Timing Matters: Understanding Sequence-of-Returns Risk

If you're close to retiring, beware of the little-known sequence-of-returns risk that could take a huge slice out of your retirement income.

Experiencing a market drop in the early years of retirement can create problems that go beyond the immediate hit to your portfolio—potentially to the point where your portfolio may not last as long as you need. That could prove catastrophic if you're just embarking on what could turn out to be 25- or 30-year retirement.

Timing matters

At issue here is a phenomenon known as sequence-of-returns risk. "Sequence" refers to the fact that the order and timing of poor investment returns can have a big impact on how long your retirement savings last.

After all, a retirement portfolio generally isn't just a lump of cash in a savings account that you draw inexorably down to zero. It also includes a mix of investments that can provide both income and growth over time. Ideally, the growth will replenish at least a portion of what you take out, making your withdrawals more sustainable over the length of the retirement you've envisioned.

However, a major drop in the early years of retirement can scramble this picture. When you tap into your portfolio as it's losing value, you have to sell more investments to raise a set amount of cash. Not only does that drain your savings more quickly, but it also leaves you with fewer assets that can generate growth and returns during potential future recoveries.