Picking the right color to paint your money may seem like a frivolous task, but when it comes to investing, the wrong color can mean losing out on potential profits. The sequence of returns risk is one of the lesser-known risks investors face, but it can be just as damaging as market volatility or inflation. What is the sequence of returns risk, and how can you ensure your money is the right shade?
What is the sequence of returns risk?
For those who don’t know, “sequence of returns risk” is the risk that your portfolio will experience poor returns at the beginning of your retirement.
For example, look at the table below. Investors A and B are entering the distribution phase with a $1,000,000 balance. Pay close attention to the varying percent of annual returns, especially in the first 3 years.
| Distribution: $1,000,000 Starting Balance | |||||
| Investor A | Investor B | ||||
| Age | Annual Return | Portfolio Year-End Value | Withdrawals | Annual Return | Portfolio Year-End Value |
| 65 | -9.03% | $844,700.00
| 65,000 | 13.48%
| $1,069,800.00
|
| 66 | -11.85% | $679,603.05
| 65,000 | 31.15%
| $1,338,042.70
|
| 67 | -21.97%
| $465,294.26
| 65,000 | 15.89%
| $1,485,657.69
|
| 68 | 28.36%
| $532,251.71
| 65,000 | 2.10%
| $1,451,856.50
|
| 69 | 10.74% | $524,415.55
| 65,000 | 14.82%
| $1,602,021.63
|
| 70 | 4.83% | $484,744.82
| 65,000 | 25.94%
| $1,952,586.04
|
| 71 | 15.61% | $495,413.48
| 65,000 | -36.55%
| $1,173,915.84
|
| 72 | 5.48% | $457,562.14
| 65,000 | 5.48%
| $1,173,246.43
|
| 73 | -36.55% | $225,323.18
| 65,000 | 15.61%
| $1,291,390.20 |
| 74 | 25.94% | $218,772.01
| 65,000 | 4.83%
| $1,288,764.34 |
| 75 | 14.82% | $186,194.02
| 65,000 | 10.74%
| $1,362,177.64 |
| 76 | 2.10% | $125,104.10
| 65,000 | 28.36%
| $1,683,491.21 |
| 77 | 15.89% | $79,983.14
| 65,000 | -21.97%
| $1,248,628.19 |
| 78 | 31.15% | $39,897.89 | 65,000 | -11.85%
| $1,035,665.75 |
| 79 | 13.48% | -$19,723.88 | 65,000 | -9.03% | $877,145.13 |
This is an example of the sequence of returns risk. While the average annual return is the same in both scenarios, the order of those returns makes a big difference in terms of how long your money lasts.
What is red and green money?
Red money is money we’re willing to expose to market risk. We accept the possibility of losses, even significant losses, knowing there is the potential for greater gains. Red money is exposed to both upside and downside market risk.
With green money, we aren’t willing to accept the risk of losses. We’re okay with earning a lower return because we know our investment is safe. Green money has no downside market risk. Some annuities and insurance products are examples of this kind of safe money.
How do these colors tie into the idea of the sequence of return risk?
If you have a portfolio that is 100% exposed to the stock market (red money), then you are 100% subject to the sequence of return risk. All your money is at risk of being depleted if the market tanks early in retirement.
However, if you have a mix of red and green money, you may reduce your exposure to sequence risk. For example, let’s say you have a portfolio that is 50% stocks and 50% guaranteed rate annuities. If the stock market drops, you will still have the annuities to provide income. This can help ensure you don’t run out of money during retirement.
The key takeaway is that annuities and other safe money products may help protect you from the risk of poor returns early in retirement. If you’re worried about sequence risk, then speak with a retirement planning specialist about adding some green money to your portfolio.
Many people have learned about the power of using the Safe Money approach to reduce volatility. Our Safe Money Guide is in its 20th edition and is available for free.
It is an Instant Download. Here is a link to download our guide:
Safe Money Guide – Annuity.com
The exception is any article about life insurance. For ant life insurance articles, please use this one.
Many people are interested in looking at life insurance options with a Doing It Yourself. If you would like to explore that approach.
Here is the link: Life Insurance – Ethos (ethoslife.com)
