Is Your Portfolio Prepared for Sequence Risk?

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As you save for retirement, your portfolio’s value increases and decreases with the ebb and flow of market volatility. Retirement is still far away, so you’re not concerned. There’s always time to catch up, plus your continual contributions and reinvested dividends help smooth things out. 

But what if a market crash occurs right as you enter retirement? 

Although our investment portfolios will inevitably face a few years of negative returns, the timing of those unfavorable periods is more crucial than the mere fact they occurred.

Let’s look at two examples.

George & Melissa

George and Melissa have a $1,000,000 retirement portfolio on the eve of retirement, and they plan on withdrawing $50,000 a year, adjusted 3% for inflation, from it. Their first years of retirement saw some positive market returns, followed by a three-year market downturn after year five. Their portfolio takes a hit but manages to not just pull through but thrive. 

Chris & Olivia

Chris and Olivia also have a $1,000,000 retirement portfolio but aren’t so lucky. In the year of their retirement, the markets crash, severely impacting their savings. In the absence of alternative income sources, they’re forced to continue making their $50,000 withdrawals, adjusted for a (in our case hypothetical) 3% inflation rate. 

Sequence of Returns Impact Calculator

Sequence of Returns Impact Calculator

Portfolio Value Over Time

Year Starting Balance Market Return End Balance

The results are shockingly different, even though they received the same returns on paper, just in a different order. 

George and Melissa’s portfolio actually grew for a while; those early years of growth gave their portfolio the momentum necessary to overcome down years. 

Chris and Olivia had quite the opposite experience. Those first few years of negative returns, combined with their annual withdrawal, reduced their portfolio size to such a degree that it didn’t have the momentum to recover. Instead, it quickly went into a downward spiral until they ran out of retirement savings after year 13.

How to Avoid Sequence Risk

Implement a Flexible Withdrawal Rate

The previous examples assume that each couple withdrew an identical amount, adjusted for inflation, annually. However, in reality, your withdrawal amount will vary depending on your needs. In some years, you may require significantly less, allowing you to keep more funds invested in the market and potentially recover losses.

Sell the Right Assets

During a market downturn, it’s unlikely that all your assets will underperform. Instead of liquidating assets proportionately, consider selectively selling those that have appreciated in value. This strategy allows your remaining assets to remain untouched and recover over time.

Purchase the Right Assets

Certain assets excel at delivering long-term growth despite unpredictable short-term fluctuations. If you anticipate needing funds within a few years, consider adjusting your asset allocation to include more stable investments, such as bonds, that are less susceptible to market volatility.

Incorporate an Annuity

Annuities can provide a reliable income stream during retirement, helping to mitigate the risks associated with market volatility and longevity. By purchasing an annuity, you enter into a contract with an insurance company, which guarantees regular payments for a specified period or the rest of your life. This can help ensure that you have a consistent source of income to cover essential expenses, even in a down market.

Keep Working

While probably not the most appetizing option, continuing to work or starting work again might be your best option. Even if you just work a year or two more, you’ll continue to contribute to your savings instead of using them, cushioning the impacts of the down market. Then, you can head into retirement a bit more confident that your savings have the ability to keep generating enough gains to make it through retirement.

Final Thoughts

The stock market is one of the most incredible ways to build long-term wealth, and you don’t need to be exceptionally talented, rich, or lucky to take advantage of it. But with its enormous potential comes a powerful opposite force – the possibility of losing everything. Without a careful withdrawal strategy and fallback plans, your retirement savings are in needless danger. You’ve worked so long to build them up – why risk them now?

A financial advisor can help you not just mitigate sequence risk, but also inflation, longevity, healthcare, and tax risks, allowing you to rest easy knowing your retirement is as secure as possible. Care for a consultation with a professional? Click the button below!

Please Note: The information contained in this article is general in nature and for educational purposes only. Cornerstone Financial Services Group does not provide tax advice and one should always consult with their tax professional regarding their specific situation.

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