One of the biggest threats facing investors as they approach retirement is known as the “sequence of returns risk.” This risk, also referred to as sequence risk, occurs when poor investment returns are combined with withdrawals from retirement accounts, especially in the early years of retirement. This dangerous combination can lead to a gradual erosion of your retirement nest egg over time. Certified financial planner Collin Lyon, of Anderson Financial Strategies, warns that the investment returns and withdrawal decisions made in the early years of retirement are crucial and can have a lasting impact on the financial health of retirees for the next 30 years.
The Impact on Younger Retirees
For younger retirees who have decades of living expenses to cover from their nest egg, the sequence of returns risk presents a significant challenge. Withdrawing from your retirement portfolio during a market downturn can force you to sell off more assets in exchange for the same amount of cash. This means that you will have fewer investments left to capture future growth when the market eventually rebounds. The sequence risk is particularly pronounced for those who are close to retirement or have recently retired and could have serious consequences for the longevity of their retirement savings.
Financial advisors recommend several strategies to mitigate the impact of sequence of returns risk on your retirement savings. As retirement approaches, it is important to adjust your portfolio allocations to reduce exposure to high-risk assets and increase investments in less volatile options like bonds. Diversifying your portfolio across different asset classes can help lessen the impact of market volatility and reduce the risk of significant losses during downturns.
To avoid selling off assets during a market downturn, some advisors suggest maintaining a six-month emergency fund and a “war chest” with enough funds to cover living expenses for at least five years. This can provide a financial buffer during periods of market volatility and help retirees weather the storm when the sequence risk is at its highest. Additionally, adopting a flexible withdrawal strategy that adjusts based on market performance can help preserve the core of your portfolio during years of negative returns. By reducing withdrawals during turbulent times, retirees can allow their investments to recover and potentially mitigate the impact of sequence risk.
The sequence of returns risk poses a significant threat to retirees’ nest eggs and can have long-lasting consequences on their financial well-being. By understanding the impact of poor investment returns combined with withdrawals, investors can take proactive steps to minimize the risk and safeguard their retirement savings. Through prudent portfolio allocations, emergency funds, and flexible withdrawal strategies, retirees can navigate turbulent market conditions and protect their financial futures. Ultimately, managing sequence of returns risk is essential for ensuring a secure and stable retirement for years to come.
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