Have you heard about the sequence of returns risk?
A sequence of returns risk shows how your retirement can be better or worse, depending on how the market is performing when you retire. Some people are fortunate enough to retire when the markets are good, and their investments enjoy substantial growth in those early years, which helps them better withstand losses later in their retirement.
Other people have the terrible luck of retiring in a down economy. In their early retirement years, they may suffer through market losses while withdrawing money from their retirement accounts to live on. Even if the market rebounds later in their retirement, it may be too late for them to recover from those significant losses.
Because of a sequence of returns risk, two people can retire with the same amount of savings but have considerably different portfolio results depending on the economic conditions when each retires. One may thrive, while the other sees an ever-diminishing portfolio balance.
Add Inflation to the Sequence of Returns Risk
If that’s not bad enough, now there’s an added factor that can worsen the sequence of returns risk: inflation.
It’s no secret that when inflation happens, your dollar buys less. So, imagine a scenario where you enter retirement in a down market, your investments are losing money, you are withdrawing money from those same investments to live on, and you have to withdraw even more money than you anticipated because the cost of goods has gone up.
That’s not exactly a recipe for the relaxing, fulfilling retirement you presumably dreamed about.
Some people may look at the market and postpone retirement in that scenario. But only some have that option, and even then, whether or not a good economy will take a downturn in six months or a year can’t be anticipated.
How to Lessen the Impacts
All that said, though, there are things you can do to try to mitigate the double whammy of inflation and sequence of returns risk. Those include:
Create An Income Plan
Creating an income plan is essential because, without one, you are flying blind as you head into retirement. An income plan will help guide your spending and investing. When creating the plan, look at all your income sources and assets. Then, look at the net amount you estimate you will need to live on monthly. What kind of return on your investments will you need over the next 30 years or so to avoid running out of money?
However, the plan could require tweaking over time as circumstances change. It’s usually best to revisit the plan once a year to see what updates are needed.
Even when you have a good plan for how much income you anticipate needing and how much you will have to withdraw from your accounts each month to live on, you may need to adjust your spending habits. Inflation could cause groceries, utility bills, and other necessities to take up more of your monthly budget than anticipated.
To counter that, you may need to adjust your discretionary spending so your money will last longer.
Consider Transferring Money Into Low-risk Funds
One way the Federal Reserve tries to battle inflation is to increase interest rates, and that can make less-risky investments, such as bonds and CDs, more attractive. If you transfer some of your money into those investments, that portion of your portfolio isn’t subject to the market’s volatility.
One problem with this, though, is that even with higher interest rates, these investments may still fail to keep up with inflation.
Watch Interest Rates on Debt
Interest on debt takes a toll on a monthly budget, so the quicker retirees or near-retirees can pay debts, particularly on home equity loans and credit lines, the better.
Likewise, avoid taking on more debt, as this will lead you to spend more of your retirement income on interest instead of on necessities or the hobbies you’ve always hoped to do during retirement.
Either inflation or sequence of returns risk can cause trouble for your retirement, even more so when combined.
But with some planning and the help of a financial advisor, you can at least prepare and limit problems. They will advise you on strategies that will work best for you as you try to get the most out of your money and enjoy the retirement you’ve earned.