What Is Sequence of Returns Risk in Retirement?
The order in which investment returns occur can matter when you're withdrawing money from your retirement savings. Understanding this concept can help you think more carefully about income, withdrawals, and market volatility in retirement.
Why Can the Order of Returns Matter?
Two retirees could experience the same average investment return over a period of time, yet the timing of those returns can produce different results when withdrawals are being made.
Returns Don't Always Arrive in the Same Order
Investment markets move up and down over time. A period of strong returns followed by weaker returns is different from experiencing those same returns in the opposite order.
Withdrawals Change the Picture
During retirement, money may be withdrawn from investments to help meet income needs. The effect of those withdrawals can depend on what the portfolio is doing at the time.
Early Retirement Years Can Be Important
Market declines early in retirement can interact with withdrawals differently than declines that occur later. This is one reason retirement income planning considers more than an average return.
The key idea: investment returns are only one part of the retirement income picture. The timing of returns and withdrawals can also be relevant.
The Same Average Return Can Produce a Different Outcome
Consider two hypothetical retirement portfolios that experience the same set of annual returns, but in a different order. When withdrawals are being made, the timing of those returns can affect the path a portfolio takes.
Stronger Returns First
If stronger returns occur earlier, withdrawals may take place while the portfolio has experienced growth. The later declines still matter, but they occur at a different point in the withdrawal period.
Weaker Returns First
If weaker returns occur while withdrawals are already being made, the portfolio may have fewer assets remaining when later growth occurs. This illustrates why timing can matter.
This example is intended to explain the concept, not to predict investment results. Actual outcomes depend on factors such as investment performance, withdrawals, taxes, fees, inflation, and the length of retirement.
What Can You Consider When Planning for Retirement?
Sequence-of-returns risk is one of several factors that may be worth considering when creating a retirement income strategy. There is no single approach that applies to everyone.
Consider Your Withdrawal Strategy
Think about how much you expect to withdraw, when withdrawals may begin, and which accounts or sources of income may be used.
Consider Your Income Sources
Social Security, pensions, retirement accounts, investments, and other sources may play different roles in meeting retirement income needs.
Consider Market Volatility
Retirement planning can include thinking about how market declines could affect a portfolio while withdrawals are being made.
Keep the Bigger Picture in Mind
Taxes, inflation, spending needs, longevity, investment allocation, and changing circumstances can all be relevant to retirement income planning.
How might your retirement income plan respond if markets perform differently than expected?
Thinking through different possibilities can help you better understand the relationship between your investments, withdrawals, and other sources of retirement income.
How Could This Concept Apply to Your Retirement Plan?
Understanding sequence-of-returns risk is less about predicting markets and more about understanding how investment returns, withdrawals, and income needs can interact over time.
When might you begin taking withdrawals?
The timing of withdrawals can be an important part of thinking about how your retirement savings may be used.
Which sources could provide retirement income?
Consider how Social Security, pensions, retirement accounts, investments, and other income sources may fit together.
How much flexibility might you have with spending?
Understanding which expenses are essential and which may be adjustable can be useful when considering different market environments.
How could your plan respond to changing conditions?
Retirement circumstances can change. Reviewing income needs, withdrawals, investments, and other assumptions over time may be part of an ongoing planning process.
Retirement planning is about more than an average return.
Looking at the timing of returns, withdrawals, income sources, and spending needs can provide a broader view of the retirement income picture.
Retirement Income Planning Starts With Understanding the Bigger Picture.
Sequence-of-returns risk is one consideration among many when thinking about retirement income. Learning how withdrawals, investments, income sources, and changing circumstances can interact may help you ask more informed questions about your own retirement plan.