Navigating Retirement with Confidence: Understanding Sequence-of-Returns Risk

Marissa Mah, B.Comm., LL.B., LL.M. - May 13, 2024
Retirement planning is a journey filled with various financial considerations, but one often overlooked aspect is the sequence-of-returns risk

Retirement planning is a journey filled with various financial considerations, but one often overlooked aspect is the sequence-of-returns risk. While rates of return are essential, it's the sequence in which these returns occur that can significantly impact your retirement portfolio, especially when you're relying on it for income and no longer actively contributing new funds.

Imagine this scenario: you've diligently saved for retirement and have achieved the financial goal where you feel comfortable with stepping away from making an income. Just as you begin withdrawing funds, however, the markets take a downturn. This sequence of poor returns coupled with withdrawals can have a compounding effect, making it harder for your portfolio to recover from losses. This is what we call sequence-of-returns risk, and it's a real concern for retirees.

Here is an illustration of sequence-of-returns risk:

Put another way, suppose we have $100,000, and we need $5,000 (or 5%) in income.  If the market declines 15% when we withdraw this income, we’re left with $80,000 in capital remaining ($100,000 - $15,000 (15% market decline) - $5,000 (5% income withdrawal)).  To recover from this, we would need 25% return to recoup our capital.

This example clearly illustrates why managing volatility in your portfolio is critical, especially during retirement.  And to manage volatility, we, at the Mah Investment Group, employ a combination of strategies, some of which are highlighted below.

  1. Diversification:  Diversification is key, and we select managers with complementary investment styles to build a well-rounded portfolio. We do not limit our portfolios to a single investment style.  For example, our dividend portfolios may also incorporate value and growth managers to ensure targeted coverage across different market conditions.
  1. Cash Flow Management:  Cash flow management is equally vital. We don't assume consistent market growth every year. Instead, during prosperous periods, we capitalize on profits and set aside a cash buffer to sustain you through leaner years. This approach reduces the need to sell from your portfolio during market downturns, giving your investments the time they need to recover.
  1. Dividend Growth:  Dividend growth plays a crucial role in our strategy. While dividend yields fluctuate with market volatility, we prioritize managers who focus on companies with strong earnings potential and a commitment to increasing dividends over time. This approach ensures a steady stream of income for retirees, irrespective of market fluctuations.
  1. Downside Protection:  Downside protection is another cornerstone of our approach. By selecting managers who actively manage portfolios with limited overlap with conventional indices like the S&P/TSX, we aim to minimize downside risk. This means that during market downturns, your portfolio may experience smaller losses compared to broader market indices, helping it recover more quickly.

At the Mah Investment Group, our goal is to provide you with a smoother investment journey throughout retirement, one that minimizes volatility and ensures reliable income over time. We understand the complexities of retirement planning and the importance of having a trusted investment advisor by your side. Our tailored strategies are designed to provide you with peace of mind, knowing that your financial well-being is in capable hands. Let us guide you through your retirement journey, so you can focus on enjoying the fruits of your labor without worrying about market volatility.