The sequence of returns risk can significantly impact retirement savings, particularly when negative market returns occur early in retirement. For instance, if a retiree invested half of their funds in the Indian equity market in December 2007, they would have faced substantial losses when the market declined by over 60% in October 2008. This risk, also known as the order in which returns are experienced, can affect the longevity of retirement savings.
Consider two retirees, A and B, who made investment decisions based on different market conditions. Retiree A invested in an Index Fund in March 2003, witnessing significant growth by December 2007. In contrast, Retiree B, influenced by A's success, faced losses during the mentioned market downturn. The unpredictability of market patterns makes it challenging to anticipate specific gains or losses in advance.
During retirement, negative returns become more problematic as regular withdrawals are made, leading to actual losses. Unlike the accumulation phase, where ongoing contributions can absorb market fluctuations, retirees may experience a shortened longevity of their funds if a downturn occurs early in retirement.
To mitigate this risk, investors can adopt various strategies. The bucket strategy, proposed by Harold Evensky, divides retirement savings into cash and investment buckets. The cash bucket covers living expenses for a specified period, acting as a buffer during market downturns. Diversification is another crucial strategy, spreading investments across asset classes to protect against poor performance in a specific class. Additionally, the dynamic withdrawal strategy adjusts withdrawals based on portfolio performance, allowing investors to preserve their funds during bear markets.
Awareness of the sequence of returns is the first step in risk mitigation. Understanding that a significant downturn early in retirement could impact longevity prompts investors to take preventive measures. By implementing strategies like the bucket strategy, diversification, and dynamic withdrawal, retirees can navigate market volatility more effectively and enhance the resilience of their retirement funds.
