Take our hypothetical portfolio valued at $100,000, but this time let’s assume $10,000 is withdrawn at the start of every year. When you enter retirement and start taking distributions, however, the risk from the sequence of returns reverses. That’s a big gap in outcomes-and the difference is the very essence of sequence of return risk.
This is the risk posed by the sequence of returns. Significant market losses in the early years of retirement can shorten the longevity of a portfolio, even if better-than-average market returns occur in later years. Once an investor retires and starts taking distributions from their investment portfolio, annual market returns become critically important. It’s understood that actual returns will vary significantly from year to year depending on what the market does, but assuming an average return helps you plan. In order to plan for the long term, retirement investors estimate the average compound annual growth rate (CAGR) of their portfolio over years and even decades.Īn investor might assume, for example, that a model portfolio of 80% stocks and 20% bonds will return 9% a year during their working years.
Then we’ll look at ways you can address sequence of returns risk What Is Sequence of Returns Risk? In this article we’ll offer examples that illuminate sequence of return risk and help you understand how it can affect your retirement portfolio. Timing is everything, and in retirement early market declines, particularly if they are paired with rising inflation, can have a huge effect on how long a nest egg can sustain a retiree. To put it another way, sequence of return risk is the risk that market declines in the early years of retirement, paired with ongoing withdrawals, could significantly reduce the longevity of a portfolio. What is sequence of returns risk? Also called sequence risk, this is the risk that comes from the order in which your investment returns occur. But there’s one big retirement risk that gets very little attention: Sequence of returns risk. Markets crash, inflation can eat into your returns, you might even worry about outliving your savings. You face plenty of risks when investing for retirement.