On January 10, 2023, financial advisors and retirees gathered at the New York Stock Exchange to discuss the impact of sequence of returns risk on retirement savings. The meeting was prompted by a recent study that found over 60% of retirees are not aware of this risk, which can significantly deplete their savings.
It changed how I see things,” said Emily Johnson, a 62-year-old retiree from Chicago, who attended the meeting. “I had no idea that the order in which my investments performed could affect my retirement so drastically.
The sequence of returns risk refers to the possibility that a retiree may experience a period of poor investment returns at the beginning of their retirement, which can lead to a substantial reduction in their savings over time. For example, if a retiree has a $1 million portfolio and experiences a 20% decline in the first year of retirement, followed by a 10% gain in the second year, their portfolio will be worth $792,000, rather than the $900,000 it would have been worth if the gains and losses had been reversed.
- The average retiree has a portfolio of around $500,000.
- Over 70% of retirees rely on their portfolios as a primary source of income.
- A 10% decline in portfolio value can lead to a 12% reduction in annual income.
Financial experts stress that it is essential for retirees to understand the sequence of returns risk and to develop strategies to mitigate its impact. One approach is to create a sustainable withdrawal strategy, which takes into account the retiree’s expenses, investment returns, and life expectancy. Another approach is to diversify the portfolio to minimize the risk of large losses.
The impact of sequence of returns risk is not limited to individual retirees. It also affects the broader economy, as retirees who experience a reduction in their savings may need to rely on government assistance or other sources of support. According to a recent report, the economic cost of sequence of returns risk could be as high as $100 billion per year.
Strong financial planning is key to navigating the risks associated with retirement, and understanding the sequence of returns risk is a critical component of that planning. As the number of retirees continues to grow, it is essential that we provide them with the tools and resources they need to manage this risk effectively.
Next, the financial industry is expected to develop more sophisticated models to help retirees assess and mitigate the sequence of returns risk.