Your spending power today and also in the future is one of the primary determinants of your quality of life as well as your happiness. However, if you are not careful, your nest egg will not be properly shielded against the risk of sequence of returns. Let’s take a closer look at this risk and explain how to shield your savings properly.
Sequence of Returns Risk
Sequence of returns risk or SOR for short, is a reference to a down market that occurs near the time of retirement. If the market were to dip right around when you planned on retiring, your spending power in retirement would decline. In other words, you are at the mercy of the market, timing and macroeconomic factors. The worst-case scenario is a significant financial loss due to a market downturn immediately after retiring as there is no longer an opportunity to make up the difference by extending your career. However, you have the power to manage SOR.
Implement a Buffer
Those who are attempting to guard against the risk of SOR have several options. The right option for you hinges on your unique asset allocation, appetite for risk, wealth level and other nuanced factors. SOR risk can be mitigated by determining exactly how much money is necessary in retirement to pay for essentials ranging from healthcare costs to insurance, utilities, food, the monthly mortgage payment, etc. then developing a portfolio consisting of sources of guaranteed income. Examples of such guaranteed income include annuities, Social Security payments, pensions and fixed income assets.
The aim is for these sources of fixed income to cover daily expenses so the market’s fluctuations do not force you to go back to work after retiring. Though there is always the potential to pick up contract work or downsizing, prudent planning is designed to prevent such undesired outcomes. If you aren’t a fan of the strategy detailed above you can shield your money by holding a cash position that equates to half a year or a year of living expenses, relying on this cushion when the market dips and building it back when the pendulum swings the other way.
Flexibility is the Name of the Game
Most retirees assume they will be able to use a specific percentage of their savings and investments, gradually increasing the amount to offset inflation. Such a strategy usually proves prudent as long as unexpected hurdles do not arise. History has shown this approach makes it that much easier to generate a steady flow of income while amassing that many more assets. However, there is the potential for the unexpected to occur.
If the market does not perform as expected or if your desires/needs are not aligned with your budget, your planned withdrawals might not work out as anticipated. You can avoid such an unenviable outcome by being flexible. Be open to the idea of altering your withdrawal plan every couple years to keep pace with the market and other factors.
Continue to Adjust as Necessary
Adapt to the changing economy and stock market as required in the years ahead and you will find your retirement proves that much more enjoyable. Though you cannot account for every hypothetical scenario, you are empowered to pivot, making the necessary alterations to your withdrawal strategy.
Any opinions are those of Paramount Wealth Management and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Investments mentioned may not be suitable for all investors. Guarantees are based on the paying ability of the issuer.