Knowledgeable investors are aware that investing in the capital markets presents any number of risks – interest rate risk, company risk, and market risk.
Risk is an inseparable companion to the potential for long-term growth. Though some risk can be mitigated through diversification, it does not eliminate the risk of loss if security prices decline. Chances are, this is a risk you were very willing to take when you started investing for your future.
Did you know? As an investor, you face another, less-known risk for which the market does not compensate you, nor can it be easily reduced through diversification. Yet, it may be the biggest challenge to the sustainability of your retirement income or other goal funding.
This risk is called the sequence of returns risk.
The sequence of returns risk refers to the uncertainty of the order of returns an investor will receive over an extended period of time. As Milton Friedman once observed, you should “Never try to walk across a river just because it has an average depth of four feet.”
Sequence of Returns
Mr. Freidman’s point was that averages may hide dangerous possibilities. This is especially true with the stock market. You may be comfortable that the market will deliver its historical average return over the long-term, but you can never know when you will be receiving the varying positive and negative returns that comprise the average.
The order in which you receive these returns can make a big difference.
For instance, a hypothetical market decline of 30% is not to be unexpected. However, would you rather experience this decline when you have relatively small retirement savings or at the moment you are ready to retire or withdraw money to fund the goal you’ve been working toward – when your savings may never be more valuable?
Without a doubt, the former scenario is preferable, but the timing of that large, potential decline is out of your control.
Timing, Timing, Timing
The sequence of returns risk is especially problematic while you are in retirement. Down years, in combination with portfolio withdrawals taken to provide retirement income, have the potential to seriously damage the ability of your savings to recover sufficiently, even as the markets fully rebound.
This is one reason we discuss with clients the option of reducing their risk posture over time, or as they get nearer to their goal and are planning to start withdrawing funds to support that goal.
When we’re talking about the goal of retirement, it’s more of an age-based conversation, but this isn’t always the case. Goals may revolve around funding education for your children or purchasing a home. These are more timing-based scenarios than age based scenarios so there’s more to consider than just the timing of your retirement.
Our investment team implements rigorously researched investment strategies designed to help our clients acquire, grow and preserve their wealth. By understanding your preferences, appetite for risk, goals and your timeline, we select and manage an investment allocation specifically tailored to meet your needs.
If you are nearing retirement, already in retirement, or nearing the complete funding of one of your financial goals, it’s time to give serious consideration to the “sequence of returns risk.” If you aren’t working with our team, it’s also time to ask questions about how you can better manage your portfolio.
Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this content, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for you or your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Searcy Financial Services, Inc.
The content of this letter does not constitute a tax or legal opinion. Always consult with a competent professional service provider for advice on tax or legal matters specific to your situation. To the extent that a reader has any questions regarding the applicability of any specific issue discussed in this content, he/she is encouraged to consult with the professional advisor of his/her choosing.
Published for the blog on August 12, 2019 by Searcy Financial Services, your Overland Park, Kansas Fee-Only Financial Planner and Investment Manager.