Sequencing risk is the danger that a retiree will begin withdrawing money at an unfavorable time in the market resulting in a negative impact on future returns.
Markets have many risks. Sequencing risk can be scary for those approaching retirement because the timing of withdrawals can significantly impact your overall returns.
Similar to other risks in the market, it's crucial to have a clear picture of how you could be affected. Let's take a minute to look at the potential consequences for your portfolio.
How Does Sequencing Risk Affect My Investment Returns?
Sequencing risk affects investment returns when your first few years of retirement coincide with a down market. For this reason, those approaching retirement need to understand the impact it can have on their future returns.
Making regular contributions to your portfolio lessens the impact of a down market. When investors enter their retirement years and transition from the contribution phase to the withdrawal phase, mitigating sequencing risk is something they need to consider.
Most financial planning software is based on an average rate of return. While markets tend to go up over time, but they don't go up in a straight line. Even though one can have the same average return as another investor over a year period, when the sequence of returns is negative early on, it can drastically impact a retiree's assets and can even cause them to run out of resources earlier then an investor who achieved the same average return but didn’t experience those down markets until later in their retirement. Even when markets recover, the negative years can throw a giant monkey wrench into the plan.
Now that you understand the impact it can have on your returns, it's time to ask another important question.
Can I Avoid Sequencing Risk?
While you can't avoid sequencing risk entirely due to the unpredictable nature of the market, there are ways to lessen its impact on your portfolio.
Specific strategies that we put into place can mitigate sequencing risk. In some cases, there are ways to render it statistically improbable of occurring. The solutions are designed for each individual and are dependent on your portfolio and investment strategies.
Retirement specialists at Instrumental Wealth are ready to strike a chord with you. If you want to learn more about sequencing risk and how it impacts your returns, call us today and let us create a customized plan that is right for you.
Instrumental Wealth | What is Sequencing Risk