Perhaps you’ve heard before about sequence of returns risk.
Sequence of returns risk demonstrates how your retirement can be made better — or worse — depending on how the market is performing at the time you retire. Some people are fortunate enough to retire when times are good, and their investments enjoy strong gains in those early years, which helps them better withstand losses later in their retirement.
Other people have the bad luck of retiring in a down economy. In their early years of retirement, they may suffer through market losses at the same time they are withdrawing money from their retirement accounts to live on. Even if the market rebounds later in their retirement, it may be too late for them to recover from those big losses.
Because of sequence of returns risk, two people can retire with exactly the same amount of savings but have vastly different portfolio results depending on the economic conditions at the time each retired. One may flourish, while the other sees an ever-diminishing portfolio balance.
Add inflation to sequence of returns risk
If that’s not bad enough, now there’s an added factor that can make the sequence of returns risk even worse.
It’s no secret that when inflation happens, your dollars buy less. So, imagine a scenario where you enter retirement in a down market, your investments are losing money, you are withdrawing money from those same investments to live on, and you have to withdraw even more money than you anticipated because the cost of goods has gone up.
That’s not exactly a recipe for the relaxing, fulfilling retirement you probably dreamed about.
In such a scenario, some people may look at the market and decide to postpone retirement. But not everyone has that option, and even then, we can’t always anticipate whether a good economy will take a downturn in six months or a year.
How to lessen the impacts
All that said, though, there are things you can do to try to mitigate the double whammy of inflation and sequence of returns risk. Those include:
Create an income plan. This is important because, without a good income plan, you are flying blind as you head into retirement. An income plan will help guide your spending and investing. When putting together the plan, look at all your income sources and all your assets. Then look at the net amount you estimate you will need to live on each month. What kind of return on your investments will you need over the next 30 years or so to avoid running out of money?
Understand, though, that the plan could require tweaking over time as circumstances change. With my clients, I usually like to revisit the plan once a year to see what updates are needed.
Spend conservatively. Even when you have a good plan for how much income you anticipate needing and how much you will have to withdraw from your accounts each month to live on, you may need to adjust your spending habits. Inflation could cause groceries, utility bills and other necessities to take a greater amount of your monthly budget than anticipated.
To counter that, you may need to adjust down your discretionary spending so your money will last longer. Unfortunately, it’s not always easy to convince people to make those adjustments.
Consider moving some money into low-risk funds. One way the Federal Reserve tries to battle inflation is to raise interest rates, and that can make less-risky investments, such as bonds and CDs, more attractive. If you move some of your money into those investments, that portion of your portfolio isn’t subject to the volatility of the market.
One problem with this, though, is that even with higher interest rates, these investments may still fail to keep up with inflation.
Watch interest rates on debt. This is a conversation we are having a lot more with retirees or near retirees, particularly when it comes to home equity loans and credit lines. Interest on debt takes a toll on a monthly budget, so the quicker you can pay down debt, the better.
Also, avoid taking on more debt, if at all possible. You don’t want a good chunk of your retirement income going to pay for interest instead of for necessities or the fun activities you always hoped to be involved in during your retirement.
Either inflation or sequence of returns risk can cause trouble for your retirement, and even more so when they are combined.
But with some planning, you can at least prepare and limit the problems you encounter. A financial professional can help you better understand what strategies will work best for you as you try to get the most out of your money — and enjoy the retirement you earned.
Ronnie Blair contributed to this article.
Securities offered through Dempsey Lord Smith, LLC Member FINRA/SIPC. Advisory services offered through Dempsey Lord Smith, LLC.
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.
Lauren Ivester is a financial planner and co-founder of WealthPoint Advisors, where she helps clients work toward and achieve their financial and retirement objectives. She is a fiduciary and has passed the Series 7, 63 and 66 securities exams and has her life insurance license. Ivester began her career in 2005 as a financial adviser at Morgan Stanley, where she served as a primary point of contact for high-net-worth clients to help develop and maintain long-term relationships.
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