When planning for retirement, most people focus on one big question: "Will I have enough money?" While saving consistently and investing wisely are essential, there's another factor that can significantly affect your retirement income that many people have never heard of. It's called sequence of returns risk.
The name may sound complicated, but the concept is surprisingly simple.
Imagine two retirees who each have the same investment portfolio, earn the same average annual return over 20 years, and withdraw the same amount of money each year. You might expect them to end up with similar results. However, if one retiree experiences several years of poor market performance immediately after retiring while the other experiences strong returns early on, their financial outcomes could be dramatically different.
Why? Becauseonce you begin taking withdrawals, you're no longer allowing your investments to recover fully after market declines. Selling investments when prices are down reduces the amount of money that remains invested for future growth. Even if the market eventually rebounds, your portfolio may never completely recover from those early losses.
This is why the timing of investment returns matters just as much as the average return itself during retirement.
Fortunately, there are strategies that can help reduce sequence of returns risk.
One option is maintaining a diversified portfolio that balances stocks, bonds, and other investments based on your goals and risk tolerance. Diversification cannot eliminate market risk, but it may reduce the impact of large market swings.
Another strategy is maintaining a cash reserve or short-term investments that can fund living expenses during periods of market volatility. This allows retirees to avoid selling long-term investments when values have temporarily declined.
Flexible spending can also make a difference. During years when the market performs poorly, reducing discretionary spending, postponing large purchases, or delaying major vacations may help preserve retirement assets.
Finally, working with a financial advisor can help you develop a personalized withdrawal strategy. Rather than withdrawing the same percentage every year regardless of market conditions, your plan can be adjusted as circumstances change.
Retirement planning is about more than growing your investments. It's also about protecting them during the years when you'll depend on them most. Understanding sequence of returns risk is one more way to help your retirement savings last throughout your lifetime. Let’s schedule a talk soon, and we will discuss your retirement plan withdrawal strategy.