Many people scrimp and save for decades in hopes of enjoying a relaxing and rewarding retirement. But one thing that’s impossible to plan for when you are 25 or 30 years out from retirement is this: What will the economy be like when you reach 65, 67, 70 or whatever target retirement age you set for yourself?
If you luck into an economic upswing, good for you. But what happens if you finally reach that magic retirement moment and the market is tanking, inflation is out of control and stagflation has settled in?
In that scenario, retirees face at least two risks that have the potential to tarnish their long-awaited golden years:
- Sequence-of-returns risk, which affects long-term holdings.
- Interest rate risk in your bond funds for fixed income.
The good news is that several strategies exist to help retirees maneuver through these risks and dodge the loss exposure that can rear up at each unexpected turn of the retirement journey.
Retirement Risk No. 1: Sequence of Returns
Perhaps you have run across references to sequence of returns risk before. If not, let me give you a quick primer about how it works – and how it can quickly erode your retirement savings if you don’t take steps to counteract it.
Let’s say you decide to retire at 67. You have a hefty amount of savings to see you through the next few decades – or so you (or your accumulation-oriented financial adviser) believe. But times are tough with the overall economy at the time you retire. If you are confident that won’t affect you (you’re retired, after all, and not seeking employment), you are wrong.
Here’s why. As you enter retirement, there’s a reasonably good chance you will need to begin withdrawing money from your savings right away to help pay for your lifestyle. At the same time, an uptick in market volatility causes the value of your portfolio to decline. You are experiencing a double whammy: The market is going through a volatile cycle, and, for the first time ever, your income withdrawals accentuate those losses.
Perhaps you will look on with shock as your portfolio balance drops, drops and drops some more. Eventually, the market will turn around, but you may have lost so much ground that you can never catch up. In the past, these market dips were great buying opportunities. Now, the opposite effect is playing out.
Contrast this with someone who enters retirement in a great economy. In the first few years of retirement, they see gains in their portfolio, not losses. Yes, they also are withdrawing money, but with any luck, their gains should outpace …….