How Sequence of Returns Risk Could Affect Your Retirement—And What HNW Investors Should Do

Sequence of returns risk, which is the danger of poor investment returns early in retirement combined with the timing of withdrawals, can adversely impact how long your retirement funds will last.

For high-net-worth (HNW) investors, this threatens not only their financial security but also their ability to leave a lasting legacy.

Understanding Sequence of Returns Risk

Investors who experience negative investment returns in their portfolios early in retirement may have reduced longevity of their retirement income. This is known as the sequence of returns risk.

When retirees start withdrawing retirement funds during periods of market downturns, the value of their portfolios decreases quickly, leaving less capital available to recover when the markets begin improving.

This can be particularly damaging to HNW investors who, while having a larger amount of assets, generally also have higher expenses and dreams of leaving a legacy with their wealth.

How to Mitigate Sequence of Returns Risk

Diversify your portfolio: Diversified investment portfolios can mitigate the impact of market downturns; while some assets may perform poorly, others may not lose as much value or may even appreciate. Ensure you have a mix of asset classes: stocks, bonds, commodities, real estate, etc.

Have a flexible withdrawal strategy: Rather than relying on a fixed withdrawal schedule, such as taking out $1,000 every month, consider an approach that allows flexibility during market downturns—for example, reducing withdrawals and relying on other sources of income. This keeps a larger amount of capital in your portfolios that can recover when the market reverses.

Steve Branton, certified financial planner (CFP) and managing director at Wealthspire Advisors, suggests that “At certain predetermined trigger points (10% market correction, 20% bear market), consider reducing the monthly draw by a predetermined amount (like 10%) or have the option to pause entirely any discretionary withdrawals to avoid locking in losses and cutting more into principal during a downturn. Instead, tap into cash reserves, ultra-short-term bonds, or money market funds to meet spending needs and allow the stock portion of the portfolio time to recover.”

Keep a cash reserve: Allowing yourself a cash cushion to rely on when the market drops, rather than taking out retirement income, will also help preserve capital. This will allow you to meet basic expenses, such as food, without requiring you to sell your assets at depressed values.

Delay big expenses: When the market is volatile, it’s best to delay large expenses, such as the purchase of a new car, until there is more predictability.

Legacy and Estate Planning

For HNW individuals, passing on wealth to future heirs and preserving a legacy through charitable actions is often a financial goal. Sequences of returns can challenge these plans and need to be managed effectively.

Incorporating legacy and estate planning strategies, such as creating trusts, tax-efficient donations, and using life insurance, can help achieve your legacy goals regardless of how the financial markets perform.

In addition, Branton says, “Optimize your asset allocation during a downturn by reallocating investments across taxable, tax-deferred (individual retirement accounts), and tax-free (Roth) account types to maximize long-term return over the course of retirement. For example, concentrate high-growth, tax-inefficient assets like real estate investment trusts in Roth IRAs.”

Branton also adds that “Roth converting during declining markets can lock in lower tax costs on the future growth of the investments. Using the current sky-high estate tax exemption level (set to expire by year-end) could allow certain high-net-worth families to shift out of their estate more assets while valuations are temporarily depressed.”

The Bottom Line

A comfortable and financially secure retirement isn’t just about amassing retirement funds. It’s also about how and when you use those retirement funds. Market timing combined with withdrawals has a significant impact on your nest egg, especially during times of market upheaval.

This is damaging for everyone and can impact the legacy plans of HNW individuals. Strategies, such as diversification, a cash pile, thoughtful planning, and strategic spending, can be employed by all to help reduce the ramifications of a bad market.