Why Sequence of Returns Risk Matters

The stock market initially posted a major drop at the beginning of the U.S. coronavirus outbreak. Since then, it has gained back some ground, but there continues to be daily volatility with no end in sight. That initial shock affected a lot of people, with the greatest concern often among those who have either recently retired or were planning to within the next year or so. This is an example of what market analysts call “sequence of returns” (SOR) risk in action. SOR is when there has been a sustained market decline (i.e. a poor sequence of returns) that severely reduces an investor’s principal right around the time he or she retires.

Ideally, an investor will transition portions of portfolio assets to more conservative holdings as he or she gets closer to retirement. However, since we are in the midst of an economic crisis, the following strategies are intended to help investors who have already lost significant principal and need to figure out what to do to help repair their retirement income plan.

SOR Strategy #1: Delay Retirement – The reason this could be an ideal solution is because you typically want to avoid retiring during or just after a market decline. Allowing time for the market to recover some of its losses could impact how long your money will last throughout retirement. An additional advantage to working one more year is that your Social Security benefit could accrue as well.

SOR Strategy #2: Reduce Expenses – If the last recession is any indicator, this economic recovery may take several years. If you must retire this year, then it’s important to take a serious look at your retirement budget to see where you can cut back expenses. By doing so, you can withdraw less from your portfolio each year, which will help your money last longer.

SOR Strategy #3: Develop Alternative Streams of income – Whether you continue working full time or not, it may be possible to develop other streams of income. For example, pursue an income-producing hobby, leverage some of your assets to generate real estate rental income, or use a portion of your funds to purchase an insurer-guaranteed income stream via an annuity. The goal is to create multiple sources of reliable income so that if one resource is reduced, such as a dividend cut, you have others that can help cover the loss. It can be ideal to have diversity among passive income sources so that you don’t have to work during retirement.

Annuities are insurance contracts designed for retirement or other long-term needs. They provide guarantees of principal and credited interest, subject to surrender charges. Annuity guarantees and protections are backed by the financial strength and claims-paying ability of the issuing insurer. Annuities are not a deposit of nor are they insured by any bank, the FDIC, NCUA, or by any federal government agency.

SOR Strategy #4: Establish a Distribution Plan – It is critical that you develop a viable distribution plan as you head into retirement. You don’t want to withdraw too much money early on, so that you can retain enough for the latter stages of retirement. Consider the following factors as part of your distribution strategy:

• At what age should you start taking Social Security?
• How much of your net worth should be moved to conservative vehicles?
• From which accounts should income be withdrawn first (e.g. tax-deferred or taxable accounts)?
• What will be your total required minimum distribution?
• Should you roll over 401(k) assets to an IRA?
• Would a Roth IRA conversion be appropriate?
• Who should be designated as beneficiaries for your 401(k), IRA or other retirement plan?

 If you don’t like the idea of possibly having to find part-time work during retirement, you should address your portfolio’s exposure to sequence of returns risk — now. It’s also worth considering that, in the not-too-distant future, Congress will have to find ways to reduce the growing federal deficit and national debt. This can be accomplished by increasing taxes and/or decreasing expenses — which might include things like Social Security and Medicare benefits. That is why now is the time to be proactive about your retirement income sources.

This is a difficult time, particularly for new or soon-to-be retirees. If you have questions or concerns about your retirement plan, give us a call at 801-465-6990. We’d love to help you feel confident in your retirement plan.