As retirement nears, investors need to be aware of a potential threat known as the “sequence of returns risk.” This risk, also called “sequence risk,” arises when poor investment returns are coupled with withdrawals, particularly in the early years of retirement. The combination of these factors can gradually diminish a retiree’s nest egg over time. The implications of the sequence of returns risk are significant, as it can have a lasting impact on an individual’s financial well-being in retirement.
Certified financial planner Collin Lyon has emphasized the critical role that early retirement years play in determining the financial trajectory of the next three decades. The timing of withdrawals from retirement accounts, particularly during periods of stock market downturns, can exacerbate the sequence of returns risk. When retirees sell assets in a falling market, they may end up with fewer investments to generate future growth when the market eventually rebounds. This presents a major challenge for younger retirees who have many years of living expenses to cover using their nest egg.
Financial advisors recommend several strategies to mitigate the sequence of returns risk as retirement approaches. One key approach is to adjust portfolio allocations to reduce exposure to higher-risk assets and increase investments in less volatile options like bonds. Diversification across different asset classes can help cushion the impact of market volatility and minimize the risk of significant losses during downturns.
To avoid being forced to sell assets in a down market, retirees can establish an emergency fund and a “war chest” to cover living expenses. The “war chest” typically consists of fixed-income assets such as bonds or certificates of deposit that can provide stability and liquidity during periods of market turbulence. By having a financial cushion in place, retirees can navigate market volatility without compromising their long-term financial security.
Another effective way to protect against sequence risk is to adopt flexible withdrawal strategies. Rather than adhering to a fixed withdrawal percentage, retirees can adjust their withdrawal rates based on market performance. Decreasing withdrawals during years of negative returns can help to preserve the core of the portfolio and mitigate the impact of market downturns on long-term financial goals. It is essential for retirees to stay adaptable and proactive in managing their withdrawal strategies to safeguard against the sequence of returns risk.
The sequence of returns risk poses a significant threat to retirees’ financial stability and should not be overlooked. By understanding the implications of this risk and implementing proactive strategies to mitigate its impact, retirees can safeguard their nest egg and ensure a more secure financial future in retirement.