One of the biggest things that create problems for people who retire is a market decline at the wrong time …. just as they retire.
The reason is easy to understand.
Retirement usually corresponds to the time people have gathered the most assets. Let’s assume that the retiree has managed to gather a million dollars. If this money is fully invested in the stock market and the market goes down 50%, he’s lost $500,000. Suddenly half the money he’s put aside has evaporated, just as he started on his retirement journey. If this happens the retiree may run out of money much earlier than planned.
This is referred to as “sequence of returns” risk. It applies to the time people begin to withdraw their money to fund their retirement dreams. One pension consultant believes that there is a 10 year period when this risk is greatest: five years before retirement and five years after. This is the time when portfolio balances are highest and the amounts of money that can be lost are greatest.
In contrast, a big loss at the beginning of the time we begin to save has much less impact. Simply put, if we put $2000 aside to begin our savings journey to retirement, a 50% loss is only $1000. That’s a lot less damaging than losing the same percentage of a million dollars. Plus we have much less time to make it back.
That’s why “sequence of returns” has very little impact when we’re accumulating assets, but a big impact when we’re taking money out.
Risk control is important at all stages of life, but especially as we’re near – on into – retirement.