Broker Check

Sequence of Returns: What's the Risk?

July 22, 2022

Sequence of Return Risk: What is it?

As you approach retirement, the biggest concern is whether your nest egg will be enough to live on for the rest of your life. As you consider and evaluate your investment portfolio, a little-known phenomenon, the sequence of return risk, should be at the top of your mind.

This article explains the sequence of return risk and how you can structure your retirement withdrawals to ensure your nest egg lasts as long as possible.

What is Sequence of Return Risk?

The sequence of return risk refers to how the order and timing of investment returns can impact the longevity of your retirement savings. For instance, a major market loss in the formative years of your retirement can impact your retirement portfolio and affect the total returns you realize in the long term.

This phenomenon is so detrimental that a year’s decline in the early years of retirement can make you lose large amounts of income, and returns, later in retirement. When there is a chance of having a 30-year or more retirement, the effects of the sequence of return risk is something that we always want to discuss with clients as they think about walking away from a steady paycheck.

What is the Biggest Factor? Timing. 

When it comes to protecting your retirement income from the sequence of return risk, timing is everything.

A retirement portfolio often includes various investments that generate income over time, replenishing a portion of your annual withdrawals so you can keep drawing on the portfolio sustainably and for longer.

Unfortunately, a major market loss early in retirement can wreak havoc on the total returns of your investment portfolio, especially if you proceed to make a withdrawal when the market is down. Withdrawing from your retirement portfolio in a slow market reduces your assets, meaning you’ll have less to generate significant returns when the market recovers.

However, suppose the market drop occurs much later in retirement. In that case, the portfolio’s returns will have compounded significantly over the better market years, which means the impact on your portfolio will be less, and your withdrawals won’t be affected as much.

We have strategies that can help with avoiding large market loses at the beginning of retirement, or just before you start to take withdrawals from your portfolio. 

The Impact of Sequence of Returns: An Example   

We have included an example of how sequence of returns affect one’s retirement during the income phase. The first part of the example shows how sequence of return doesn’t have an impact with the accumulation phase of an investor’s portfolio. Then, the examples shows what happens during income years. This story is a lot different. You can see two investors taking 6% from the portfolio every year. One gets great returns to start retirement income, while the other isn’t so fortunate in scenario B. The outcome speaks for itself in scenario B.

Sequence of Return Example

Don’t Wait; Create a Plan Today

Clients will ask when the best time to start planning from retirement is. The sooner, the better. We recommend to really look at income strategies when you are within five years of retirement. Laying the foundation to an income strategy can make all the difference between retirement success or running out of money.

Reach out to use to start having the conversation with Elevated Wealth Advisory. To see our client onboarding process, visit our website.