over five years, a portfolio achieves returns of 25%, 15%, 5%, -5%, and -20%. Despite an average annual return of 6%, the portfolio’s value decreases by 10% because of the sequence in which the returns occurred.
Scenario B: The same portfolio has returns of -20%, 5%, 5%, 15%, and 25% over the same period. Even though the average annual return is still 6%, the portfolio’s value increases by 20% due to a more favorable sequence of returns.
Key Takeaways:
- The timing of returns is often more crucial than the average return itself.
- Experiencing losses early in retirement can significantly harm your financial stability.
Strategies to Reduce Sequence of Returns Risk:
- Adaptive Withdrawals: Adjust the amount you withdraw each year based on the current value of your portfolio.
- Diversification: Invest in a mix of asset types to help cushion against market volatility.
- Income-Generating Assets: Include bonds or annuities in your portfolio to create a consistent income stream.
- Regular Portfolio Rebalancing: Periodically realign your investments to maintain your desired asset mix.
By understanding the sequence of returns risk and implementing strategies to manage it, you can make more informed decisions to protect your retirement savings.
Bottom Line:
The All in One Income 4 Life-Income 4 LTC strategy can reduce and perhaps eliminate the Sequence of Returns Risk!.