Protect your Retirement from Market Volatility

Key Takeaways:
  • Sequence of returns risk can shorten retirement savings if market downturns happen early in retirement.
  • Strategies like maintaining a cash reserve, reallocating assets and lowering early withdrawal rates can help protect retirement funds.
  • Consulting with a personal financial planner can help provide tailored strategies to manage risks and ensure long-term retirement security.

 

Retirement planning is much more than simply saving money—it involves careful navigation of various risks impacting your financial future. One often overlooked, yet crucial, risk is known as the sequence of returns risk. By understanding this concept and taking proactive steps to mitigate its effects, you can protect your retirement portfolio and ensure a more secure future. 

What is Sequence of Returns Risk? 

Sequence of returns risk refers to the potential threat posed by poor or negative investment returns, particularly in the early years of retirement. Even if your portfolio averages strong returns over the long run, the specific timing of gains and losses can dramatically affect how long your savings will last. If you experience market downturns early in your retirement while you’re drawing down assets, those losses may reduce the value of your portfolio, making it more difficult to recover when the market eventually rebounds. 

Why Sequence of Returns Risk Matters 

Many people assume the average return on investments is the most important factor in determining the health of their retirement portfolio. However, the order in which returns occur is equally, if not more, important. Negative returns at the beginning of retirement can cause your savings to deplete more quickly, especially as you’re withdrawing funds to cover living expenses. This can leave less money in the market to grow when returns improve, creating a compounding effect that shortens the longevity of your assets. 

Example: Imagine two retirees with identical portfolios, but one experiences a market downturn in the early years while the other enjoys positive returns. Even if both portfolios eventually average the same return over time, the retiree with early losses will have less money in the long run due to the timing of withdrawals and reduced growth potential. 

How to Prepare for Sequence of Returns Risk 

While no one can control market fluctuations, you can implement strategies to protect your portfolio from sequence of returns risk. By planning, you can reduce the impact of early retirement market declines and help ensure your savings last throughout your retirement. 

1. Maintain a Cash Reserve 

One of the most effective ways to mitigate sequence of returns risk is by maintaining a cash reserve at the start of your retirement. By keeping 1-2 years’ worth of living expenses in cash, you create a buffer allowing you to avoid withdrawing from your investment accounts during periods of market volatility. This gives your portfolio time to recover from losses without forcing you to sell assets at lower values, which can lock in those losses and permanently shrink your retirement savings. 

2. Reallocate Assets Before Retirement 

As you approach retirement—generally within 3-5 years—it can be beneficial to shift a portion of your portfolio from growth-oriented investments to more defensive, stable assets. This strategy helps to preserve the gains you’ve made during your working years and reduces larger exposure to the ups and downs of the market. While growth remains important, minimizing volatility is key in the years leading up to retirement to help reduce the impact of early negative returns. 

3. Adopt a Lower Withdrawal Rate 

Another strategy to combat sequence of returns risk is to adopt a conservative withdrawal rate in the early years of retirement. The lower your withdrawal rate, the less you’ll need to sell in a down market, which can help your portfolio recover more effectively when market conditions improve. A common rule of thumb is the 4% rule, but depending on your risk tolerance and financial goals, you might consider an even lower withdrawal rate, especially in volatile market environments. 

Example: Two retirees with $100,000 at the start of retirement who both experience the same market conditions—5% loss in year one, 10% loss in year two, followed by 7% annual returns—could see very different outcomes depending on their withdrawal rates. Retiree A, withdrawing 4% annually, ends up with $97,667 after 10 years, while Retiree B, withdrawing only 2%, grows their balance to $120,032. The difference of $22,365 highlights the importance of being mindful about how much you withdraw, particularly early on. 

The Importance of Professional Guidance 

Managing sequence of returns risk is an ongoing process and can be complex, and no single strategy works for everyone. That’s why working with a financial consultant is key. They can help you assess your individual risk tolerance, financial goals and investment timeline, tailoring a plan to best position you for a stable retirement. 

Whether it’s diversifying your portfolio, setting up an appropriate withdrawal strategy or creating a cash reserve, a financial advisor can guide you through the decisions that will have a lasting impact on your retirement security. 

Questions? 

Sequence of returns risk is an often underestimated factor that can influence the longevity of your retirement savings. Taking steps now to prepare for market volatility in retirement will help you maintain financial security and peace of mind for years to come. 

Remember, planning for retirement is not just about the numbers—it’s about timing, strategy and careful risk management. Contact an Adams Brown Wealth Consultant if you would like to learn more. 

Any information and hypotheticals shown are for estimation/planning purposes only with data coming from reliable sources and any calculations made believed to be accurate, however, there are no absolute guarantees implied.