You may be familiar with the types of risks involved with investing. The pattern in which returns are realised by investors, known as sequencing risk, also plays a critical role in determining the ultimate value and long-term sustainability of your retirement savings.

What is sequencing risk?

When you are growing your savings, most market losses can be cancelled out by a long-term investment strategy; it makes sense that things will eventually "average out". But, as you get closer to your retirement, the way markets perform becomes an increasing concern. And, when coupled with the need to start taking out income from your savings, just one negative year on the sharemarket can be a significant adversary for your retirement lifestyle.

The examples below highlight the impact of sequencing, showing how the simple act of reversing the order of the returns results in two drastically different outcomes – when building your wealth and when pension withdrawals are taken into account.

Your investment journey

Portfolio A – Growing your savings with a starting value $500,000 and an average return 7% p.a.*

Year

Annual return (%)

Account value ($)

Annual return reversed %

Account value

($)

1

19

595,000

-12

440,000

2

11

660,450

-15

374,000

3

18

779,331

-11

332,860

4

-7

724,777

16

386,117

5

21

876,981

26

486,508

6

26

1,104,996

21

588,675

7

16

1,281,795

-7

547,467

8

-11

1,140,798

18

646,011

9

-15

969,678

11

717,073

10

-12

853,317

19

853,317


 

Portfolio B – Enjoying your retirement. Starting value $500,000 with an average return 7% p.a. and an annual $20,000 withdrawal (includes adjusted 3% CPI p.a.).*

Year

Annual return (%)

Account value ($)

Annual return reversed %

Account value

($)

1

19

575,000

-12

420,000

2

11

617,650

-15

336,400

3

18

707,609

-11

278,178

4

-7

636,221

16

300,831

5

21

747,318

26

356,538

6

26

918,435

21

408,225

7

16

1,041,504

-7

355,768

8

-11

902,341

18

395,209

9

-15

741,651

11

413,347

10

-12

626,560

19

465,787

*Figures are illustrative only.

As can be seen above, the impact of negative returns in the early years of retirement can be significant. During these years managing investment portfolios with the "sleep test" in mind is imperative.

So what can you do?

While we cannot control the sequence of returns, the good news is that there are ways that may help protect against the effects of this risk, such as:

  • Diversifying across asset classes;
  • Adjusting your asset allocation;
  • Adjusting your contribution rate, and;
  • Adopting the "bucket approach" to retirement income funding.

There are few times in life when working with a professional advisor is so important. Give your Johnsons MME Financial Advisor a call today to help you  navigate your retirement planning. 

This information is general in nature and does not take into account your personal goals, objectives or financial situation. Personal advice should be sought prior to making any investment or strategy decisions. Luke Fitridge is an employee advisor of Johnsons MME Financial Advisory Pty Ltd ABN 30 141 828 033 and is authorised to provide advice on behalf of Johnsons MME Financial Advisory. 

Luke is a degree qualified Certified Financial Planner with the Financial Planning Association and have over fifteen years' experience in the financial sector. Luke's qualifications include a Bachelor of Business (Accounting), Post Graduate Diploma in Applied Finance & Investment and a Diploma of Financial Services (Financial Planning).