Avoid letting bad luck ruin your retirement dreams.
Avoid letting bad luck ruin your retirement dreams.
Preparing for Retirement: Mitigating Sequence of Returns Risk
It’s natural to feel concerned about the possibility of a market downturn when thinking about retirement. We’ve all experienced that feeling of not wanting to open an account statement after a particularly tough period. However, simply hoping that the market will go up or stay stable won’t protect your retirement savings. In fact, being overly stressed about the day-to-day or month-to-month changes in your portfolio may indicate that you are taking on too much risk as you approach retirement age.
As you near retirement, your margin for error becomes narrower. You will have less time to rebound from a market correction compared to when you were younger. Additionally, once you start withdrawing from your investment accounts, rather than contributing to them, a down market can have a devastating impact. If your stocks experience a significant loss in value and you find yourself having to sell more shares to generate the income you rely on, it could greatly affect how long your retirement savings will last. The pot of money you worked so hard to accumulate may be depleted much sooner than anticipated, which is consistently ranked as the top fear for retirees.
To illustrate the importance of transitioning your investment plan before retirement, let’s look at a hypothetical comparison involving two retirees.
Linda vs. Steve: A tale of two retirees
Let’s consider Linda and Steve, both of whom had $500,000 in an IRA when they retired and planned to withdraw $2,500 per month to supplement their retirement income. The only difference is that Linda retired in 1990, while Steve retired in 2000.
During the 1990s, the U.S. stock market experienced only one mildly down year. Linda was able to withdraw over $300,000 for income over the course of ten years, and her ending IRA balance in 2000 was an impressive $1,625,254. Linda retired at the perfect time, when the market was an exceptional tailwind.
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However, Steve’s experience was quite different. The early 2000s began with the bursting of the “tech bubble” and was followed by the events of 9/11, resulting in three consecutive years of market declines. By the end of 2002, Steve’s IRA had less than half of what he started with. And in 2008, the Great Recession further eroded his savings. By the close of the decade, Steve was left with a mere $60,241. Steve had to downsize his retirement simply because he stopped working at the wrong time.
Mitigating sequence of returns risk
It’s important to recognize that U.S. and world history is filled with boom-and-bust cycles. As an average investor who may live two decades or more in retirement, it is almost certain that there will be both good and bad times ahead.
To prepare for these ups and downs, proactive planning is essential to ensure you are not caught off guard. One approach to better preserve your nest egg is a two-bucket investing strategy. This strategy involves having a more conservatively invested “income” or “now” bucket from which you can reliably withdraw funds for your immediate needs. Simultaneously, a separate “growth” or “later” bucket should be invested to keep producing income for the future. The specific portfolio mix for each bucket depends on several factors, including your time horizon and risk tolerance.
Reducing risk doesn’t mean eliminating it entirely. Avoiding risk altogether often results in pathetically low rates of return, which can lead to other problems, such as failing to keep pace with inflation. However, by smoothing out the rough edges and adding a level of safety and predictability, investors have a much better chance of achieving their retirement goals.
In baseball terms, it’s not necessary to swing for the fences every time. Sooner or later, you’ll strike out. And striking out in retirement can be disastrous.
Seeking guidance from a retirement specialist
If you are approaching retirement within the next five to ten years, it may be time to seek the guidance of a financial adviser who specializes in retirement planning. A retirement specialist can help you navigate the necessary changes and build a winning plan to ensure a secure retirement.
Remember, mitigating sequence of returns risk requires proactive planning and a strategic approach. Planning ahead and adjusting your investment strategy can go a long way in protecting your retirement nest egg.
– Kim Franke-Folstad contributed to this article.
Investment advisory products and services are provided through AE Wealth Management, LLC (AEWM), a Registered Investment Advisor. Investing involves risk, including the potential loss of principal. The scenarios mentioned in this article are hypothetical examples provided for illustrative purposes only and should not be construed as advice designed to meet the particular needs of an individual’s situation. 1871256 – 07/23
