Retirement

How Does Sequence Risk Impact Your Retirement?

May 31, 2021

It’s finally here. After years of saving, planning, and dreaming, your retirement is just around the corner. Maybe you've already begun withdrawing your retirement savings, or maybe you’re just about to. Either way, we need to talk about the potential impact of sequence risk (also known as sequence of return risk) on your retirement savings.

The easiest way to illustrate the sequence of return risk to one’s retirement portfolio is through an example.  In the following examples, the Retiree began with a portfolio of $1,000,000 and withdrew $50,000 from the account on December 31st of each year.

Sequence risk table. Two columns reading Fund 1 and Fund 2, and four rows reading Years 1-4. The first barely drops in value, while the second nearly drops by half its value.

In these two examples, we simply reversed the series of annual returns. Before retirement, the sequence of returns will have a negligible impact on one’s portfolio value. Unfortunately, the order of those returns during retirement, coupled with withdrawals, can significantly impact one’s portfolio value over time. As the examples above illustrate, strong portfolio performance in the early years of retirement led to Fund 2 having $85,000 more than Fund 1 after five years.

While we are confident with our assessment of what the capital markets will do over more extended periods of time, the reality is that no one can tell you with any degree of confidence what they will do in any given year. So, how can the sequence of return risks impact you? Once retired, the flexibility on the timing of those withdrawals is probably significantly reduced.  You’re probably now wondering – is there anything I can do to mitigate the risk seen in Fund 1? And the answer is, absolutely!

Regardless, risk cannot be eliminated entirely - including sequence risk. Reaching out to one of our wealth strategists to develop a retirement income plan that fits your needs is a start. Building a well-diversified portfolio, continuous monitoring, and adjusting throughout your retirement are critical components to reduce sequence risk and help you enjoy your retirement years.

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