Three Ways to Protect Your Retirement From Sequence of Returns Risk
Retiring in a down market doesn’t have to ravage your retirement, but safeguarding your savings requires planning well in advance.
![A piggy bank is wrapped in bubble wrap.](https://cdn.mos.cms.futurecdn.net/qcdRmxAXEmDM27BvYagkXm-415-80.jpg)
Have you ever been forced to sell investments in a down market? If so, then you know it’s not a great feeling — and it’s probably something you’d like to avoid in the future.
Taking withdrawals during a market downturn can have a lasting impact on the longevity of your nest egg — especially if that downturn occurs early in your retirement. This is why preparing for sequence of returns risk, or sequence risk, should be a critical part of your retirement plan.
Why does the sequence of your returns matter?
There’s no predictable pattern for when the market will go up or down — and a bear market could happen when you least expect it. Sometimes, you might even experience negative returns for a whole year or for multiple years in a row.
![https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-200-80.png](https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-320-80.png)
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
If you’ve just started your retirement and you’re making systematic withdrawals during that time, there’s a chance you could shrink your portfolio to the point that you can no longer maintain your planned retirement lifestyle. (Remember, you won’t be making contributions anymore, so you won’t be able to build back your balance the way you could when you were still working.)
The reason this retirement bogeyman is called sequence of returns risk is because it’s about the order in which your returns occur — and it is, for the most part, a matter of good or bad timing. If you retire just before or after a bull market, your account may grow enough so you can more easily deal with a downturn later on. But if you retire in a bear market, your balance may never recover.
Here’s a basic example of how the sequence of returns could affect two retirees quite differently — even if they experience the same overall rate of return, start with the same amount of money ($500,000) and withdraw the same amount ($20,000) every year for five years.
Investor A gets lucky and starts his retirement during a bull market. His returns look like this:
- Year 1: +26.67%
- Year 2: +19.53%
- Year 3: -10.14%
- Year 4: -13.04%
- Year 5: -23.37%
Even with a huge loss in year five, because of his early success, Investor A finished the five years with $378,376.
Investor B is not so fortunate. She takes her long-planned retirement just as a painful bear market begins. Her returns come in the exact opposite order of Investor A’s:
- Year 1: -23.37%
- Year 2: -13.04%
- Year 3: -10.14%
- Year 4: +19.53%
- Year 5: +26.67%
Investor B ends up with $326,831. That may not seem like a big difference, but it’s $51,545 less than Investor A has left working for him — after just five years.
What can you do to prepare for sequence of returns risk?
The less time you have to make up for investment losses, the more important it is to protect your principal.
By the time you reach retirement, you may have read or heard the previous sentence so often that you’ll start tuning it out. But it’s something that everyone who expects to take regular withdrawals from their portfolios should keep in mind.
As you make a plan to safeguard your retirement income, here are some strategies to consider:
1. Know your sustainable withdrawal rate.
This is the estimated percentage of your savings you expect to be able to withdraw each year in retirement without running out of money. Don’t just assume it’s 4%. That was an old rule of thumb, but it may not work for you. There are formulas and online calculators that can give you an idea of what a safe withdrawal rate might be. But I suggest working with a retirement specialist — someone who understands your needs and goals — when designing your individual income and investment plan.
2. Think about using a retirement bucket strategy.
With a bucket strategy, you can be sure you’ll have the money you need in the short term while you continue growing money for later in retirement. You can tailor this strategy to suit your specific needs, but here’s how it generally works:
- Bucket No. 1, the short-term bucket, usually holds enough cash and cash equivalents (on top of your Social Security benefits and pension income) to cover your costs for three years. Having this money set aside at the start of your retirement could help you avoid having to sell stocks at a loss if a market downturn should occur.
- Bucket No. 2, the intermediate-term bucket, typically holds some type of low-risk or guaranteed income investment to replenish the short-term bucket. Some options might include fixed annuities or multi-year guaranteed annuities (MYGAs), CDs or short-term high-quality bonds held to a laddered maturity. (In my opinion, long-term bond funds are not a suitable solution for the principal-protected portion of your portfolio. There are many investments available that provide better stability these days.)
- Bucket No. 3, the long-term bucket, usually holds higher-risk investments (such as stocks) to provide the growth you’ll need as a hedge against inflation and longevity risk later in retirement.
3. Don’t put off retirement planning.
If you’ve been DIYing your portfolio for years, or if you’re working with a financial professional who isn’t retirement-focused, you may have to make serious adjustments to transition from accumulation to preservation.
Some of these changes can take time, so don’t wait until you’re a few months or even a couple of years away from your planned retirement date. In the best-case scenario, you should start to shift your mindset and your money 10 years out — but five years ahead of time is a minimum.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Related Content
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
David McGill is president of Comprehensive Financial Consultants, which he founded in 1998. He is an Accredited Investment Fiduciary (AIF®) and a financial professional who can offer both investment advice and insurance products. McGill has passed the Series 7, 24, 63 and 65 securities exams and has life, health and annuity insurance licenses.
-
Visa Is the Worst Dow Stock Wednesday. Here's Why
Visa stock is down sharply Wednesday after the credit card company came up short of revenue expectations for its fiscal Q3.
By Joey Solitro Published
-
Another Analyst Moves to the Sidelines on Tesla Stock After Earnings
Tesla stock is spiraling Wednesday after the EV maker's big earnings miss and Wall Street has been quick to weigh in. Here's what you need to know.
By Joey Solitro Published
-
Confused by Annuities? Making Sense of the Different Types
Many investors aren't sure if annuities are a good option for meeting financial goals. Let's look at the different categories, along with their pros and cons.
By Kris Maksimovich, AIF®, CRPC®, CPFA®, CRC® Published
-
Talkin' 'Bout My Generational Wealth: Baby Boomers
With retirement, each generation has different priorities and challenges. For Baby Boomers, it's a matter of ready or not, here it comes.
By Alvina Lo Published
-
How to Avoid a Big Hassle if Your Financed Car Gets Wrecked
How an insurance check is made out for repairs can cause a world of problems if the lienholder is left out.
By H. Dennis Beaver, Esq. Published
-
Estate Planning Strategies to Consider as Election Nears
Are big changes in tax laws coming soon? Not likely, but you might want to take advantage of higher estate and gift tax exemptions well before the end of 2025.
By David Handler, J.D. Published
-
How to Get Your Money's Worth From Your Financial Adviser
A good financial adviser will focus on how your financial planning and investment strategy align with your lifestyle and aspirations.
By Pam Krueger Published
-
Think of Prenups and Postnups as Financial Planning Tools
These contracts provide a clear framework for asset management and protection and are especially useful if you get married later in life.
By Andrew Hatherley, CDFA®, CRPC® Published
-
Congratulations on Your Raise: Three Things to Do With It
We're not saying you shouldn't spend it on a new car, but there are some considerations to guard against lifestyle creep and to help ensure a comfy retirement.
By Andrew Rosen, CFP®, CEP Published
-
Check Off These Four Financial Tasks to Finish 2024 Strong
The new year is a popular time to set financial goals, but now is the ideal time to check how you're doing. Four tweaks could make a big difference.
By Daniel Razvi, Esquire Published