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It’s happening right now. Just as many committed themselves to “The Great Resignation,” the market has decided it doesn’t like the prevailing economic conditions. And with that, those on the cusp of retirement may be rethinking their decision to leave the workforce.
This is a form of risk that has made the rounds over the last several years. Initially, it was talked about as merely a theoretical conjecture. Recent events, however, have brought the “sequence of returns” risk into the realm of reality.
“Sequence of returns risk refers to the order that market returns arrive when retirees spend from a portfolio in retirement,” says Rob Stevens, Financial Planning Thought Leader at TIAA in Charlotte, North Carolina. “Negative returns early in retirement will increase the percentage of remaining assets withdrawn to maintain the desired income level. While historically equities have done very well—averaging about 10% a year for close to a century—if there is a market correction early in retirement, the income security of a retiree can be greatly diminished.”
You’ve been told all your life to ride out the undulations inherent in the market. Why is the volatility any different now that you’re about to retire compared to ten or twenty years earlier?
Nicole Riney, VP, Financial Planner at Oak Harvest Financial Group in Houston, says, “Sequence of returns is a term used by financial professionals to illustrate what can happen in an investment portfolio when the market has two down years in the first two years of retirement. Once a retiree stops collecting a paycheck and starts relying on their investment account for income, they are more susceptible to this risk. If the market is down, and you now must sell positions to generate income, you are forced to sell at a loss, and therefore you are depleting your funds much more quickly. And if you must do this forced selling two years in a row, it could be the difference between running out of money and not running out of money throughout the rest of your retirement.”
There are clear strategies to protect yourself from the sequence of returns risk in advance of retirement. But what happens if it’s too late. What can you do if you find yourself unprepared at your retirement date and the market decides to do a swan dive? Is there anything you can do to recoup these losses?
“The quickest way to recover is to stop withdrawing,” says Anthony Martin, CEO of Choice Mutual in Reno, Nevada. “This could mean returning to work or putting off retirement, if possible. Accessing other funds, such as home equity, can also help.”
It’s important for you to remember that you also need to treat your portfolio the same way you did ten or twenty years ago. Chances are you’ll live that much longer past your retirement date. That means you need to make sure at least a portion of your retirement savings continues to grow. The last thing you want to do is make a knee-jerk decision that compromises your future.
“A sensible approach is to maintain a long-term perspective,” says Tyler Papaz, Director of Private Wealth at Cornerstone Advisors Asset Management in Bethlehem, Pennsylvania. “Hitting the panic button and moving everything into cash when the market is down often leads to missing the recovery on the upside. A long-term perspective and an appropriate asset allocation can go a long way in managing periods of heightened volatility or negative returns.”
When the market drops during the first year or two of retirement, the risk isn’t in the short term. You’ll have enough money to fund those early years of retirement, even if you sell securities at lower than expected prices. The challenge will come in the later years. You’re now working off of a smaller base to grow from. You do have options, though. And they may surprise you.
“One possible approach is to take more risk in your investment portfolio,” says Linda Chavez, Founder & CEO of Seniors Life Insurance Finder in Los Angeles. “While this may seem counterintuitive, it can help you regain some of the losses that are caused by the sequence of returns risk. This might include increasing your exposure to stocks and other higher-risk investment vehicles or moving some of your funds out of traditional savings accounts and into these more aggressive options. Of course, this approach is not without its risks, and you should always speak with a financial advisor before making any major changes to your investment strategy. But if you’re comfortable with taking on more risk, it can be an effective way to offset the negative effects of sequence of returns risk.”
Mind you, as Chavez says, there is a very real hazard to investing aggressively. If you overshoot your aggression, you may end up making things worse. Not to worry though. There is an alternative.
“It can be dangerous to try to recover from negative market returns in retirement as it can lead to investors taking on more risk to recoup their portfolio losses,” says Michael Fischer, Director and Wealth Advisor at Round Table Wealth Management in Westfield, New Jersey. “Portfolio construction is critical heading into retirement, and the portfolio must be stress-tested to understand the impact of negatively sequenced returns early in retirement. One strategy to help recover is to reduce discretionary spending early in retirement, especially if markets are negative. It may mean foregoing a vacation or cutting back on entertainment expenses in the short term, but in the longer term, temporarily cutting these expenses will allow for more flexibility later in retirement.”
Cutting back on activities and other expenses may not be in the cards for some. That, unfortunately, leaves them with little choice when it comes to overcoming near-term losses just as retirement begins: they face the daunting prospect of unretiring.
“Once in retirement it can be very difficult to recover from the sequence of returns risk because people are no longer working and saving money but now turning their savings into income,” says Sean Rawlings an advisor with Battock Wealth Management Group in Scottsdale, Arizona. “Without being able to allow for time to let their assets recover, retirees often have to go back to work or live off less income if they don’t want to risk running out of money. This is why having a volatility buffer is crucial when planning for income in retirement. Retirees must be able to weather the storm for a short period of time.”
Typically, it takes about two years for stocks to recover from a bear market. In the most pessimistic case, you’re looking at five years. In either of these scenarios, however, recovery is something to look forward to. That means it’s critical that you stay cool through the worst of times.
“Keep your emotions out of your decisions,” says Greg Womack, President of Womack Investment Advisers, Inc. in Edmond, Oklahoma. “Review your portfolio and determine which securities will help you the most. Stay focused on the strength of the markets.”
Don’t panic and focus on the things within your control. Maybe you don’t start retirement with the bang you hoped for. Maybe you take it slower at first. Get the lay of the land. Find less expensive substitutes and see if they are adequate for your needs.
“Overall, what you need to do to recover from the sequence of returns risk is to minimize your expenses and take as little money as you possibly can from an account that has gone down in value,” says Jeff Kronenberg, Founder and President of Imagine Wealth Group in Ridgefield, Connecticut. “Theoretically, you also could consider taking on more risk to get a potentially higher return, although that is obviously not an ideal situation.”
The blunt reality is you “either spend less, save more, or earn greater portfolio returns,” says Brian Haney, Founder of The Haney Company located in Silver Spring Maryland. “Those are the only three options and sometimes it’s a combination of them depending on how much your assets have declined.”
Don’t let the market rule over your fate. You control your own destiny.
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