When are sequence-of-returns risk and retirement date of concern? Are they issues only after retirement begins and then progresses?
Michael Kitces in a recent Nerd’s Eye View blog post defines sequence-of-returns risk as “the fact that even if markets average out to long-term returns eventually, if early returns are too low for too long, ongoing withdrawals can deplete the portfolio before the ‘good’ returns finally arrive.” He calls it “a fundamental challenge,” but he notes that it is only an issue if there are withdrawals, since if there are not, all the revenue that experiences a market decline can later also experience a recovery.
Sequence-of-returns risk is intimately connected with retirement date, Kitces says. The process by which a future retiree builds savings can be subject to volatility, which creates what he calls retirement date risk — which he defines as the danger that a planned retirement date may end up being later than had been anticipated because of bad market returns.
Portfolio volatility causes retirement date risk, Kitces says, because two components to retirement planning are common: a target dollar amount and a target date by which that amount will be accumulated. And since there are two parts to the plan, if a future retiree can’t achieve one, the other must be adjusted.
With a sequence of returns in which an account shrinks, Kitces says, “there is a significant risk that their actual retirement date will be materially different than the goal that was set in the first place.” Still, it can be a matter of degree, he writes: “as it turns out, the greater the volatility of the portfolio and reliance on growth, the greater the retirement date risk that goes along with it.”
So — the short answer to the first question: Sequence-of-returns risk and retirement date risk require attention before retirement as well as when and after it begins, writes Kitces. “The reality is that sequence-of-return risk is equally relevant for accumulators in the years leading up to retirement as well,” he says. The only difference between its relevance at both stages, he says, “is the problematic sequence is reversed — for retirees, the dangerous sequence is to get bad returns at the beginning (of retirement), while for accumulators it’s getting bad returns at the end (of the accumulation phase) that causes the problem.”
“Accordingly,” says Kitces, “accumulators in the final years leading up to retirement may wish to proactively manage risk and reduce the volatility of the portfolio, specifically as a means to reduce the retirement date risk they face.” And retirement date risk can be mitigated, he says: “Managing retirement date risk really is all about managing the volatility of the portfolio itself, and not necessarily the contributions to it (except to the extent that a lower volatility portfolio with a lower growth rate may require larger contributions to meet the retirement goal in the first place).”
In the end, Kitces argues, “portfolio volatility is not merely a risk to be taken and ‘waited out’ through a series of adverse market returns.” Instead, he says, “proactively managing portfolio volatility, and the retirement date volatility it creates, can be a meaningful way to manage retirement date risk as well.”
Michael Kitces in a recent Nerd’s Eye View blog post defines sequence-of-returns risk as “the fact that even if markets average out to long-term returns eventually, if early returns are too low for too long, ongoing withdrawals can deplete the portfolio before the ‘good’ returns finally arrive.” He calls it “a fundamental challenge,” but he notes that it is only an issue if there are withdrawals, since if there are not, all the revenue that experiences a market decline can later also experience a recovery.
Sequence-of-returns risk is intimately connected with retirement date, Kitces says. The process by which a future retiree builds savings can be subject to volatility, which creates what he calls retirement date risk — which he defines as the danger that a planned retirement date may end up being later than had been anticipated because of bad market returns.
Portfolio volatility causes retirement date risk, Kitces says, because two components to retirement planning are common: a target dollar amount and a target date by which that amount will be accumulated. And since there are two parts to the plan, if a future retiree can’t achieve one, the other must be adjusted.
With a sequence of returns in which an account shrinks, Kitces says, “there is a significant risk that their actual retirement date will be materially different than the goal that was set in the first place.” Still, it can be a matter of degree, he writes: “as it turns out, the greater the volatility of the portfolio and reliance on growth, the greater the retirement date risk that goes along with it.”
So — the short answer to the first question: Sequence-of-returns risk and retirement date risk require attention before retirement as well as when and after it begins, writes Kitces. “The reality is that sequence-of-return risk is equally relevant for accumulators in the years leading up to retirement as well,” he says. The only difference between its relevance at both stages, he says, “is the problematic sequence is reversed — for retirees, the dangerous sequence is to get bad returns at the beginning (of retirement), while for accumulators it’s getting bad returns at the end (of the accumulation phase) that causes the problem.”
“Accordingly,” says Kitces, “accumulators in the final years leading up to retirement may wish to proactively manage risk and reduce the volatility of the portfolio, specifically as a means to reduce the retirement date risk they face.” And retirement date risk can be mitigated, he says: “Managing retirement date risk really is all about managing the volatility of the portfolio itself, and not necessarily the contributions to it (except to the extent that a lower volatility portfolio with a lower growth rate may require larger contributions to meet the retirement goal in the first place).”
In the end, Kitces argues, “portfolio volatility is not merely a risk to be taken and ‘waited out’ through a series of adverse market returns.” Instead, he says, “proactively managing portfolio volatility, and the retirement date volatility it creates, can be a meaningful way to manage retirement date risk as well.”
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