The Retirement Danger Many Investors Overlook

Two people can earn the same average return on the same amount of money, yet one may exhaust their savings in retirement while the other lives comfortably and still passes wealth on to the next generation.

How is that possible? The answer is a risk many people have never heard of, so they have not planned around it.

Picture retiring at 65 with $500,000 in investment accounts and planning to withdraw $45,000 a year. For most retirees, the main question is whether the money will last as long as they do. The answer depends partly on chance and partly on having a strategy in place when luck turns against you. The risk involved is known as sequence of returns risk.

Why It Happens

The order in which portfolio gains and losses occur matters a great deal once withdrawals begin. If you take out $45,000 in a year when the market rises by $50,000, you end the year $5,000 ahead of where you started. But if the market drops by $50,000 and you still withdraw $45,000, your account ends up $95,000 lower. Even if the market fully rebounds the next year, there is less money left to recover.

The Role of Luck

One retiree might leave the workforce in a year when investments fall 40%, while another retires a year later with the same starting balance. If several strong years follow, the first person could run out of money and the second may not.

It would be easy to assume the second person simply made better choices, but in reality the difference may have been timing. One retired when markets were favorable, while the other absorbed a major loss before the portfolio had a chance to recover. The calculations behind this are clear, and the idea can be reviewed in detail with a financial professional.

Relying on good luck is not a sound retirement plan. If the money is gone by age 75 but life continues to 85, would family need to step in? Rather than leaving that outcome to chance, it is better to build a plan that reduces the risk.

The Strategy

There is a way to lessen the danger. Nothing in life is guaranteed except death and taxes, but retirees do not want to hope a market downturn will not damage their savings. A strategy that improves the odds of making assets last can make a meaningful difference.

That strategy is called a volatility buffer. At its simplest, it is money set aside so that when markets decline, withdrawals can come from the buffer instead of the investment portfolio. It may be cash in an emergency fund, a line of credit, or another asset not tied to the market. With that in place, a retiree can avoid selling investments in down years and allow the portfolio time to recover.

In many cases, this plan is best created well before retirement. For people already retired, it may mean moving some money into an asset that is not exposed to market swings. Because every situation is different, the best approach should be developed with a financial advisor.