The Most Overlooked Risk
The Most Overlooked Risk
When it comes to retirement income planning, there are often uncertainties. Investors often view risks as market loss, inflation risk, out living our money (longevity risk), and others. However, there is also a risk known as “sequence of returns” risk that is equally as crucial to mitigate. Here’s why. Suppose there are two investors who are of equal age and have the exact same stock portfolio and income needs. Both investors average an 8% return over a 25-year retirement period, however the first investor experiences severe market loss in the first several years of retirement, while the second investor doesn't experience severe market loss until the end of their retirement. Which investor is in greater danger of outliving their assets?
The answer is the first investor. Why? If this investor is taking withdrawals from an account that is also losing value because of investment loss, it is possible for the account value to drop so low that it is no longer large enough to support the required annual income needs of the investor. When stocks rebound, the investor is not in a position to participate in the recovery because their account value is being overly strained by income needs. So, while both of our investors earned the exact same return over their retirement, when they experienced poor investment markets was just as important as the return they got from their investments.
So, what does that mean for you? Thankfully, you can protect against sequence of return risk by having access to multiple years of income that are in assets protected from severe loss. Common examples are a money market, short-duration bonds, cash value life insurance, fixed or indexed annuities. If you have 2 to 3 years’ worth of essential income in assets that can avoid severe losses, your odds of a successful retirement increase dramatically. Keep in mind, because we have no way of predicting when poor investment markets will come, ideally, we want the money we place in “safer” investments to still grow fast enough to outpace inflation. This often means something beyond a money market or savings account. If you are unsure what types of investments are suitable for you to protect against sequence of return risk, I would suggest seeking advice from your trusted advisor.
Need help? Give us a call!
Disclaimer: Crosby Advisory Group, LLC is a registered investment advisor. This newsletter is for general knowledge and is not intended to be individual investment advice. Investing involves risk including potential for loss. Understand all risk and fees before investing. NMD Insurance is affiliated with Crosby Advisory Group, LLC.
