Sequence of Returns Risk
What happens in the market shortly before and after you retire is more important than you might think. If you retire during or before a market downturn, the combination of withdrawals and poor performance can quickly deplete your main source of income and make it difficult to recover. This is known as “sequence of returns” risk. Are you protected from poor financial market performance in the 10 or so years before or after you retire? Will you be forced to retire and begin withdrawing when the market is down? Will poor returns after you retire cause them to deplete your next egg?
As you can see below the market has always moved up and down in cycles. In fact, there have been exactly four long-term bull markets and exactly four long-term bear markets in its history. When it comes to your retirement you want the confidence of knowing you’re prepared for both.
The chart below shows sequence of returns risk in action. Even though both investors start retirement with the same amount, and take the same withdrawals, they have very different results. Why? Because of how different the markets perform when their retirements begin.
This is a hypothetical illustration and does not represent the results of an actual investment. It does not reflect any investment fees, expenses or taxes associated with investments. An average annual return of 4% is reflected for both investors. Annual withdrawals of $5,000 are taken at the end of each year.
Not only do different market cycles affect investment performance, the order in which these cycles
occur also matters. By taking a deeper look at the same two investors, you can see their annual returns over a 15-year period are the same. What’s different is the order of the returns, which has been reversed. Notice how much their investment value changes.