Sequence of Risks: There Are No Additions, No Risks of Returns Sequence
Sequence risk, or “return sequence risk,” analyzes the order in which your investment returns occur. It affects you when you are adding or withdrawing money from your investments periodically. During retirement, it can mean that you achieve a much lower internal rate of return than you expected.
If Returns Occur in Reverse Order
If returns occur in reverse order, you still have the same amount of money: $238,673. Note: The order of returns does not affect your outcome if you are not investing or withdrawing regularly.
Withdrawing Income and Getting the Same Returns
Assume you retired in 1996. You invested $100,000 in the S&P 500 and withdrew $6,000 at the end of each year. Over 10 years, you received $60,000 in income, and you had $162,548 in remaining capital. Note: You can check six guidelines that you can use to help adjust your withdrawals during retirement.
How Sequence Risk is Similar to Dollar-Cost Averaging in Reverse
Return sequence risk is somewhat the opposite of dollar-cost averaging. With dollar-cost averaging, you invest regularly and buy more shares when investments are down. When you are withdrawing income, you are selling regularly rather than buying. You need to devise a plan to ensure that you are not forced to sell too many shares when investments are down.
Protecting Yourself from Sequence Risk
Because of sequence risk, using a simple average return in an online retirement planning tool is not an effective way to plan. It assumes that you achieve the same return every year, but portfolios do not operate that way. In some cases, you may invest the same way, and over a 20-year period, you may achieve returns of 10% or more. In a different 20-year period, you might generate only 4% returns. Average returns do not work, and half the time, returns will be below average. Most people do not want a retirement plan that only works half the time. A better option than using averages is to use a lower return in your planning – something that reflects some of the worst decades of the past. You can also create a laddered bond portfolio so that a bond matures each year to meet your cash flow needs. You can cover the required cash flow value for the first five to ten years.
This way, the remainder of your portfolio can be in stocks. Since this part of the stocks is still in the accumulation phase, you can choose to take any gains from it to purchase more bonds during or after years of strong stock market returns.
The best thing you can do is understand that all options involve a trade-off between risk and return. Develop a retirement income plan, take a disciplined and time-tested approach, and expect to be flexible.
Source: https://www.thebalancemoney.com/how-sequence-risk-affects-your-retirement-money-2388672
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