Sequencing risk is when the order and timing of your investment returns are unfavourable. This risk is hidden to some degree and is a subset of market risk / volatility.
That sounds a little technical, so here’s an example:
This is a really common concern for people, and we’ve seen it with our clients. Sequencing risk is the fear of a drop in the market right before retirement. People understand there is a risk but don’t always know how to fix it, and we see that they either over-cater for it or don’t take it into account at all. There’s a middle ground there, and that’s what we need to find.
If you withdraw your money after a drop in the market, your money won’t actually be around to see the recovery of the market. For example, if you retire with $1 million but it’s reduced to $500,000 due to a drop in the market and you withdraw $50,000 a year, then that 10% will really be eating into your funds. The market wouldn’t recover fast enough to keep you living off it for long.
We’ve seen examples of people keeping $300,000 in cash to live off for 6 years in the case of such a crash. And although they are reducing their sequencing risk, they are replacing it with purchasing power risk – that with inflation, the money is not going to be quite enough on a yearly basis.
What should you do?
Our key message here is that flexibility is invaluable. Be prepared for years during retirement where you can afford to draw a large amount from super, and go to South America, the south of France or even Antarctica – but also be prepared for the years where you have to be more low-key and perhaps stay local; spend time with friends and family instead. It’s different, but you can still make it enjoyable.
Listen to the related podcast here!
Dallas Davison, Michael Hogue and Ali Hogue.