Impact of Sequence of Returns on Retirees' Wealth and Strategies for High-Net-Worth Investors
High-Net-Worth Investors Grapple With Sequence of Returns Risk
Wealthy individuals approaching retirement face a unique financial challenge: sequence of returns risk. This peril arises from the potential for underperforming investment returns early in retirement, compounded by the timing of withdrawals, which can significantly diminish the longevity of retirement funds.
This risk is particularly threatening to high-net-worth (HNW) investors, jeopardizing not only their financial stability but also their legacies. High spending and aspirations for leaving a lasting inheritance can heighten the impact of early losses.
Here are strategies to mitigate sequence of returns risk:
Diversify Portfolios
A diversified investment portfolio can shield against market downturns. By spreading assets across various asset classes, such as stocks, bonds, commodities, real estate, and more, the negative effects of a downturn on one asset class may be offset by the performance of others.
Flexible Withdrawal Approach
Rather than a fixed withdrawal schedule, consider an adaptable strategy that accommodates market downturns. This could entail reducing withdrawals during rough patches and relying on additional sources of income, leaving more capital available to recover when the market recovers.
Steve Branton, a certified financial planner and managing director at Wealthspire Advisors, advises, "During certain predetermined market corrections or bear markets, consider reducing monthly draws by a predetermined amount or even pausing discretionary withdrawals to avoid locking in losses and cutting deeper into principal during market downturns. Instead, rely on cash reserves, ultra-short-term bonds, or money market funds to meet spending needs, allowing the stock portion of the portfolio time to recuperate."
Maintain Cash Reserves
Setting aside a cash cushion for use during market downturns, rather than withdrawing retirement income, helps preserve capital. This allows you to meet basic expenses without being compelled to sell assets at depressed prices.
Postpone Big Expenses
Delaying significant expenses, such as the purchase of a new car, until market volatility decreases can also help protect your portfolio.
Importance of Legacy and Estate Planning
For HNW individuals, passing on wealth and creating a lasting legacy is often a primary financial goal. Sequences of returns can impede these plans and require effective management. By incorporating legacy and estate planning strategies, such as creating trusts, tax-efficient donations, and using life insurance, HNW investors can achieve their legacy goals, regardless of market performance.
Branton also suggests, "Optimize your asset allocation during a downturn by reallocating investments across taxable, tax-deferred (individual retirement accounts), and tax-free (Roth) account types to maximize long-term returns over the course of retirement. For example, concentrate high-growth, tax-inefficient assets like real estate investment trusts in Roth IRAs."
In addition, Branton notes, "Roth converting during declining markets can lock in lower tax costs on future growth of the investments. Utilizing the current high estate tax exemption level (set to expire by year-end) could allow certain high-net-worth families to transfer more assets out of their estates while valuations are temporarily depressed."
The Bottom Line
A prosperous and financially secure retirement is more than just accumulating retirement funds; it's about managing those funds effectively. Coordinating market timing with withdrawals has a substantial impact on a nest egg, especially during periods of market upheaval. By employing strategies like diversification, cash reserves, thoughtful planning, and strategic spending, investors can minimize the detrimental effects of a poor market sequence.
An ico in personal-finance could advise high-net-worth investors, who are grappling with sequence of returns risk, to maintain cash reserves as a buffer during market downturns, which helps preserve capital and allows for meeting basic expenses without selling assets at depressed prices. Furthermore, during a bear market, these investors might consider Roth converting to lock in lower tax costs on future growth of the investments, especially given the current high estate tax exemption level.
