Crucial Role of Risk Management in Retirement Planning

When planning for retirement, one of ten overlooked aspect that can significantly affect an individual’s financial health is risk management, particularly understanding the sequence of returns. This concept isn’t just about the average returns on investments, but more importantly, when these returns occur within an individual’s retirement timeline. The sequence of returns can dramatically alter the longevity of a retiree’s savings, potentially making the difference between a comfortable retirement and one fraught with financial stress.

To illustrate this, consider the retirement scenarios of two individuals, Alice and Bob, who both retire with the same amount of savings and achieve an average annual return of 7% over 25 years. At face value, one might expect their financial outcomes to be similar.
However, the timing of when they achieve these returns can lead to drastically different financial outcomes.

Alice begins her retirement during a bull market; her investment portfolio experiences strong returns in the early years. These early gains boost the value of her savings, providing a substantial buffer that protects her financial stability against later downturns. As a result, Alice enjoys a financially secure retirement, maintaining her lifestyle without fear of depleting her funds.

In contrast, Bob’s retirement begins on the brink of a severe market downturn. In the early years, when he starts withdrawing from his savings for living expenses, his portfolio suffers significant losses. Even though the market eventually recovers, the early losses have a lasting impact, significantly reducing the lifespan of his savings. Despite having the same average return as Alice over the same period, Bob faces the risk of running out of money midway through his retirement.

This stark contrast between Alice and Bob’s experiences underscores the critical importance of planning for the sequence of returns risk. A retirement strategy that only focuses on the average return without considering the timing of returns can lead to misleading expectations and potentially disastrous financial outcomes.

A sound financial plan addresses this risk by incorporating strategies tailored to mitigate its impact. One effective approach is adopting a more conservative asset allocation as one nears retirement, thus reducing the portfolio’s volatility and susceptibility to market downturns. Additionally, establishing a cash reserve or a “sequence of returns” risk fund can provide financial flexibility, allowing retirees to avoid withdrawing from investments during market lows.

Furthermore, the use of guaranteed principle and income sources can also play a crucial role. By ensuring a steady income stream regardless of market conditions, annuities can help cover essential expenses, allowing the investment portfolio more time to recover from poor market periods without necessitating withdrawals.

In conclusion, understanding and planning for the sequence of returns risk is not merely an optional part of retirement planning; it’s a fundamental aspect that can determine the success or failure of one’s long-term financial health. Retirees and financial planners alike should prioritize this aspect, ensuring that the golden years remain golden, irrespective of market conditions. By doing so, one can ensure that a retirement plan is not only robust in theory but resilient in practice, capable of withstanding the uncertainties inherent in any long-term investment strategy.

All investments entail risk, and these risks could result in the loss of principal in your investment. There is no guarantee of returns. If there are historic or hypothetical returns identified in this piece, these are provided as informational only, and should not be read as an indication about the returns that you should expect to receive as a result of this investment. Past performance is not an indication of future results.

The guarantees associated with Annuities are subject to the financial strength of the issuing insurer and the specific terms and restrictions of the applicable policy or contract. The insurance features do not guarantee that the investment will not fluctuate in value.

Kurt Supe, Brian Quick and John Culpepper offer securities through cfd Investments, Inc., Registered Broker/Dealer, Member FINRA & SIPC. Kurt Supe, Brian Quick and Andrew Drufke offer Advisory services through Creative Financial Designs, Inc., Registered Investment Adviser. Creative Financial Group is a separate unaffiliated company. The CFD Companies do not provide legal or tax advice.