Minimize Sequence Risk in Your Investing Strategy


How to Minimize Sequence Risk in Your Investing Strategy

Laddering your bonds or purchasing an annuity can save you from running out of money if you start withdrawing your retirement savings at the wrong time.


The markets may have recently hit a new all-time high but if you retired in 2000, you may have already run out of money. Surprisingly, it's a completely different story if you retired just a few years earlier or a few years later.

See Also: Tax Planning for Retirement

The timing of when someone retires can have a profound effect on the performance of their accounts. Sequence risk, also known as sequence of returns risk, pertains to the timing of returns during the withdrawal phase. To illustrate the impact of sequence risk, here's the story of three hypothetical brothers each born three years apart. They each retired at age 65 with a $1 million lump sum pension, which they invested according to Standard & Poor's 500-stock index models. They immediately began taking withdrawals of $5,000 on the same dates of each month. But the results, you will see, are very different.

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The oldest brother retired in January 1997. As of the end of July 2016, he has withdrawn $1,175,000 in income, and his remaining balance is currently about $1.66 million. By taking a 6% withdrawal and making slightly less than 8%, the oldest brother has approximately two-thirds more than his starting value. These results are approximately the historical rate of return for equities and illustrate how equities may be effective over the long term.

The middle brother retired three years later, in January 2000, however did not make out as well as his older brother. As of earlier this year, the middle brother ran out of money! This is despite the fact that he withdrew only $987,342, considerably less than the oldest brother.


The youngest brother finally retired in January 2003. As of the end of July, he has withdrawn $815,000 and has approximately $1.67 million remaining in the account.

(Disclaimer: This example was calculated in Morningstar Advisor Workstation as follows: $1M initial investments on 1/1/1997, 1/1/2000, and 1/1/2003 in S&P 500 TR USD (IDX), $5,000/monthly withdrawals starting immediately and ending on 7/31/2016. It is for hypothetical purposes only. It is not intended to portray past or future investment performance for any specific investment. Past performance is no guarantee of future results. You cannot invest directly in an index, and your own investment may perform better or worse than this example. This example does not include the deduction of fees, charges inherent to investing, taxes or investment costs, which could have a dramatic effect on your results.)

Why did the oldest and youngest brothers succeed while the middle brother ran out of money? One of the greatest contributing factors is the market performance during the first three years of retirement. The difference here is that the market went up as the oldest and youngest brothers started taking withdrawals, and the market went down as soon as the middle brother began withdrawing.

While no strategy assures success or protects against loss, there are techniques that can help to mitigate sequence risk. One way is to incorporate a fixed-income component of your portfolio, such as cash or a multi-year bond ladder that is designated for providing income when the markets are down. If the market recovers in a relatively short period of time, this buffer may protect you from having to sell equities at a depressed price.


Another strategy is to utilize a product, such as an annuity, that can help to provide a lifetime income stream and reduce the withdrawal need from the overall equity portion of your portfolio. The longer you receive the income stream, the greater possible rate of return on the investment. Conversely, the longer you draw from your equity portfolio, the greater the chance of running out of money.

If you were able to know how the market will perform in your first few years of your retirement, then you would have a high probability of success! Since we cannot know what the future holds, talk with your financial adviser about these techniques and others to reduce the chance of ending up like the middle brother—sleeping on one of his other brother's couch.

See Also: 12 Ways to Go Broke in Retirement

Mark Cortazzo, CFP®, CIMA® is the founder and Senior Partner of MACRO Consulting Group, an independent wealth management firm located in New Jersey.

Disclaimer: Stock investing involves risk including loss of principal. Bonds are subject to market interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Securities offered through LPL Financial, member FINRA, SIPC. Investment advice offered through MACRO Consulting Group, LLC, a registered investment adviser and separate entity from LPL Financial.

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