Mitigating Sequence of Returns Risk in Retirement Planning Amid Market Volatility
Recent historic volatility in the equity markets, exemplified by unprecedented intraday swings in the S&P 500, presents significant implications for retirement planning in the United States. Investment advisors have traditionally advocated a long-term, stay-the-course approach for younger investors, yet those nearing or in retirement confront unique risks. Specifically, the 'fragile decade'—the five years before and after retirement—is highly sensitive to sequence of returns risk, where the order of investment gains and losses can dramatically affect the sustainability of retirement savings during income withdrawals.
Data from the Allianz Center for the Future of Retirement underscores the prominence of these concerns, with 64% of Americans fearing outliving their assets more than death. This anxiety stems from economic uncertainties including inflation, Social Security benefits, and tax policies. Retired clients starting withdrawals during a market downturn may face a significant reduction in portfolio longevity compared to those retiring in a market upswing, even if the average long-term return remains the same.
Retirement income planning often relies on average portfolio return assumptions, which can obscure vulnerabilities from poor sequence of returns. An illustrative scenario reveals a 13-year difference in savings duration based solely on whether retirement coincides with market gains or losses. To counter this risk, income planning strategies that incorporate reliable, guaranteed income streams—such as Social Security benefits, pensions, or annuities—can offer stability against market shocks.
Annuities, in particular, provide mechanisms for downside protection through index buffers and floors that limit losses from market downturns, as demonstrated by reduced portfolio declines during the early 2000s dot-com crash. Furthermore, annuities may include features like locking in contract values and increasing income options to help smooth retirement income volatility. However, the security of annuity guarantees depends on the financial strength and claims-paying ability of the issuing insurance company, highlighting the necessity for advisors to select carriers with strong ratings and long-term viability.
Incorporating strategies to mitigate sequence of returns risk is critical for developing resilient retirement income plans. Utilizing guaranteed income products can provide a cushion against economic recessions and help ensure retirees maintain financial security despite fluctuating market conditions. The evolving market landscape demands proactive risk management within retirement portfolios to withstand both upward and downward volatility, safeguarding asset longevity for retirees.