The investing road to retirement can be invigorating.
You make regular contributions to an IRA or a 401(k), buy individual stocks or find other investments for your money, and you watch your portfolio’s value grow.
There might be times when growth halts or you lose money. But you hold steady with your aggressive approach, a rebound happens and the dollar figure trends upward once again.
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As you near retirement, however, you begin to wonder: Will I eventually run out of money?
That’s a legitimate concern. Unfortunately, it’s more likely to become reality if you continue the aggressive investing decisions that helped you accumulate that hefty dollar amount for your retirement. And that’s all thanks to sequence of returns risk.
What is sequence of returns risk?
Put simply, sequence of returns risk is the fact that, in retirement, the overall return on your investment is less important than the order in which those returns happen.
If the market soars during your first years of retirement, you likely can withstand market losses later. But if your investment losses happen in the first five to 10 years of retirement and you are making withdrawals to live on at the same time, your portfolio balance can evaporate quickly.
When the market eventually rebounds, you could have little or nothing left in your portfolio that would allow you to capitalize on that recovery.
In other words, you are a victim of the order in which returns on investments happen.
Two retirees with the same portfolio balance, the same withdrawal rate and the same average return over a 20-year span could have very different results.
The retiree who has a strong market performance in the early years likely could weather a poor performance later. The retiree who had a poor performance early might never recover.
Where will money come from in retirement?
One way to mitigate sequence of returns risk is to ease up on your investing when you’re about five years from retirement and begin planning how you can turn at least a portion of your savings into retirement income. That way, in a market downturn, you aren’t forced to sell some of your investments at a loss.
The first thing to do is determine your income needs.
Someone who earned $6,000 a month during their final working days might want to continue to have that amount available in retirement. Others might decide they can get by on a little less than their final salary — say 80% or 90%.
Then you need to determine where the money will come from.
Social Security is a main source of retirement income, but it typically equals about 40% of someone’s final salary. Unless you have a pension, you will need to make good use of your savings to make up the difference between that amount and your income goal.
That’s where wise investing comes into play.
Previously, I mentioned that when nearing retirement, you should ease up on aggressive investments so that you don’t see a volatile market swallow everything you worked so hard to save. But you can’t ease up entirely. Going too conservative also has its drawbacks.
Take CDs, for example. Long ago, they could generate ample income. In the mid-1980s, you could have lived off the interest on CDs because rates rose into double figures. In those days, $500,000 deposited into a one-year CD might have generated 11% in interest, giving you $55,000 a year.
That opportunity is long gone. These days, CDs barely keep up with inflation — if that. Putting a portion of your money into CDs is fine, especially since your principal is protected, but don’t count on them to produce a large amount of income for you.
The diversified income strategy
Another option is a fixed index annuity with lifetime payouts. With a fixed index annuity, you pay a premium to an insurance company, and in return, you receive a regular, guaranteed income.
Other potential income sources in retirement include dividend-paying stocks, U.S. Treasury securities, bonds and real estate investment trusts.
Ideally, you should have a diversified income strategy that balances guaranteed income sources with investment income. But don’t create a strategy and think you’re done. Revisit your plan about once a year to see how things are working and whether you need to make adjustments.
If you’re unsure about the best investing strategy for your retirement needs, a financial professional can discuss your goals with you and help you review the options.
Ultimately, the goal is for your savings to continue to work for you, no matter how long your retirement lasts.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
