Managing Sequence Risk in Retirement – AKA: What Happens When the Market Goes Down?

Share Post: facebook Created with Sketch. twitter Created with Sketch. linkedin Created with Sketch. mail Created with Sketch. print Created with Sketch.

Published by Taylor Financial Group

Has it ever occurred to you that people can retire and live off of their investments for a period of up to 35 years, and sometimes even longer?  Indeed, although it may seem unbelievable, our retirement could last almost as long their working years.  As a result of our increasing longevity, we need to rethink our spending in retirement, and how we create retirement portfolios to support our longer retirements.  Of particular interest (and potential risk) is how the “sequence of returns” affects our retirement portfolios.  This is especially relevant now that we are participating in the second longest bull market in history.  Coming off of the ninth year in a bull market, we need to consider how a potential bear market could affect withdrawals during the early years of retirement.

There are many ways to deal with sequence of return risk, such as:

  1. Conservative Spending

The first way to manage sequence risk is to spend conservatively. We know that consumption is the enemy of all good retirement plans.   Retirees should maintain spending throughout retirement with a careful eye on their account balances. With a conservative portfolio, if the spending level is pushed beyond what bonds and the like can support, then a more aggressive asset allocation may provide the highest probability of success over the long term. Of course, with a more aggressive portfolio, we need to include a liquidity bucket to provide cash flow during those lean years.  Those who are faint of heart may end up going with a less aggressive strategy that contains a higher allocation to bonds, which may entail less spending over the long term.  In addition, a bond portfolio also carries its own risks, such as interest rate risk and loss of purchasing power over the long term.

  1. Flexible Spending

A second approach to managing sequence risk is to keep the aggressive investment strategy mentioned above while allowing for flexible spending. Basically, a cash flow is created that segregates between necessary and discretionary spending, with the idea that discretionary spending (such as vacations and gifting) can be tabled in difficult years.  This reduces risk by decreasing spending when the portfolio declines, so that more assets are able to remain in the portfolio and thus are able to grow when the market recovers.

  1. Reducing Volatility

A third approach to managing sequence-of-risk returns is to reduce portfolio volatility where it matters the most. This is because if a portfolio has limited volatility, it does not create as much sequence-of-returns risk. One such approach to reducing downside risk is a rising equity glide path in retirement, which would start with an equity allocation lower than typically recommended, but would then increase the equity allocation over time.  Some studies have shown this to be an effective strategy as it has the positive effect of reducing vulnerability to early retirement stock market declines. Another approach is to use hedging techniques to limit stock market losses, which we utilize in many portfolios.  Another approach is to use income guarantee riders that can shore up the mandatory income that is required from the portfolio.  Look for more absolute return strategies as the need for reliable income becomes greater and greater, and as interest rates go up.

  1. Buffering Assets and Not Selling at a Loss

The final approach to managing sequence-of-risk returns is to have other assets available outside of the financial portfolio to use after a market downturn. The desired returns on these assets should not be ambitious as the goal behind having buffer assets is to support spending when the portfolio is down. A good strategy here is to maintain a separate cash reserve, with one to three years of retirement expenses that are separate from the rest of the portfolio. There is an obvious disadvantage with this strategy however, as the cash reserve could have been invested into something that would produce higher returns than cash provides. As a result, recent years have seen a greater focus on other approaches. One main alternative to the cash reserve strategy is to use the cash value of a permanent life insurance policy as a cash reserve, or setting up a home equity line of credit that can serve as a reserve.

The bottom line is that all investors should consider their rainy-day fund, and how to support their lifestyle in retirement when that bear market actually hits.  We try to consider this scenario when building portfolios, and are happy to discuss it with you.  Just give us a call.

 

Share:
facebook Created with Sketch. twitter Created with Sketch. linkedin Created with Sketch. mail Created with Sketch. print Created with Sketch.
Share Post: facebook Created with Sketch. twitter Created with Sketch. linkedin Created with Sketch. mail Created with Sketch. print Created with Sketch.

RECENT POSTS

5 Things To Know Now That The Bear Is Here

Dear Friends, It finally happened. On Monday, June 13th, the S&P 500 Index moved into a bear market, finally closing 20% beneath the January 3 high. And then last week, the S&P 500 Index rebounded 6.46%, to bring the year-to-date return to -17.3%.   Here are 5 things to know ab …

Will There Be A June Swoon? Maybe, But Maybe Not

Dear Friends, After a late-month rally, we can say goodbye to the month of May, which now opens the door to June. Here’s the bad news, June is historically a weak month and it is actually the worst month of the year during a midterm year, down 1.8% on average. The good news though is …

Tips to Help You Stay Strong During Market Volatility

It’s almost impossible not to feel anxious at the dips and dives the stock market has been taking recently, compounded by relentless inflation-focused headlines. That’s why you might be surprised to learn there’s a lot of positive news to be had, despite the market uncertainty. 
1 2 3 210 211 212

Get in Touch

In just 15 minutes we can get to know your situation, then connect you with an advisor committed to helping you pursue true wealth.

Schedule a Consultation