Wealth Management: Sequence of Returns

As you may have heard 2022 was an unprecedented year for investors. The equity markets saw a significant decline that coincided with one of the worst bond markets in recorded history. A year like 2022 coupled with the first few years of withdrawals during retirement can jeopardize the success of a retirement plan. The sequence of returns in retirement is often times overlooked in the planning process.

The sequence of returns refers to the order in which investment returns are experienced over a specific period. When you're drawing down retirement savings, the sequence of returns becomes crucial because it can significantly impact the longevity of your portfolio and your ability to sustain a desired standard of living throughout retirement.

The sequence of returns matters for several reasons:

Portfolio Performance: The performance of your investments in the early years of retirement can have a lasting impact. If you experience poor returns or significant losses early on, it can deplete your portfolio more quickly and reduce the overall value of your investments.

Withdrawal Rate: The sequence of returns affects the sustainability of your chosen withdrawal rate. A withdrawal rate is the percentage of your portfolio that you withdraw annually to cover expenses. If poor returns occur early in retirement when you're withdrawing funds, it can lead to a higher depletion rate, forcing you to withdraw a larger percentage of your portfolio to maintain your standard of living. This increased withdrawal rate may put your portfolio at risk of running out of money prematurely.

Loss Aversion: Humans tend to be loss-averse, meaning we feel the pain of losses more than the pleasure of equivalent gains. If you experience significant investment losses early in retirement, you may be more inclined to make emotional decisions like selling investments at a low point, which can further erode your portfolio's value.

To mitigate the impact of unfavorable sequence of returns, you can consider the following strategies:

Diversification: Maintain a diversified investment portfolio to spread risk across different asset classes. This can help reduce the impact of poor performance in a single investment.

Asset Allocation: Allocate your investments based on your risk tolerance and time horizon. Balancing assets that offer growth potential with those that provide stability can help manage volatility.

Flexibility in Withdrawals: Be prepared to adjust your withdrawal rate and spending habits based on market conditions. During periods of poor returns, consider reducing your withdrawals to protect the longevity of your portfolio.

Professional Guidance: Seek advice from a qualified financial planner or investment advisor who can help you create a retirement plan that considers the potential impact of the sequence of returns.

By understanding and accounting for the sequence of returns, you can make informed decisions to help safeguard your retirement savings and maintain financial security throughout your retirement years.

Michael Tomaw
Wealth Manager

First Merchants Private Wealth Advisors products are not FDIC insured, are not deposits of First Merchants Bank, are not guaranteed by any federal government agency, and may lose value. Investments are not guaranteed by First Merchants Bank and are not insured by any government agency. This material has been prepared solely for informational purposes. First Merchants shall not be liable for any errors or delays in the data or information, or for any actions taken in reliance thereon. Any views or opinions in this message are solely those of the author and do not necessarily represent those of the organization.