Sequence of returns risk: more important 
now than ever

WHY timing is money in retirement.
As Americans contend with the threats of the coronavirus, we are challenged not only to protect the health and safety of our loved ones, but also to safeguard our financial future. The uncertainty of our financial markets and broader economic picture raise concerns for those in, or nearing retirement. With a clearer understanding of the retirement landscape and financial risks in retirement, particularly the sequence of returns risk, individuals can plan for a more secure financial future.

They say ‘time is money’ but when it comes to retirement, it’s often timing that matters most. Significant losses or depletions to savings early in retirement could derail retirement plans by diminishing a retiree’s nest egg. This is known as the sequence of returns risk and it is an important concept to discuss – and plan for – particularly in times of market volatility.

WHEN losses occur is important.
Losses and significant withdrawals occurring early in retirement after a market downturn can have severe consequences to a retiree’s portfolio. Because any possible future gains would now accrue off a smaller base, a retiree may not have the time to benefit from a market recovery, particularly if they need to make additional withdrawals to their portfolio.

WHAT solutions are available.
Income annuities are a useful hedge against sequence of returns risk for two main reasons: 1) they provide a guaranteed source of lifetime income that is not correlated to market ups and downs or interest rate fluctuations, and 2) annuity income, which can be higher than other fixed-come assets of similar quality, lowers the withdrawals that retirees take to cover expenses. This is particularly good news when the market performs poorly in the early years of retirement by helping retirees avoid selling at the bottom.

HOW to offset risk.
It may seem that a simple solution for reducing a retiree’s sequence of returns risk would be to encourage pre-retirees to reduce equity holdings in their portfolio in favor of fixed-income investments. However, this approach compromises the portfolio’s upside potential and may even lead to quicker depletion of one’s long-term savings. Retirees that are heavily invested in fixed-income face the risk of depleting their investments prematurely. Portfolios with higher allocations to equities have typically outperformed, because downside volatility in the U.S. equity markets has historically been short-lived.

Without proper planning, the sequence of returns early in retirement can have a significant impact on a retiree’s financial well-being in retirement.  Adding income annuities to a retirement strategy may be an efficient way to hedge against sequence of returns risk. Simply put: income annuities are not subject to the fluctuations of capital markets and will reduce the net withdrawals from their portfolio. Having additional sources of guaranteed lifetime income also reduces the role luck plays in retirement outcomes.

Dylan Huang
SVP, Head of Retail Annuities