What is Sequence Risk and how will it Affect your Retirement?

Robert M. Wyrick, Jr.

Risk tolerance is one of the key factors financial planners look at when helping their clients plan for retirement. Age, number of employable years left, and annual income/expenses are all variables in the mathematical calculations of what retirement income will look like.

Save a million dollars, average a 6% return, and you’ll be able to take $50K a year and live to be a comfortable, happy nonagenarian. That’s the American dream. If you work thirty or forty years and save consistently, you should be able to enjoy a care-free retirement. The market goes up and down during your employment years, but playing the long game usually pays off.

The numbers work if your million dollars is actually worth $1 million when you retire. As of this past Monday, the market had lost a third of its former value. If you retire today, your million may only be worth $650,000. Take $50K from that in the first year and you now have a $600K retirement fund and you’re no longer making deposits. That changes things.

Understanding Sequence Risk 

When you’re investing for retirement, you’re “buying” equities and other assets. The value of those assets will vary, but your monthly contributions remain the same. In down markets, you’re buying more shares. In up markets, those shares increase in value. Over time, their values typically level out and you end up with a consistent return number.

After you retire, you’re now “selling” and no longer contributing to your retirement fund. If you have to “sell low” in early retirement, which would be the case in today’s climate, your principle goes down significantly and you have no way to replenish it. This is known as “sequence risk” or “sequence of returns risk.” Understanding and adjusting to it is crucial to retirees.

Many workers in Houston are facing layoffs and months of living on an unemployment check. Older employees are contemplating retirement, thinking that their 401K disbursements may be higher than the unemployment income. That may be the case in the short term, but don’t do anything until you speak with a financial advisor. There are more options available.

Implementing a Safe Withdrawal Plan

The industry standard for “safe” withdrawal from a retirement fund is 4%. That seems reasonable if you set that disbursement level up in your first year, when the principle is $1 million. What happens when the market crashes and the principle goes down 30%? Do you still take your $40,000? Your needs haven’t changed, so you may not have choice.

Examining sequence risk prior to retirement and discussing it with a qualified financial professional could be the difference between enjoying a comfortable retirement or living off Social Security. There are steps you can take today to prevent that from happening. You can reach Robert M. Wyrick, Jr. by clicking the “Contact Us” button below.

 

By Robert M. Wyrick, Jr.
Share:

Get more personal wealth tips

Weekly insights delivered directly to your inbox.