You’ve all heard the saying “time in the market, not timing the market”, but there is one aspect of your investing where timing can have an impact on the end result of the money available when you retire.
Most of us know there’s peaks and troughs to ride out as we make our way to retirement, but did you know the timing of the troughs can make a significant difference to the end picture?
Sequencing risk is not often talked about when discussing investments, but it’s an area of risk that needs to be addressed and mitigated as part of an overall investment strategy. This will help to ensure some comfort and security around your investment balance at retirement.
What is Sequencing Risk?
Investment results are often published showing an average return an investment has received over a particular time period, like 5 or 10 years. But sequencing risk isn’t just about the annual returns that happen in an investment, but also the timing of when those returns occur.
Sequencing Risk is an in depth look at the positive and negative returns in your investment and the order in which they occur. The timing of these can have a significant impact on your investment and without being managed effectively, can affect your retirement plans. Its greatest effect is when you are regularly contributing to or withdrawing from your investment. It’s not so much of a risk if you’ve made a lump sum payment that will have no additional contributions.
The volatility of an investment can have a marked effect on sequencing risk as you may be more susceptible to the swings of both positive and negative returns.
What’s the impact of sequencing risk on retirement?
The impact of sequencing risk can be significant and could mean the difference between a comfortable retirement that embraces your lifestyle potential, or a retirement where every penny counts. The greatest risk occurs as we near retirement and just after retirement. This time period can be as much as 5 – 10 years.
A negative return or a downturn in the market during this time period can have a greater impact on your portfolio than downturns that occur at other times. This is because your portfolio is at its highest value at this point. It also means that it’s likely you won’t have the time to allow it to recover before needing to withdraw funds.
How to Mitigate Sequencing Risk
Our role is to consider risk in all of our recommendations to you and devise an investment strategy that balances your comfort around risk and reaching your lifestyle potential. We call this the ‘sleep at night’ factor.
In a perfect world, it would be great to be able to remove the risk entirely, but in reality, it’s a case of minimise risk as much as possible and plan for the risk that remains.
You might assume that keeping the majority of your investment in cash could be a way to minimise the effect of sequencing risk on your portfolio. However, if you have a high proportion of cash in your portfolio too early in your investment journey, you then face the likely scenario of having a shortfall of funds when you retire.
Developing an investment strategy that takes into account your contribution rate, future lifestyle needs, and retirement expectations is the only way to effectively manage risk.
Here are some general strategies to mitigate sequencing risk:
- Build buffers into your portfolio so there’s no need to sell during downturns
- Contribute larger amounts early on if possible
- Monitor returns
- Adjust asset allocations at appropriate times
- Adjust spending levels if required (if you are able to meet your income needs elsewhere)
All Investments Cary Risk. Plan Early to Mitigate them
There are risks associated with every investment. Even cash. There are plenty of ‘rule of thumb’ directives about investment, but we want to do better than that for you. We consider all risks in their entirety when developing an investment strategy to guide you on your way to a life you’ve always imagined.
Nothing beats expert advice. Talk to your planner for advice on sequencing risk and being in control of your retirement.
IMPORTANT INFORMATION: This blog has been prepared by Modoras Pty. Ltd. ABN 86 068 034 908 an Australian Financial Services and Credit Licences (Number 233209). The information and opinions contained in this presentation is general information only and is not intended to represent specific personal advice (Accounting, taxation, financial, insurance or credit). No individuals’ personal circumstances have been taken into consideration for the preparation of this material. Any individual making any investment or borrowing decisions should make their own assessment taking into account their own particular circumstances. The information and opinions herein do not constitute any recommendation to borrow funds or purchase, sell or hold any particular investment. Modoras Pty Ltd recommends that no financial product or financial service be acquired or disposed of, credit contract entered into or financial strategy adopted without you first obtaining professional personal financial advice suitable and appropriate to your own personal needs, objectives, goals and circumstances. Information, forecasts and opinions contained in this blog may change without notice. Modoras Pty. Ltd. does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained within, Modoras Pty. Ltd. does not warrant that the articles within are free from errors, inaccuracies or omissions. To the extent permissible by law, neither Modoras Pty. Ltd. nor its employees, representatives or agents (including associated and affiliated companies) accept liability for loss or damages incurred as a result of a person acting in reliance of this publication.