Most people would be thrilled at the prospect of 10% average annual returns or higher in retirement. But now that folks are living longer, they face more challenges than just adequate returns. With decades of retired living on the horizon, people must ensure their portfolios last as long as they might need them.
Sequence of returns risk can affect your long-term income the most in your early-retirement years. That is the timespan just before and right after you retire. You may have heard of that period called the “retirement red zone,” or generally the 10-year spread prior to and after retirement.
It's true that average returns for the S&P 500 from 1928 to 2017 have exceeded 10%. But averages can be deceiving for long-term income planning. What matters just as much is the order of returns, or the actual timing of when a portfolio grows or loses value. As we will see, losses in those early years could make or break your income goals, setting up the risk of running out of retirement money.
This potential hazard is called sequence of returns risk, or just sequence risk. To illustrate it, we will talk about it in two formats: by analogy and then through two hypothetical portfolio scenarios.
