The Risks of Sequence Risk in Your Portfolio
As retirement approaches, the importance of managing your investment portfolio to mitigate risks becomes even more critical. One of the biggest risks that younger retirees face is sequence risk. This risk occurs when market downturns coincide with the beginning of your retirement or as you start withdrawing funds from your accounts.
When you withdraw funds from your portfolio during a market downturn, you may end up selling off more assets than planned to receive the same amount of cash. This leaves you with fewer investments to capture future growth when the market eventually rebounds. This sequence of returns risk can have a significant impact on your retirement savings and long-term financial security.
Diversify Your Portfolio
One way to combat sequence risk is to diversify your portfolio. As retirement nears, it’s important to adjust your portfolio allocations to include a mix of assets with varying levels of risk. By diversifying among different asset classes, you can help reduce the impact of market volatility on your investments.
"Diversification among several different asset classes can help make volatility less pronounced," advises Collin Lyon, a Wealth Strategy Advisor at Anderson Financial Strategies. Finding the right mix of assets will depend on factors such as your risk tolerance, goals, and life expectancy.
Build a ‘War Chest’ to Cover Living Expenses
To avoid selling assets in a down market, consider building a "war chest" to cover your living expenses. This includes keeping a six-month emergency fund and setting aside five years of expenses in fixed-income assets, such as bonds or CDs. Having this buffer can help you weather market volatility during times when sequence risk is highest.
Jonathan Bednar II, a Certified Financial Planner at Paradigm Wealth Partners, recommends having a war chest to help retirees navigate market fluctuations without compromising their long-term financial goals.
Opt for a Flexible Withdrawal Rate
Another strategy to protect your portfolio from sequence risk is to opt for a flexible withdrawal rate. Instead of withdrawing a fixed percentage, adjust your withdrawal rate based on market performance. By reducing withdrawals during years of negative returns, you can preserve the core of your portfolio and give your investments a chance to recover.
"Flexible withdrawals are a key tool in safeguarding your portfolio from sequence risk," says Brad Brescia, a CFP based in Orlando. While some retirement accounts may have required minimum distributions, adjusting your withdrawal rate based on market conditions can help you maintain financial stability throughout your retirement.
By implementing these strategies and staying informed about market trends, you can better protect your portfolio from sequence risk and ensure a more secure financial future. Visit Extreme Investor Network for more personalized insights and advice on managing your personal finances effectively.