As retirement approaches, investors are often warned about a looming threat known as the “sequence of returns risk.” This risk, also called “sequence risk,” stems from poor investment returns paired with withdrawals, especially in the early years of retirement. The detrimental impact of this combination can lead to a significant reduction in your retirement nest egg over time. Certified financial planner Collin Lyon, wealth strategy advisor at Anderson Financial Strategies, emphasizes that the investment returns and withdrawal timing during the early retirement years can have a lasting impact on your financial stability for the next three decades.
One of the biggest challenges posed by sequence of returns risk is for younger retirees with decades of living expenses ahead of them. The timing of stock market downturns just before or during the initial stages of withdrawing from retirement accounts can have a drastic effect on the longevity of your investments. Withdrawing from a portfolio during a market decline may force you to sell more assets to receive the same amount of cash, ultimately leaving you with fewer investments to capitalize on future market rebounds.
Financial advisors suggest several strategies to mitigate the impact of sequence of returns risk on your retirement nest egg. One key recommendation is to adjust your portfolio allocations as retirement nears, shifting from heavy concentrations in higher-risk assets to more stable investments like bonds. Diversifying among different asset classes can help reduce volatility and safeguard your investments during market downturns. It’s crucial to consider factors such as risk tolerance, financial goals, and life expectancy when determining the right mix of investments for your portfolio.
To shield your portfolio from the adverse effects of sequence risk, experts recommend building a safety net through various means. Maintaining a six-month emergency fund and a “war chest” to cover living expenses can help you avoid selling assets during market downturns. The “war chest,” consisting of five years of expenses in fixed-income assets, provides a buffer against market volatility when sequence risk is at its peak. This safety net allows retirees to weather turbulent market conditions without jeopardizing their long-term financial security.
Flexible withdrawal strategies are also identified as a proactive approach to safeguarding your portfolio from sequence of returns risk. Rather than following a fixed withdrawal percentage, adjusting the withdrawal rate based on market performance can help preserve the core of your portfolio. Orlando-based CFP Brad Brescia recommends reducing withdrawals during years of negative returns to mitigate the impact of market volatility on your investments. However, it’s essential to note that some retirement accounts eventually mandate required withdrawals, which may limit flexibility in withdrawal strategies.
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