Are you thinking about retirement? Whether you’re currently retired, approaching retirement, or simply curious about future planning, understanding the risks that can impact your financial security is critical. Today, we’ll explore one of the biggest retirement risks: the sequence of risk.
What is the Sequence of Risk?
The sequence of risk, or sequence of returns risk, refers to the order in which investment returns occur. It’s not just about how much your investments earn, but when those gains or losses happen. If your portfolio experiences significant losses early in retirement, the impact on your long-term financial health can be substantial—even if the market eventually recovers.
For example, let’s say you’ve saved $500,000 or $1,000,000 in retirement assets. If you experience a market downturn early in your retirement, and you’re withdrawing $300,000 annually from your savings to cover living expenses, you may deplete your assets faster than expected. This scenario could leave you with insufficient funds to sustain your lifestyle throughout retirement.
How Market Trends Impact Retirement
Market fluctuations can significantly affect your retirement savings. The value of your portfolio may rise or fall depending on market trends, which we often refer to as the sequence of returns. A rising market will help grow your savings, but a downturn—especially early in retirement—can shorten the lifespan of your portfolio. This is why the sequence of returns is a critical factor in retirement planning.
Everyone who has retired has experienced a bad market at some point, and longevity only multiplies this risk. The longer you live, the more likely you are to face periods of poor market performance, which can deplete your savings faster than anticipated.
Preparing for the Sequence of Risk
While it’s impossible to predict exactly when the market will dip, there are several strategies you can use to protect your retirement income from the sequence of risk.
1. Diversify Your Portfolio
Diversifying your portfolio means spreading your investments across different asset classes, such as Canadian and U.S. stocks, global stocks, and real estate. This strategy helps mitigate risk by reducing your exposure to a downturn in any single market sector. However, be mindful not to over-diversify, as this can dilute your returns.
2. Use a Dynamic Withdrawal Rate
Instead of withdrawing a fixed amount each year, consider adjusting your withdrawal rate based on market performance. In good years, you can afford to take out more; in bad years, you might reduce your withdrawals or tap into other assets. This flexibility helps protect your savings when the market takes a hit.
3. Consider a Bucket Strategy
The bucket strategy divides your assets into short-term, mid-term, and long-term buckets. The idea is to keep your short-term funds in safer investments, like cash or low-risk bonds, while allowing your long-term investments to grow in riskier assets like stocks. This approach reduces the need to sell assets during market downturns, protecting your portfolio from the sequence of risk.
4. Look into Guaranteed Income Products
While annuities may not be for everyone, they can provide guaranteed income for life, transferring investment risk to an insurance company. This strategy can offer peace of mind, especially for those concerned about outliving their savings.
5. Delay CPP and OAS
Delaying your Canada Pension Plan (CPP) and Old Age Security (OAS) benefits can significantly increase your guaranteed income. This higher income reduces the pressure on your investments, giving your portfolio more time to grow while providing a reliable income stream.
Don’t Let the Sequence of Risk Derail Your Retirement
The sequence of returns is a risk that every retiree will face at some point. However, by diversifying your portfolio, adjusting your withdrawal strategy, and implementing other protective measures, you can better prepare for market downturns and safeguard your retirement.
It’s always advisable to consult with a financial advisor who can tailor a plan to your unique needs. After all, you only want to retire once, and a well-thought-out strategy can help ensure that your retirement is secure for the long haul.
If you found this blog helpful, feel free to reach out for a discovery call, or check out my book. Stay informed and take control of your financial future!
