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What Is the Sequence of Return Risk?

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In its most basic sense, retirement planning is about playing the “bidding time” game. You sequentially put money into your investment, wait for it to grow with time and interest, retire, and start withdrawing the money you kept for countless years. Sounds easy, right?

In a perfect world, an investment could look as simple as this, but times are changing, and the market is growing more volatile. The timing of when you withdraw your retirement funds could mean the difference between a depleting financial resource or a flourishing stockpile.

In this blog post, we’ll discuss why you should be concerned about how often and when you withdraw your retirement funds.

Understanding the Sequence of Return Risk

Imagine this: you’ve invested in the stock market and bonds for 20 years. The time has come for you to retire and start withdrawing money from your portfolio to support your retirement years.

However, you start noticing that your portfolio is growing at a different rate than it used to. In fact, you’re losing money, and your portfolio can no longer support your lifestyle.

What happened? Was it because you stopped investing in the stock market? Are you withdrawing more money than you should? Well, yes and no. The sudden drop in your portfolio is a phenomenon called the sequence of return risk or, simply, return sequence.

As mentioned earlier, investment funds rely on time and interest to grow. The interest your portfolio earns or loses depends on how much money is left in your portfolio.

For example, if you have $100 in your portfolio and the market grows at 10%, you can expect a $10 gain in your investment, bringing it to a total of $110. If the market continues to grow by 10% next year, you’ll gain $11. This process continues for a bullish market.

However, the situation is reversed in a bearish market. Taking our previous example, suppose you have $100 in your portfolio, and the market drops by 10%. In that case, you’ll incur a $10 loss to your money, which brings down your investment to $90. If the market continues to decline by 10% the following year, you will lose $9.

This compounding gain or loss is the principle followed by the sequence of return risk. If you retire in a bearish market and start using your retirement fund, you will deplete your portfolio twice as fast because of the compounding market losses.

In contrast, if you retire in a bullish market, your portfolio will grow with time, allowing you to withdraw without worrying about draining your funds.

The Importance of Sequencing Return

Planning your retirement wisely can help you minimize the sequence return risk. By understanding how the market behaves and how to protect your investment, you can take the necessary steps to guard yourself against a bearish market.

Unfortunately, there’s no telling how a market will perform in the future. However, there are specific tools that can help you analyze and understand the trajectory of the market, giving you an edge over your retirement plans.

You can also seek professional financial advice to help you plan your retirement withdrawals in the future or set up fail-safe mechanisms to protect your hard-earned investments and live a stress-free retirement life.

Different Ways To Protect Yourself Against Sequence of Returns Risk

Although the market is one big volatile mess, you can still do something to protect yourself in bearish retirement years. Here are some precautions you can take when planning your retirement portfolio:

Boost Your Personal and Emergency Savings

This one takes a long time to prepare. When you start saving for retirement, you must also set aside some money for personal and emergency funds. Doing so will give you a safety net when your retirement fund fluctuates.

Having a cache of funds will also give you the freedom to withdraw from your retirement portfolio without worrying too much about market conditions.

Keep Your Withdrawal to a Minimum

Suppose you retire during a bearish period and don’t have enough emergency funds to support your lifestyle. In that case, you must minimize the amount of money you withdraw from your portfolio. Remember that market loss has a compounding effect and can quickly deplete your retirement savings if you’re not careful. You must be wise with how much and when you withdraw your money.

Sell Some Assets

If worse comes to worst, you can always sell some of your assets to keep yourself afloat. Selling non-essential assets is always a better option than depleting your retirement fund. This will also give you an opportunity to diversify your portfolio and invest in stocks, bonds, or other safe assets with the money you get from selling your assets.

Get Yourself an Annuity

Another fail-safe option is to get yourself an annuity. Annuities pay you a regular sum for a certain number of years or until the end of your life. This plan will guarantee you income during retirement, giving you a steady stream of cash no matter what happens in the market.

How Annuities Can Protect You From the Risk of Sequencing Return

Purchasing an annuity plan is a great way to secure your retirement income and protect yourself against the risk of sequencing returns. Annuities don’t heavily rely on the current market conditions because the policy provider will pay you a set sum of money for the years you have agreed upon.

This gives you more stability and security during retirement, even when the market is volatile or bearish. You can also choose from different types of annuities to find the one that best suits your needs.

Which Type of Annuity Is Right for You?

Various types of annuities exist in today’s market to accommodate the different needs of retirees. Here are some common types of annuities by different classifications.

  • By payouts
    • Immediate Annuity: Payouts begin immediately upon the purchase of an annuity.
    • Deferred Annuity: Payouts are deferred until you reach a certain age or amount of money accumulated.
  • By length of payment
    • Fixed-term Annuity: Payments are made over a fixed length of time, usually monthly or yearly.
    • Lifetime Annuity: Payments are made for the rest of your life.
  • By growth potential
    • Fixed Annuity: Your money’s growth potential is fixed. You will get the same amount of money you invested, plus some interest, depending on the agreement.
    • Variable Annuity: Your money is invested in different sub-accounts, such as stocks or bonds. Your return will depend on the market’s performance, but you’ll still get a guaranteed minimum return.
    • Fixed-index Annuity: This type of annuity allows you to boost your gaining potential based on the performance of a stock market index.
    • Multi-year Guaranteed Annuity: This annuity provides guaranteed interest returns for a defined number of years.

This doesn’t cover all the types of annuities out there. However, understanding these will give you a basic idea of how each type works and what type is best for your needs.

Schedule a Consultation With Our Safe Wealth Agents Today

Retirement is a critical stage of life, and you must be aware of the risks that come with it. Without proper retirement planning, you might deplete your portfolio quickly and leave without any financial security for your retirement years.

Relying solely on your portfolio without a fail-safe plan is not wise, and you should always make sure you have an insurance policy in place to protect yourself from the risk of sequencing returns.

Pairing your investment with a comprehensive annuity plan can give you more stability and safeguard your retirement fund.

At Safe Wealth Plan, we provide encompassing advice on all retirement and financial planning aspects. We can help you choose the right annuity plan to protect you from sequencing risk and secure your financial future.

Book an appointment with us today to learn more about annuities and how they can benefit you during retirement.

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About the Author: Benjamin Hulburt

Benjamin Hulburt - Safe Wealth Plan