Understanding Sequence Risk: The Retirement Pitfall
Sequence risk, also known as sequence of returns risk, is the danger that the timing of withdrawals from your retirement account will negatively impact the overall amount of money available for your retirement. This risk is particularly acute during the early years of retirement, when large withdrawals coupled with market downturns can severely deplete your savings.
Unlike average returns, which provide a long-term view of investment performance, sequence risk focuses on the order in which returns occur. Even if your portfolio has an average return over time, poor returns in the initial years of retirement can significantly reduce your nest egg, making it difficult to recover.
The Impact of Market Volatility on Retirement Savings
Market volatility plays a crucial role in sequence risk. Fluctuations in the market can lead to periods of high returns followed by sharp declines, or vice versa. When you are withdrawing funds for living expenses during retirement, these fluctuations can have a pronounced effect on your financial stability.
For instance, if you experience a market downturn early in retirement while making withdrawals, you may be forced to sell investments at a loss, thereby locking in those losses and reducing the future growth potential of your portfolio. Conversely, experiencing strong market returns early on can provide a buffer, making it easier to weather future downturns.
Strategies to Mitigate Sequence Risk
One effective strategy to mitigate sequence risk is to create a diversified investment portfolio that balances risk and return. This can help smooth out the impact of market volatility over time. Hedged equity strategies in particular can be effective in allowing you to adequately weather any significant market fluctuations during pre-retirement or retirement. Additionally, allocating some of your investment funds into fixed income bond ladders may also provide a source of funds that are not subject to market fluctuations. These tactics will help allow you to avoid selling investments at a loss during downturns.
Another approach is to adopt a flexible withdrawal strategy. Instead of withdrawing a fixed amount each year, you can adjust your withdrawals based on market performance. For example, you could reduce withdrawals during years when the market performs poorly and increase them when returns are strong. This flexibility can help preserve your portfolio's longevity.
The Role of Diversification in Protecting Your Nest Egg
Diversification is a key component in managing sequence risk. By spreading your investments across a variety of asset classes, such as stocks, bonds, and alternatives, you reduce the impact of any single investment's poor performance on your overall portfolio. This balanced approach can help stabilize returns and reduce the likelihood of significant losses during market downturns.
Working with a Financial Advisor to Secure Your Retirement
Navigating sequence risk and market volatility requires careful planning and a thorough understanding of your financial situation. A financial advisor can help you develop a comprehensive retirement strategy tailored to your specific needs and risk tolerance. They can provide guidance on asset allocation, withdrawal strategies, and diversification, ensuring that your retirement savings are protected against sequence risk.
Additionally, a financial advisor can help you stay disciplined and avoid emotional reactions to market fluctuations. By keeping you focused on your long-term goals and providing ongoing support, they can help you make informed decisions that enhance the security of your retirement.
To ensure alignment of all aspects of your financial life, consider reaching out to a NorthCoast financial advisor to schedule a review.
NorthCoast Asset Management is a d/b/a of, and investment advisory services are offered through, Kovitz Investment Group Partners, LLC (Kovitz), an investment adviser registered with the United States Securities and Exchange Commission (SEC). Registration with the SEC or any state securities authority does not imply a certain level of skill or training. More information about Kovitz can be found at www.kovitz.com.
NorthCoast and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
The information contained herein has been prepared by NorthCoast Asset Management ("NorthCoast") on the basis of publicly available information, internally developed data and other third party sources believed to be reliable. NorthCoast has not sought to independently verify information obtained from public and third party sources and makes no representations or warranties as to accuracy, completeness or reliability of such information. All opinions and views constitute judgments as of the date of writing without regard to the date on which the reader may receive or access the information, and are subject to change at any time without notice and with no obligation to update. This material is for informational and illustrative purposes only and is intended solely for the information of those to whom it is distributed by NorthCoast. No part of this material may be reproduced or retransmitted in any manner without the prior written permission of NorthCoast. NorthCoast does not represent, warrant or guarantee that this information is suitable for any investment purpose and it should not be used as a basis for investment decisions. © 2024 NorthCoast Asset Management.
PAST PERFORMANCE DOES NOT GUARANTEE OR INDICATE FUTURE RESULTS.
This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or investment products or to adopt any investment strategy. The reader should not assume that any investments in companies, securities, sectors, strategies and/or markets identified or described herein were or will be profitable and no representation is made that any investor will or is likely to achieve results comparable to those shown or will make any profit or will be able to avoid incurring substantial losses. Performance differences for certain investors may occur due to various factors, including timing of investment. Investment return will fluctuate and may be volatile, especially over short time horizons.
INVESTING ENTAILS RISKS, INCLUDING POSSIBLE LOSS OF SOME OR ALL OF THE INVESTOR'S PRINCIPAL.
The investment views and market opinions/analyses expressed herein may not reflect those of NorthCoast as a whole and different views may be expressed based on different investment styles, objectives, views or philosophies. To the extent that these materials contain statements about the future, such statements are forward looking and subject to a number of risks and uncertainties.
