Negative returns near retirement could mean less money to live on than if you were to experience the same returns several years earlier, or later.
Why does sequencing risk matter in retirement?
Sequencing risk is greatest at, or near, retirement when your retirement savings tend to be at their highest value. A run of negative returns close to retirement, can be hard to recover from. There are two key reasons for this - time and withdrawals.
In retirement, you don’t have as much time to recover from falls in the share market. It can take six to ten years for share markets to recover from significant dips. If you’re withdrawing money in the form of account-based pension payments for example, it’s even harder for the value of your investments to recover. That’s because withdrawing money from investments that are performing poorly is usually more costly.
A real-world example of sequencing risk in retirement
The impact of sequencing risk means two investors can experience the same average share market returns over a 20-year period and yet one person can run out of money sooner than the other. This is all because of timing, as shown in this chart below.
The blue line shows the actual value of a retirement portfolio invested in 50% Australian equities and 50% bonds between 1992 and 2019. The green line shows the value of that same portfolio if the order of the returns had been reversed. In this case, poor returns at the start of the sequence would have had a significant impact on the value of the investor’s savings.
It’s not possible to control the performance of the share market, or the order in which you experience returns, but there are strategies available to help you manage sequencing risk. We cover some of your options below.
The example shown in the chart above uses a hypothetical investor and is based on historical Australian market performance data for the period 1992 to 2019. The investor illustrated in the chart retired at the end of 1992 with an investment balance of $350,000. His portfolio was 50% invested in Australian equities and 50% in Australian bonds. Following his retirement, he lived off his retirement savings, drawing $22,530, indexed to inflation, each year.
Managing sequencing risk in retirement – what are the options?
Here are some steps you can take to manage sequencing risk in retirement:
- Check in with a financial adviser to make sure you are comfortable with your current investments and the risk you’re taking on. Reducing your exposure to the share market may help to reduce sequencing risk.
- Consider complementing your existing retirement income with income that’s not linked to the performance of the share market, such as a lifetime annuity.
- Talk to an adviser about using an income ‘bucketing’ strategy. In very simple terms, this means having enough cash set aside so you can recover from a large fall in the share market before you continue to withdraw income.
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