How to Mitigate Sequence-of-Returns Risk in Retirement
By Brian Famigletti, Managing Director & Head of Marketing
What Is Sequence-of-Returns Risk?
Sequence-of-returns risk describes the elevated impact of market volatility in the early years of retirement. And as market uncertainty abounds and concerns of inflated tech valuations grow louder, it’s an increasingly key consideration today for high-net-worth investors nearing their golden years.
When you are 20 years out from retirement, a negative sequence of returns — the value of an asset declining from your purchase price — isn’t really a problem for your portfolio. You may see short-term losses, sure. But the broader market has historically recovered and risen from every recession, yielding substantial returns over most decades-long periods.
Past performance is never a guarantee of future results. But precedence suggests disciplined, long-term investing strategies eliminate the need to “time” the market. Take dollar-cost averaging, for example. Simply invest a fixed sum into a diversified range of stocks each month, regardless of price, and there’s a high probability that you will make money in the long run.
However, when closer to retirement, dollar-cost averaging can turn ravaging. Let’s break down why, and how to protect your nest egg when retiring into an uncertain market.
How Does Dollar-Cost Ravaging Work?
In essence, sequence-of-returns risk describes the inverse of dollar-cost averaging: when investors are compelled to sell, regardless of price, rather than buy. Hence, “dollar-cost ravaging”.
The risk is highest in early retirement. Contrary to conventional wisdom, retirement spending tends to peak early, rather than increasing over time, per J.P. Morgan research. Most new retirees want to spend their money while they are still relatively young and freewheeling. On top of that, medical costs will start to take a larger role in outgoings. For households around normal retirement age, healthcare tends to become a fixed expense.
Should a low rate of return on your retirement portfolio coincide with this period of high spending, it can deal a significant blow to your nest egg’s longevity. In a volatile or declining market, capital can erode fast, as you lock in losses to spend in the short term. Before there’s a chance for the market to rebound — and for you to realize benefits — your funds may dry up.
How To Protect Against Sequence-of-Returns Risk
The best defense against dollar-cost ravaging is to protect against downturns in general. This can be achieved through diversification. A healthy balance of stocks with long-term appreciation prospects and those with reliable payouts amid inevitable corrections may help you tap into sharp gains and avoid steep losses in the lead up to retirement and beyond.
It’s also important to balance risk exposure heading into retirement; for example, rotating away from tech stocks into high-quality bonds.
Additionally, dynamic withdrawal strategy — taking less in down years and more in strong ones — can also preserve capital. Finally, guaranteed income options such as annuities or in-plan lifetime income features can help predictably cover essential expenses.
Market timing is more important for investors facing down retirement. But that doesn’t mean they should “time the market”, any more than other investors. Dollar-cost averaging can help young investors succeed over time in any economic landscape. Similarly, retirees who combine diversification, flexible withdrawals, and reliable income sources stand a better chance of avoiding dollar-cost ravaging, no matter how markets behave.
Are you nearing retirement and concerned about the rising risk of market volatility? Griffin Asset Management can help you adapt your strategy for any outcome.
Sources:
JPMorgan: How to avoid dollar-cost ravaging in retirement
The Balance: Sequence Risk’s Impact on Your Retirement Money
