How can the sequence of return risks affect your retirement?

Investing for retirement means factoring in varying types of risk affecting your portfolio over time. The return risk sequence can come into action, when you begin withdrawing from your retirement account. Generally, it can be the possibility that the timing of your retirement withdrawals might impact negatively on your overall rate of return. Knowing how to account for the sequence of return risk in your financial strategy can help minimize the threat it might impose on your retirement income. Make sure to use the insights and experience of any financial advisor for investing plans during your retirement.

The sequence of returns risk is an exposure to various adverse series of investment returns with ongoing withdrawals. Collectively, these factors have a significant effect on an investment portfolio value, especially a retirement portfolio. The sequence of return risk usually describes year-over-year investment returns experienced by the portfolio for a selected period. This type of risk is pertinent for any investor and is a risk to a retired person. To prevent this, a proper retirement plan is needed to assess the full range of potential outcomes that could provide a retiree with correct visibility into the complete spectrum.

How to manage the sequence of return risk?

Attempting to grab a fixed living standard while using distributions from a portfolio of various volatile assets could be an inefficient retirement income strategy. It could be a unique source of sequence risk, and there are usually four general techniques to manage the sequence of returns risk in retirement.

To spend conservatively

The first primary option to manage sequence risk in retirement is spending conservatively. Retired people keep spending consistently on an inflation basis throughout their retirement. With a total returns investment portfolio, an aggressive asset collection offers a high probability of success. To combine aggressive investment portfolios with concerns of outliving your assets means spending should be conservative. 

To maintain spending flexibility.

This approach maintains the prior strategy’s aggressive investment portfolio while permitting flexibility in spending. Sequence risk is mitigated here by spending reduction after any portfolio decline. Hence, allowing more to get into the portfolio to experience any subsequent market recovery. This strategy will result in volatile spending that enables practical approaches to flexible retirement spending. It seeks to balance off the trade between increased spending volatility and reduced sequence risk just by partially linking them to their portfolio performance.

To reduce volatility

The third approach to managing the sequence of returns risk is to lower portfolio volatility, at least at that time when it matters most. A portfolio free of volatility does not create any return risk sequence. Individuals should not expect constant spending from any portfolio volatility, and those who require upside need to be flexible with their spending and make proper adjustments. To achieve continuous spending, you need to look to hold fixed-income assets.

Create diversified portfolio

A diversified investment portfolio seems to be the foundation of every retirement plan, and your portfolio composition should reflect your preference between return and risk. During creating your portfolio, ensure achieving a correct level of diversification within and across assets. A much-diversified portfolio capitalizes on less than perfect correlations across assets and tamps down the volatility. It provides a more facilitating and more stabilized return pattern. 

Importance of sequencing return

Return sequencing always matters because the order in which returns happen with ongoing withdrawals can affect an investment portfolio value. The retiree might have little to no flexibility, making your portfolio resilience a chief concern. They require the return to have a complete drawdown till the earth. This situation can increase when inflationary pressure increases an individual’s living cost. 

Protection against sequence risk

Due to sequence risk, plugging in a simple rate of return into an online retirement planning tool is not a very effective way to plan. You might invest the same way, and during the 20 years, you could earn a return of 10% or more than that. In a different 20-year period, you could only get 4% returns. Average returns also don’t work, and after half-time, returns could become below average. Some people don’t want any retirement plan that only works for half-time. A much better option in place of using averages is to use lower returns in your planning. In that way, if you have ever got a poor sequence, you have already planned for it. 

End Thoughts

The sequence of return risk is a type of risk in which a market will experience a downturn resulting in lower returns at the same time you retire and then begin with withdrawal of accumulated assets. It can even distract you from your efforts to save money and invest it in the future, increasing the possibility of getting out of money whenever you retire. It might not be possible to prevent sequence risk when preparing for retirement. You can even insulate your portfolio from it as much as possible.