Retirement planning often emphasises investing to build a large nest egg. However, protecting your savings is equally crucial.
One major financial challenge that retirees face is the sequence of returns risk (SORR). This refers to the risk of market losses occurring near the end of your career or early in retirement. Poor market performance at this stage can deplete your corpus quickly, potentially causing a shortage of funds that can hurt you throughout retirement.
During retirement, individuals withdraw a fixed amount from their portfolio regularly. If the portfolio suffers losses early on, these withdrawals eat up a larger portion of the corpus, leaving less to recover when markets improve. Conversely, positive returns early in retirement allow the portfolio to grow, creating a stronger foundation for future withdrawals.
How SORR works
Consider two retirees, A and B, each starting with a portfolio of ₹1 crore. Both plan to withdraw ₹4 lakh annually, increasing the amount by 5 per cent each year to account for inflation.
Let us assume that while their portfolios earn similar average returns over time, the yearly performance differs.
Retiree A enjoys strong returns in the first three years (25 per cent, 10 per cent and 14 per cent), but faces losses in the fourth and fifth years (-15 per cent and -9 per cent). Retiree B, on the other hand, struggles with losses in the first two years (-15 per cent and -9 per cent), but sees gains in the next three years (14 per cent, 10 per cent and 25 per cent). Though the annual returns are the same and only their sequence is different, the two investors will be left with vastly different sums. After five years of withdrawals, retiree A’s portfolio would be worth ₹98 lakh, while retiree B’s would be just ₹85 lakh. This demonstrates how the timing of returns can significantly impact the final value of a retirement portfolio, even if average returns are similar.
So what can you do about this? You can’t control the markets, but you can factor this into your own plans.
Following are the popular strategies followed to minimise the impact of SORR.
Conservative withdrawal rate
One approach is to follow a conservative withdrawal rate. Financial experts often recommend a conservative withdrawal rate from your retirement corpus, adjusted annually for inflation, as a safe option for retirees. According to a study by Rajan Raju, Director, Invespar Pte Ltd, and Ravi Saraogi, Co-founder, Samasthiti Advisors, the safe withdrawal rate for an Indian retiree retiring at 60, with a life expectancy of 90 and a retirement period of around 30 years, falls within the range of approximately 3-3.5 per cent. This rate applies to the first year after retirement, with adjustments in the following years to reflect the impact of prevailing inflation.
Bucket strategy
Allocating assets into different buckets based on time horizons (short term, medium term and long term) when retiring can help you keep up withdrawals during market downturns without needing to sell depreciated assets. Every bucket can have a distinct risk profile, time horizon and serve a specific purpose.
When you retire, you can allocate a portion of your savings to a short-term bucket to cover your expenses for the upcoming year. This allocation can act as both an emergency fund and a source for daily expenses. Suitable investment options for this portion include savings accounts, fixed deposits or debt mutual funds like liquid funds.
You can allocate funds to a medium-term bucket, spanning 1-10 years, which can be used to cover future expenses such as travel, down payments or early repayment of home loans. The amount allocated to this bucket should match the estimated expenses for the next 10 years, adjusted for inflation. Preferred investment options for this bucket include short-duration mutual funds, bank and corporate fixed deposits, and hybrid mutual funds.
The long-term bucket aims to generate returns that outpace inflation, helping build wealth without being affected by occasional withdrawals. Funds that won’t be needed for the next 10 years can be allocated to this bucket. Investment options may include stocks, equity mutual funds, gold and real estate.
Annuity
Annuities are another option, offering a guaranteed income stream that reduces reliance on investment portfolios during market downturns. While annuities provide longevity protection and help preserve savings, they have drawbacks such as lower returns, lack of liquidity and taxable payouts.
By combining these strategies — conservative withdrawals, the bucket approach and annuities, retirees can navigate SORR.