Traders use their mobile phones outside the New York Stock Exchange (NYSE) in New York.
Brendan McDermid | Reuters
A decline in stock markets can pose significant portfolio risk early in retirement years. Many investors don't prepare, financial experts say.
Known as a “sequence of return risk,” the issue refers to how timing of withdrawals, paired with stock market losses, affects how long retirement savings last.
According to Amy Arnott, a portfolio strategist at MorningStar Research Services, the first five years of retirement are the “danger zone” for tapping your account.
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When you acquire assets from an account when value is decreasing, you “return to the ultimate rebound in the market as there is less money left in your portfolio,” she said.
Additionally, the risk of sequencing could increase the likelihood of outweighing retirement savings, Arnott said.
For example, let's say your portfolio fell at least 15% in the first year of retirement and you withdraw 3.3% of your balance.
According to a 2022 report from Morningstar, the combination would increase the likelihood of depleting your portfolio six times within 30 years compared to those with positive returns in the first year. (This study assumed that future annual withdrawals would be locked to the same share of the portfolio.)
Negative returns are More harmful early in retirement Later, according to a 2024 report from Fidelity Investments. That's because retirees miss out on more potential compound growth.
“It's extremely difficult to overcome these losses early on,” said David Peterson, head of Fidelity's advanced wealth solutions.
In comparison, in the early years of positive returns after retirement, he said, “there are the advantages of the market that works in your favor.”
Maintain a balanced asset allocation
As we approach retirement, “balanced asset allocation” is one of the best things investors can do to reduce sequencing risk during early retirement years, Arnott said.
For example, the portfolio She has 60% stakes and 40% bonds compared to heavier stock allocations.
With “good asset allocation,” Peterson said negative returns may not be as extreme as stock market losses. Of course, the right mix will ultimately depend on your risk tolerance and goals.
Adopting a “bucket approach”
You can also protect your portfolio from stock market losses with a retirement strategy known as the “.Bucket approach“Arnot said.
Usually you will hold your living expenses for 1-2 years in cash.
Spending over the next five years could be closer to a short-term bond or bond fund. Beyond that, the third bucket focuses on stock growth, Arnott said.
“It requires some maintenance every year,” but it could provide “satisfaction,” reducing the risk of a series of returns, she said.
