What Is Sequence Risk?

Sequence risk is the danger that the timing of withdrawals from a retirement account will negatively impact the overall rate of return available to the investor. It addresses the longevity of your retirement account or portfolio based on the returns and any withdrawals you have to make. This can have a significant impact on an individual who is close to retirement as well as a retiree who depends on the income from a ♔lifetime of investing and is no longer contributing n꧙ew capital that could offset losses.

Understanding Sequence Risk

Sequence risk, which is also called sequence-of-returns risk. revolves around the timing dynamics in investing. It's usually most important during the initial stages of retirement or when a retiree withdraws funds from their investment portfolio. The sequential order of investment returns can have a significant impact on the overall effectiveness of an 澳洲幸运5开奖号码历史查询:investment strategy.

Simply put, if a portfolio experiences negative returns right when any withdrawals are happening, it can have a lasting and adverse effect on the portfolio's value. This is especially true during retirement.

This happens because there are fewer assets left to benefit from potential market recoveries in subsequent periods. Conversely, positive returns in the early stages of retirement can positively influence the longevity of a portfolio, especially if the early portfolio balance is high.

How Sequence Risk Happens

When you retire, you no longer contribute new money but begin regularly 澳洲幸运5开奖号码历史查询:withdrawing money. If you're in a 澳洲幸运5开奖号码历史查询:bull market, your withdrawals are partly offset by new gains. If you're in a 澳洲幸运5开奖号码历史查询:bear market, each of your withdrawals takes a bite out of the balance and isn't offset by new deposits. This ▨means you take the same amount of cash out of an account that steadily shrinks in size.

Sequence risk is, for the most part, a matter of luck. If you retire in a bull market, your account may grow large enough to sustain a subsequent downturn. If you retire in a bear market, though, your account balance may never recover. This is not under the investor's control, but there are opportunities to limit the 澳洲幸运5开奖号码历史查询:downside risks. 

Higher life expectancies can also contribute to sequence risk. Living longer means that you have a longer draw period, which makes them more susceptible to market volatility and downturns early on during your retirement.

Sequence Risks and Asset Classes

Sequence risk can impact different asset classes in various ways, and investors should be aware that it may be better or worse to treat certain assets in a certain way when they retire. Here's a brea🦋kdown of how different asset classes may be affe♐cted:

• Equities: Equities are generally more volatile than other asset classes. In the early years of retirement, a downturn in the stock market can significantly impact the value of a portfolio, especially if withdrawals are being made. This can amplify sequence risk.
• Fixed income: Bonds are sensitive to changes in 澳洲幸运5开奖号码历史查询:interest rates, and rising interest rates can lead to capital losses in bond portfolios. If interest rates rise during the early years of retirement, it can negatively impact the value of bond holdings, also amplifying sequence risk. Note that bonds typically don't have as much volatility as equities, so retirees may prefer holding them to preserve their portfolio value when they begin withdrawing.
• Cash and cash equivalents: While cash provides stability, it typically generates lower returns. In a low-interest-rate environment, relying too heavily on cash equivalents may mean your portfolio doesn't earn anything. There is a little sequence risk here in that your portfolio may be eroding purchasing power over time.
• Real estate: 澳洲幸运5开奖号码历史查询:Real estate values can be influenced by many different economic conditions. If there's a downturn in the real estate market during the early years of retirement, it may also further perpetuate the impact of sequence risk.
• Alternative investments: Alternative investments, such as hedge funds, 澳洲幸运5开奖号码历史查询:cryptocurrency, commodities, or 澳洲幸运5开奖号码历史查询:private equity, may offer diversification benefits. However, they may also be more volatile based on how the market is doing. These asset classes may leave investors more exposed to portfolio losses (with the chance of higher portfolio profit), thus escalating sequence risk as well.

Strategies to Mitigate Sequence Risk

Protecting against sequence risk means anticipating a worst-case scenario. Don't assume that a bull market will reign through your retirement. Here are a few tips to help you cut back on possible sequence risk:

• Consider working as late as you can to contribute more to your retirement account, particularly in your peak earning years.
• Keep saving and investing even after you retire. Keep in mind that if you contribute to a traditional individual retirement account (IRA), you must begin taking 澳洲幸运5开奖号码历史查询:required minimum distributions🍌 (RMDs) by April 1 of the year after you turn 72.
• 澳洲幸运5开奖号码历史查询:Diversify your portfolio. You can protect your portfolio by investing in high-quality corporate and government bonds.
• Consider adjusting 澳洲幸运5开奖号码历史查询:asset allocation based on market conditions and your proximity to retirement. A more conservative allocation may be appropriate if you foresee higher sequence risk based on your short-term withdrawal needs.
• Establish an 澳洲幸运5开奖号码历史查询:emergency fund separate from your investment portfolio. Having a cash reserve can provide a buffer for living expenses during periods of market downturns, reducing the need to sell investments.
• Consider getting a 澳洲幸运5开奖号码历史查询:permanent life insurance policy. This can provide your loved ones with a guaranteed benefit that isn't subjected to market volatility.
• Cut back on spending, Hold off on making any major or extravagant expenses if you can.
• Conduct regular reviews of your investment portfolio and retirement plan. Periodic assessments can help you make necessary adjustments based on changing market conditions or personal circumstances.
  

Example of Sequence Risk

Let's consider the hypothetical case of Sarah, a retiree who begins her retirement with a $1 million investment portfolio. Sarah plans to withdraw $40,000 annually for living expenses, adjusting for 澳洲幸运5开奖号码历史查询:inflation each year. She has a well-diversified portfolio consisting of ꦕ60% stocks and 40% bonds.

In Scenario A, the early years of Sarah's retirement experience positive investment returns. The stock market performs well, and her portfolio grows by 8% in the first two years. As a result, her portfolio balance after the second year is approximately $1.166 million.

However, in Scenario B, the sequence of returns is unfavorable. The first two years of Sarah's retirement see negative investment returns, with the portfolio declining by 10% each year. After the second year, her portfolio balance drops to around $810,000.

Although Sarah will withd🦂raw $40,000 annually, there is sequence risk due to the amount she will reduce her overall portfolio. In Scenario A, where positive returns occur early in retirement, Sarah experiences growth and she withdraws $40,000 annually. In Scenario B, the negative returns in the early years, coupled with annual withdrawals, lead to a more significant reduction in the portfolio balance. For Portfolio A, she would still have over $1 million after the first two years; for Portfolio B, she would at less than $7🔥50,000.

This illustrates how sequence risk can have a lasting impact on the sustainability of a retirement portfolio, as early losses can deplete the portfolio more rapidly. This is because Sarah's annual withdrawal amount ($40,000) represents a larger proportion of the smaller portfolio that experienced losses.

The Bottom Line

Sequence risk highlights the vulnerability of investment portfolios to poor performance during specific periods, particularly in the early years of retirement. The order in which investment returns occur can significantly impact the long-term sustainability of a portfolio. This means you may end ꧂up facing more challenges when trying to pay for expenses during retirement.