by Debra May
A “sequence of returns risk” or “sequencing risk,” is a situation created by a combination in which returns are generated, then withdrawn from a portfolio, particularly in the decumulation (retirement) phase of life.
Normally, if you aren’t investing regularly or making systematic withdrawals, the order in which your returns occur has little to no effect on your outcome. However, as soon as you take withdrawals, you may experience the consequences of sequence risk, especially if the markets are struggling.
Sequence risk also tends to intensify other wealth-eroding situations, such as market risk and longevity risk. For this reason, sound retirement plans should always include strategies for mitigating sequence risk. Failure to contemplate sequence risk may result in you having to work longer than you anticipated or having to cut expenses to the bone in retirement.
There are some measures you can take to protect your wealth against sequencing risk. Diversifying your portfolio to spread investments across different asset classes, for example, may help reduce volatility of your investment returns.
Regularly reviewing your portfolio to ensure you have the correct asset allocations for your stage of life is a strategy recommended by many financial advisors. For example, if you invested heavily in growth assets like real estate when you were younger, you may want to move some of that money into “defensive” safe money assets such as annuities, life insurance, or bonds.
If you are still working and participating in an employer-sponsored plan such as a 401k or IRA, you might take a look at increasing your contributions. As you near retirement, you may even consider maximizing your contributions, which could also save you on tax. Consult your financial advisor to see if maxing out your qualified plan makes sense in your unique situation.
Some other ways you can protect your wealth from sequence of returns risk include:
- Lowering the percentage of your draw-down. Many retirees have adopted planner William Bergen’s “4% Rule.” However, modern planners have been poking holes in this rule, saying it’s unrealistic given today’s chaotic economic environment. It’s possible you might need to reduce your withdrawal rate to 3%.
- Purchase a guaranteed income annuity. A guaranteed income annuity is a financial product designed to provide you with guaranteed, predictable income for life, depending on the annuity company’s claims-paying ability. Plus, knowing you have an additional stream of reliable income will make your retirement much less stressful.
- Add “buffers” to your portfolio, such as a reverse mortgage line of credit or cash value life insurance policy.
To sum it up: Sequence risk is a potential threat to even well-designed retirement blueprints. Fortunately, although you can never eliminate 100% of you sequence risk, there are still effective ways to protect your nest egg. If your advisor specializes in retirement income planning, they will have solutions for managing this risk, including the addition of safe money vehicles such as cash value life insurance and annuities. If you’d like me to evaluate your portfolio’s vulnerabilities and make suggestions on how to reduce those vulnerabilities, contact me directly at (989) 846-9581.