What is Sequence Risk and How Can it Hurt Your Retirement?

A lot of Americans will never retire. But those who do retire may commit financially consequential mistakes that could negate having a retirement fund in the first place.

Refusing to downsize your current lifestyle and finances is a good way to slowly waste away your retirement.

For example, downsizing from a large house to a smaller home or apartment will save you money and the toil of physical maintenance. 

Many retirees never consider getting senior citizen discounts. You can start qualifying for senior citizen discounts as low as 50%, or lower, at age 50.

The best place to start learning about senior citizen discounts is AARP. If you’re paying full price without checking for potential senior discounts that could be available, then you’re squandering your retirement fund.

Millions of senior citizens bankrupt themselves and destroy their retirement futures by coddling and paying all of the finances for their adult children or grandchildren.

However, one of the greatest threats to the viability of your retirement account could be sequence risk.

And this is especially true if your retirement account or pension is heavily tied to the stock market.

What is sequence risk?

“Sequence risk,” also known as sequence of returns risk, is a technical term in finance that refers to a order of investment returns relative to your retirement account or investment portfolio.

The threat of sequence risk is direr in a bear market than in a bull market. It’s a complicated term, but let’s talk about this in a basic way.

Let’s pretend that you have a $1 million retirement fund. Your retirement fund is mainly augmented by distributions and profits from business investments or investments tied to your retirement account.

Now that you are retired, you are not actively contributing to your investments anymore, just living off of the regular distribution of returns.

Now imagine that your investment portfolio loses 15% of its value in year one of retirement and then another 10% in the second year.

Also, you are withdrawing $10,000 annually. Even if your investment makes some gains in successive years, your retirement account has dwindled in size and value.

If you are withdrawing and not contributing to your investments in your retirement account, the fund will continue to lose value.

The market may recover, but it will recover from a lower base, stunted long-term returns.

An unfortunate series of withdrawals and investment losses during the early years of retirement can create a perfect financial storm where your retirement account becomes exhausted far earlier than expected.

How to protect your retirement against sequence risk

You would need a lot of bad luck and be actively refraining from contributing or monitoring your investments to suffer from sequence risk.

Still, there are a few ways to protect against it.

  • Keep working for as long as you are able to. Making enough to pay your basic cost of living can allow you to avoid making withdrawals when markets are down.
  • Continue contributing to your investments if you can. Any money you can invest in a down period will pay off later when stocks recover. That could be reinvested dividends, new contributions or simply avoiding withdrawals for a time.
  • Always diversify your portfolio. Concentrated investments tend to do poorly when markets fall.
  • Finally, always keep a a topped-up savings account for unexpected expenses and update your budget regularly.