Reviewed by Sep 30, 2020| Updated on
It is the risk that the timing of withdrawals via a pension account will cause a negative impact on an investor's overall rate of return. It is also known as sequence-of-returns risk. This can have a considerable impact on a retired individual who is dependent on the income from a lifetime of investment and no longer contributes new capital that could compensate for losses.
At some point in life, you will be opting for retirement in your life. Hence after retirement, you will no longer contribute new money, but you will be withdrawing money at regular intervals. In case you actively participate in a bull market, your new gains will be offset via your withdrawals, at least partially.
If a bear market has been in place for months or years, every withdrawal of yours will take a bite off balance and will not be offset by new deposits. You will be encashing the same amount of cash out of an account which is decreasing slowly in size.
Sequence risk is mostly a matter of luck. But you can safeguard your account against sequence risk. You can continue to save and invest even after your retirement.
If you are retiring in a bull market, your account could grow large enough to sustain a decline that follows. When your retirement is from a bear market, the balance of your account might never recover. It is not in control of an investor, but opportunities exist to reduce the downside risks.
Safeguarding yourself from sequence risk means expecting a worst-case scenario. Here's how you can protect yourself from sequence risk:
Look at working as late as you can so that you get more time to contribute to your pension account, especially during your peak earning years.
Have a diversified portfolio. No one has ever failed after investing in high-quality government and corporate bonds.
Continue to save and invest even after your retirement.