Joe Edgeworth

The Edgeworth Insurance Group

Mitigating Sequence of Returns Risk

Embarking on retirement amidst the turbulence of financial markets requires a well-thought-out strategy to shield one's lifetime savings. A crucial element in this planning process is understanding and addressing the sequence of returns risk. This risk, particularly potent during the early stages of retirement, can significantly erode your nest egg if not appropriately managed.

The Significance of Sequence of Returns Risk

The sequence risk revolves around the timing of investment returns, especially during market downturns at the onset of retirement. Withdrawals during such times amplify the impact on your portfolio's longevity. This is because, unlike during your working years, you will not be making contributions to offset any losses, making early retirement years particularly vulnerable to market fluctuations.

To illustrate, consider two retirees with identical portfolios starting at $500,000 and planning to withdraw $20,000 annually. One begins retirement in a bull market, enjoying early gains that cushion later losses. The other starts in a bear market, suffering immediate losses that significantly deplete their portfolio and stunt its growth, showcasing the dramatic effects of sequence risk over time.

Strategic Defenses Against Sequence Risk

Fending off sequence risk involves a multi-pronged approach that includes understanding withdrawal rates, diversifying investment strategies, and considering insurance products like annuities. Here's how:

  1. Sustainable Withdrawal Rates: The foundation of a robust retirement plan involves determining how much you can safely withdraw each year. While the 4% rule is a standard benchmark, it's essential to tailor this to your specific situation, possibly requiring a more conservative or aggressive approach based on your total assets, life expectancy, and retirement goals.
  2. Adopting a Bucket Strategy: This strategy segments your retirement savings into three buckets to balance immediate financial needs with long-term growth objectives. The first bucket contains cash and equivalents for short-term expenses, reducing the need to sell investments at a loss during market downturns. The second bucket includes low-risk investments like fixed annuities or high-quality short-term bonds, providing a stable income stream to replenish the first bucket. The third bucket is allocated to higher-risk assets for long-term growth and inflation protection.
  3. Incorporating Annuities: Annuities can play a vital role in your retirement plan by offering a guaranteed income stream as a buffer against market volatility. Fixed annuities or multi-year guaranteed annuities (MYGAs) can be particularly effective, providing predictable returns that can fund your medium-term bucket or serve as a foundation for your overall income strategy. This reduces reliance on stock market performance for essential expenses, mitigating sequence risk.
  4. Early and Proactive Planning: Transitioning from accumulation to preservation mode in your investment strategy is crucial as retirement approaches. This shift should begin well in advance, ideally a decade before retirement, to gradually adjust your portfolio towards a more conservative stance. This proactive approach allows for a smoother transition and reduces the potential impact of market downturns on your retirement savings.

Protecting your retirement from the sequence of returns risk requires a comprehensive strategy that encompasses sustainable withdrawal rates, a diversified bucket strategy, and the strategic use of annuities to ensure a stable income. By adopting these measures and planning proactively, you can navigate the market's uncertainties and secure a financially stable retirement, safeguarding your golden years against the unpredictability of market downturns.

Don't let market ups and downs disrupt your retirement plans. Mitigate the sequence of returns risk with a tailored strategy, combining wise withdrawal rates, diversified investments, and annuities. Contact a trusted advisor today to secure your financial future.

Many people have learned about the power of using the Safe Money approach to reduce volatility. Our Safe Money Guide is in its 20th edition and is available for free.  

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Joe Edgeworth picture

Joe Edgeworth

The Edgeworth Insurance Group

2715 Spring Valley Rd.

Lancaster, Pennsylvania 17601

(800) 824-8609

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