Author: Rob Sevilla
Agency: Agape Insurance & Financial Group, Tupelo, MS
For years, you have diligently contributed to your retirement plan. Youโve watched your retirement savings grow, riding the waves of the stock market. But as you approach the first year of retirement, your retirement portfolio faces a new enemy and it is one that doesnโt care about your average return, but rather the timing of investment returns.
This enemy is called sequence of returns risk.
Most people understand market risk (the market goes up and down). However, sequence risk is the specific danger that poor investment returns occurring early in retirement will deplete your savings faster than expected.
Essentially, your 401(k) needs a bodyguard. At Agape Insurance, we specialize in strategies to reduce sequence of returns risk and protect your retirement from this invisible threat.
What is Sequence of Returns Risk?
Sequence of returns risk (often called sequence-of-returns risk) is the risk that the order of investment returns will hurt your financial longevity.
Sequence risk refers to the luck of the draw. If you experience negative investment returns in the years leading up to retirement or the first few years of retirement, the results can be devastating.
Here is why: When you are saving, a negative return is annoying, but you have time to recover. But when you are withdrawing money from your retirement account to pay bills, a market drop is permanent. You are selling shares at a loss, meaning you have less money working for you when the market eventually recovers. This risk is the danger that poor investment returns early in your withdrawal phase will drain your portfolio.
Example of Sequence Risk: How It Affects Your Retirement
To understand the impact of sequence of return, letโs look at an example of sequence risk.
Imagine two retirees, Bill and Ted. Both start with a $500,000 portfolio and withdraw $25,000 annually. Both have the same average return of 6% over 20 years.
- Bill enjoys positive investment returns in the initial years of retirement. His portfolio grows despite his withdrawals.
- Ted suffers negative market returns in his first year of retirement and the subsequent two years.
Even though their average return was identical, Ted runs out of money years before Bill. Why? Because the negative return happening early in your retirement dug a hole too deep to climb out of. The potential impact of sequence risk is that it forces you to cannibalize your principal.
How to Mitigate Sequence of Returns Risk
You cannot control the stock market, but you can mitigate sequence of returns risk. The goal is to ensure your retirement income strategy is robust enough to handle a downturn early in retirement.
Here are strategies to mitigate sequence risk and protect against sequence risk:
1. The “Bodyguard” Strategy (Fixed Indexed Annuities)
One of the best ways to minimize sequence of returns risk is to add a “safe money” tool, like a Fixed Indexed Annuity, to your portfolio. This product provides a floorโmeaning you cannot lose money due to market crashesโwhile still offering growth potential. It acts as a bodyguard, ensuring a portion of your retirement savings is immune to market returns.
2. The Cash Buffer
Keep 1โ3 years of living expenses in cash. If the market crashes early in retirement, you spend the cash instead of selling investments at a loss. This helps manage sequence risk by giving your investment portfolio time to recover.
3. Adjusting Withdrawals
Being flexible helps. If you have poor investment returns, skipping an inflation adjustment or lowering your withdrawal helps minimize the risk.
Strategies to Mitigate Sequence Risk in Your Portfolio
Your retirement income depends on the health of your investment portfolio. To protect against sequence risk, you must balance risk tolerance and financial goals.
Diversification is key. If your entire retirement nest egg is in stocks, a crash early in retirement will have a significant impact on your retirement. By shifting a part of your retirement assets into guaranteed income vehicles or bonds, you help manage sequence risk.
Positive returns in the early years are great, but you cannot count on them. You need a retirement plan that works even if you get negative investment returns in year one. A proper retirement income strategy helps protect against sequence risk by ensuring you aren’t forced to sell assets at the wrong time.
Why This Risk Can Significantly Affect Your Retirement
Sequence of returns risk is the “silent killer” of retirement security. The impact of sequence risk can shorten the longevity of your retirement by a decade or more.
If you are withdrawing money from your retirement accounts, you must be aware that investment returns in the early years carry more weight than returns later in retirement.
This risk can impact anyone with a market-based investment portfolio. However, those who mitigate sequence risk by using insurance tools to create a floor for their retirement assets can sleep better at night.
Let Agape Help Minimize the Sequence of Returns Risk
Do not let the timing of investment returns dictate your lifestyle. You worked too hard to let a bad year in the market hurt your retirement.
At Agape Insurance, we help you design a retirement portfolio that helps protect against sequence risk. We look at your investment returns, your risk tolerance, and your retirement income needs to build a plan that lasts.
Whether through annuities or smarter asset allocation, there are ways to minimize sequence risk. Let us help you mitigate sequence of returns risk and protect your retirement.
Call Rob Sevilla today at 662.260.5188 to discuss how to put a bodyguard on your 401(k).
Disclaimer: Agape Insurance & Financial Group does not provide investment or tax advice. Fixed Indexed Annuities are insurance contracts, not registered investments, and are backed by the claims-paying ability of the issuing carrier.