Financial planning tools and services to put you on the path to the future you want
Your guide to financial planning and retirement
Connect with peers and experts
Get to know the people behind the company and the mission behind the work
Offer financial wellness to the people at the heart of your business
June 16, 2022
“Sequence of Returns Risk” is a term you’ll see in online articles and thrown around by financial pundits, but what does it really mean?
It is kind of a mouthful. However, it is actually a fairly simple concept. And, one that is important to understand by anyone who will be requiring withdrawals from savings to contribute to their retirement income.
Let’s break it down. The dictionary defines:
So, sequence of returns risk is a term that describes the risk associated with the timing of cashing out your investments.
What sequence of returns risk really means is that timing is everything.
If you have to sell assets at a loss early on in your retirement, you are much worse off than if you experienced the same loss late in your life.
This is an especially important idea to consider now, as markets threaten to enter a period of uncertainty following the pandemic and uncertainty mounts with the war in Ukraine. Individuals who have recently retired, are in the process of retiring, or plan on entering retirement soon need to understand the ramifications of making withdrawals from invested assets while the markets are down.
While the market generally trends upward, we experience cyclical bull and bear markets that can be anywhere from 1-many years. It’s extremely difficult to predict these markets. However, timing of the negative returns can have a huge impact on your ultimate nest egg.
Take for example, two investors who have saved $100,000 for retirement. Both withdraw $5k a year and both experience the same years of % gain/losses, with the same average return, but in a different order.
Retiree A sees the gaining years in the beginning, and losing years later on. Their annual rate of return across 15 years is as follows:
8%, 11%, 18%, 14%, 12%, 9%, 11%, 9%, 7%, 5%, -4%, -15%, -6%, -5%
Retiree B sees these years in the reverse order, with the losing years in the beginning and the gaining years later on. Their annual rate of return across 15 years is as follows:
-5%, -6%, -15%-4%,, 5%, 7%, 9%, 11%, 9%,, 12%, 14%, 18%, 11%, 8%
This results in the same exact average rate of return across all years — 4%.
Even though their average interest rate is the same, retiree A saw a much higher overall return than retiree B.
This demonstrates how powerful these first few years can be to either help or hurt your retirement.
So, how can you defend against this risk? Let’s explore your options.
Firstly, it’s important to spend conservatively and manage emergency funds in the case that you do experience a downturn.
This can also encompass spending flexibility — or maintaining a lifestyle that allows you to quickly reduce your spending if needed.
If your investments are down but you need access to money, it may behoove you to get creative. You want to have adequate cash available to cover 1-3 years of living expenses so you don’t need to withdraw from investments at a loss.
Explore sources of emergency money, consider side gigs, passive income, or additional work. Is it time to cash out on home equity by downsizing your home? Look at ways to cut housing costs.
It’s important to balance your portfolio with volatile vs. safe investments, and change that balance as needed. This can mean shifting your funds out of risky companies and into an index when the market turns. Additionally, it’s important to choose which investments to draw down. Selecting strategically from your portfolio can minimize the impact of this risk.
Many retirees plan to withdraw a fixed percentage from their accounts throughout their retirement.
However, it may be a better idea to adjust your withdrawals depending on economic conditions. If:
Finally, annuities can provide lifetime income to hedge against this risk if purchased earlier in retirement. These are explored more in depth in our other articles.
Building and monitoring a long term financial plan is key to your financial wellness. A plan provides a road map to your financial life.
The NewRetirement Planner goes well beyond savings and investments to give you a comprehensive framework for financial decisions. Evaluate your own sequence of returns risk, see how to save on taxes, and so much more.
Forbes Magazine calls it “a new approach to planning.”
Do it yourself retirement planning: easy, comprehensive, reliable
Take financial wellness into your own hands and do it yourself retirement planning: easy,
Share this post:
Here are 5 quick and easy tips to consider as stocks slide, interest rates rise, and inflation persists.
Stock market corrections are a reality, but that doesn’t make them less painful. Here are 10 tips for weathering these storms.
Average retirement income 2022 – find out how your income compares to averages and get tips for boosting your income. Read now!
Our weekly newsletter full of inspiration, podcasts, trends and news.
© 2023 NewRetirement, Inc. All rights reserved.
Disclaimer: The content, calculators, and tools on NewRetirement.com are for informational and educational purposes
only and are not investment advice. They apply financial concepts in a general manner and include
hypotheticals based on information you provide. For retirement planning, you should consider other
assets, income, and investments such as equity in a home or savings accounts in addition to your
retirement savings in an IRA or qualified plan such as a 401(k). Among other things, NewRetirement
provides you with a way to estimate your future retirement income needs and assess the impact of
different scenarios on retirement income. NewRetirement Planner and PlannerPlus are tools that
individuals can use on their own behalf to help think through their future plans, but should not be
acted upon as a complete financial plan. We strongly recommend that you seek the advice of a financial
services professional who has a fiduciary relationship with you before making any type of investment or
significant financial decision. NewRetirement strives to keep its information and tools accurate and up
to date. The information presented is based on objective analysis, but it may not be the same that you
find on a particular financial institution, service provider or specific product's site. All content,
tools, financial products, calculations, estimates, forecasts, comparison shopping products and services
are presented without warranty.