Retirement planning is a crucial aspect of our financial journey, and there’s one significant risk that retirees often underestimate: the sequence of returns risk. In this blog, we’ll explore the key elements of sequence of returns risk, common mistakes retirees make when trying to mitigate it, and an effective strategy to safeguard your retirement nest egg.
Understanding the Sequence of Returns Risk
Sequence of returns risk refers to the danger of experiencing unfavorable investment returns early in retirement. Even if two portfolios have similar long-term average returns, if one experiences poor returns in the first 5 to 10 years of retirement, it can significantly impact the sustainability of your nest egg.
Let’s consider a scenario where we have two portfolios with nearly identical long-term returns. The only difference is the year of retirement. The sequence of returns can make a substantial difference in the outcomes, potentially leading to one portfolio running out of money.
Common Mistakes Retirees Make
When it comes to addressing sequence of returns risk, retirees often make common mistakes that can hinder their financial security:
1. Neglecting the Strategy Behind the Three-Bucket Concept
The three-bucket strategy is a popular approach to managing retirement income, which involves dividing your assets into conservative, moderate, and growth buckets. While this concept provides a quick snapshot of your risk allocation, many retirees miss out on the underlying strategies that make it effective.
2. Inconsistent Rebalancing
Rebalancing your portfolio is a crucial component of managing sequence of returns risk. However, many retirees rebalance infrequently, such as once a year, which may not capture the full benefits. Instead, trigger-based rebalancing, where portfolio positions are adjusted based on predetermined tolerance bands, can yield significantly better results.
Implementing Effective Strategies
To maximize the potential of your retirement portfolio and mitigate sequence of returns risk, consider these effective strategies:
1. Adopt the Three-Bucket Strategy
The three-bucket strategy provides a visual representation of your risk allocation. It offers peace of mind by ensuring you have a conservative bucket to rely on during market downturns. Regularly review and adjust this strategy to maintain a balance between safety and growth.
2. Embrace Trigger-Based Rebalancing
Trigger-based rebalancing is a dynamic approach that recalibrates your portfolio based on preset tolerance bands. This method can capture opportunities for added return during market volatility and help protect your retirement savings.
3. Seek Professional Guidance
Managing your retirement portfolio can be complex and time-consuming. Consider enlisting the help of financial professionals who specialize in retirement planning. They can apply these strategies effectively and ensure your retirement plan is tailored to your unique goals and needs.
Retirement planning is a multifaceted endeavor, and understanding and addressing sequence of returns risk is a critical component. By adopting the three-bucket strategy, implementing trigger-based rebalancing, and seeking professional guidance, you can enhance your retirement security and increase your chances of a financially secure retirement. Don’t let the sequence of returns risk catch you off guard; take proactive steps to protect your nest egg.
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Disclosures: Securities offered through LaSalle St. Securities LLC (LSS), member FINRA/SIPC. Advisory services offered through LaSalle St. Investment Advisors LLC (LSIA), a Registered Investment Advisor. Streamline Financial Services is not affiliated with LSS or LSIA. LSS is affiliated with LSIA.