Sequence of Returns Risk: Are You in the Red Zone?

Sequence of returns risk

In football, the space within 20 yards of the opposing team’s end zone is known as the Red Zone. The goal is so close the offense can taste it. But the defense knows they’re in trouble, so they step up their game. Scoring in the Red Zone can be very difficult.

The same can be said of saving and planning for retirement. The closer the end zone (retirement), the more difficult it can be to make progress toward the goal, and any fumbles in the market could mean big trouble.

Sequence of Returns Risk

Do you fully understand the dangers of the Red Zone, a.k.a. the “Fragile Decade,” that 10-year period surrounding retirement in which the sequence of events and decisions made will have the greatest effect on retirement outcomes?

The right strategy for success in the Red Zone may look different than what you’ve done the last 25 years. There’s a good chance you’ll need to craft a more custom retirement income approach around these critical years.

Sequence of Returns Risk

People approaching their targeted retirement date in five years or less need to identify not only items such as how much income they’ll need, when to enroll in Medicare, and how to optimize social security, but they should also adjust their asset allocation in order to minimize sequence of return risk.

There has been extensive research on sequence of return risk and which retirement income strategy makes the most sense for pre-retirees and retirees (probability-based or safety-first?). The work in this area is invaluable as people approaching retirement should assess their ability to retire using numerous factors and modify risk exposure as their human capital moves closer to zero.

One solution we often find useful is a rising equity glide path. While it’s not for everyone, it can be used to:

  • Reduce portfolio volatility
  • Employ academic evidence for a valuation-based approach
  • Help investors who can’t afford to take significant equity market risk
  • Assist those who desire a probability-based approach, but fear and behavioral reasons loom

Sequence of Returns Risk

When determining an appropriate asset allocation or glide path approach, it’s important to be mindful of key considerations:

  • Would a steep equity market drop in the near-term have a significant impact as you approach retirement?

Most would probably say yes; however, a financial professional will have a better view of the real answer. They can educate and understand whether this would be the case and how to structure your individual retirement income solution accordingly.

  • Will you be able or desire to maintain a flexible spending approach in retirement to account for market fluctuations and other conditions?

Often this depends on one’s view on essential vs. discretionary needs. Some may view all of their needs as “essential” given how hard they have worked to be able to retire. Maintaining a flexible spending approach can help improve their outcome given the current interest rate environment and market conditions.

  • Is your advisor able to effectively communicate this type of approach with you?

This kind of discussion needs to be approached deliberately and cautiously. It’s hard to know the difference between a total return, bucketing, or rising glide path strategy. That’s where your advisor comes in. We can help you understand how these types of approaches may improve your outcome in retirement.

With the large number of individual investors currently living in the Red Zone, it’s important you not be exposed to excessive or unnecessary portfolio risk. Advisors are your offensive line, watching out for obstacles and danger. This is a significant opportunity to create customized solutions at a time when you need it most.

Do you use the appropriate retirement income strategies to reduce sequence of return risk? Contact us today to to see what we can do for you.

 

McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

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