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Sequence of Return Risk: The Hidden Culprit That Could Destroy Your Retirement Savings

Sequence of Return Risk: The Hidden Culprit That Could Destroy Your Retirement Savings

January 16, 2023
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Sequence of Return Risk: The Hidden Culprit That Could Destroy Your Retirement Savings


Retirement planning can be a daunting task, especially when unexpected risks are involved. Sequence of Return Risk is one such risk that could have a devastating effect on your retirement savings if you’re not aware of it. Sequence of Return Risk is the hidden danger lurking in the shadows and it’s important to understand how this risk works so you can take steps to protect yourself from its effects. In this blog post, we will discuss Sequence of Return Risk in detail, including how to measure it, what strategies investors can use to mitigate this risk and how Sequence of Return Risk affects retirement planning. By understanding Sequence of Return Risk and taking the necessary precautions now, you can ensure that your retirement savings will remain secure for years to come.


Sequence of Return Risk and why it is important for retirement planning

Sequence of Return Risk is a risk that can negatively impact your retirement portfolio if you retire during a period of market downturn. Sequence of Return Risk occurs when the sequence of returns on investments, such as stocks and bonds, are lower than expected. When this happens, your portfolio’s principal will be eroded more quickly than anticipated due to poor early years' returns, making it difficult for your retirement portfolio to generate the same level of income in retirement as if the sequence of returns had been more favorable.


During your working years, you can take advantage of any market fluctuations and buy in at lower levels before retirement, giving yourself plenty of time to recoup. Unfortunately, when you are retired and have started pulling out money for living expenses, a downward shift in the market can be difficult to overcome without sufficient funds stored up. By then there will be less money left within your account that could help it recover once the markets start rising again.


These risks become particularly pronounced in a volatile market environment, where stock prices tend to fluctuate rapidly over short time periods. Sequence of Return Risk can also affect retirement savings when retirees discontinue their contributions or withdraw larger amounts than they had originally planned. This increases the likelihood that their portfolios will not have sufficient growth before retirement to sustain them during their golden years.


It is important to understand Sequence of Return Risk and take steps to mitigate it before building a retirement portfolio. Pre-retirees should thoughtfully contemplate what retirement will look like if the market is negative in their initial years when evaluating a retirement plan. As my father has always said, "When reaching retirement, it's not a matter of how much you make, it's how much you keep!"


What factors contribute to Sequence of Return Risk?

Certain factors contribute to Sequence of Return Risk, including economic conditions, market volatility, and one’s investment strategy. Economic conditions may cause Sequence of Return Risk due to changes in stock prices or other economic indicators. In addition, market volatility could lead to drastic price changes creating uncertainty about future returns on investments. Finally, if an investor fails to diversify their portfolio or make speculative investments with higher risk levels than what was initially planned for retirement savings, they could be taking unneeded risk.


Ultimately, Sequence of Return Risk is something that needs to be taken into account when planning for retirement. Understanding how Sequence of Return Risk works and what factors contribute to it is essential for creating a secure retirement plan that will protect your savings even during periods of market turmoil.


Explain the different ways Sequence of Return Risk can be measured

Sequence of Return Risk can be measured in a variety of ways. One of the best ways is to analyze an investor’s portfolio over different points in time and compare the returns in each period. If you are planning to retire in 2-3 years, imagine the first couple years of retirement were the year 2000-2003. If the market repeats itself, would you still be able to withdraw the income needed in retirement? Would your assets last all the way through retirement?


Another measure of Sequence of Return Risk is to look at the correlation between portfolio returns and stock market returns. If portfolio returns are highly correlated with the stock market, your risk is higher and your Sequence of Return Risk is likely present.


Finally, Sequence of Return Risk can be measured by examining a retirement account’s drawdown—the amount an investor withdraws from their retirement account over time. A large drawdown can indicate a higher risk should the market drop in the first few years of retirement. Withdrawing large amounts from an account while it is down make it very difficult for the account to recover when the market does.


Discuss strategies investors can use to mitigate Sequence of Return Risk

Investors can take several steps to mitigate Sequence of Return Risk. One of the most important strategies is to diversify the portfolio with different types of investments, such as stocks, bonds, real estate, commodities, alternatives and cash, so that any losses in one area will be offset by gains in another. This type of diversification helps protect retirement savings even when markets are volatile.


Another important strategy is to use a systematic approach to investing, such as dollar cost averaging or rebalancing the portfolio on a regular basis. This allows investors to take advantage of market fluctuations and spread out purchases over time, reducing Sequence of Return Risk and dampening any potential drops in retirement savings.


Finally, it is important to create a retirement income plan that is designed to last throughout retirement. This should include strategies for how much can be withdrawn each year, how long withdrawal periods will need to be adjusted depending on Sequence of Return Risk, and the types of investments needed in order to have enough money for retirement expenses.


Conclusion

Sequence of Return Risk is a serious issue that all investors should consider when planning for retirement. It can have a major impact on the amount of money available to retirees, so it’s important to understand how Sequence of Return Risk works and what strategies you can use to mitigate this risk. Diversifying your portfolio with different types of investments, using systematic approaches such as dollar cost averaging or rebalancing your portfolio regularly, and creating an income plan designed to last throughout retirement are just some of the ways in which Sequence of Return Risk can be managed effectively. With smart planning and sound investment practices, Sequence of Return Risk need not stand between you and a successful retirement.