How the sequence of returns risk can be a spoiler for your retirement
BSE Sensex closed above 20,000 on 11 December 2007. By October 2008, the retiree would have notionally lost more than 60% of their equity corpus when the Sensex plummeted below 8,000. This risk, wherein negative market returns occur early in retirement or even during the last leg of working years, impacting the longevity of retirement savings, is known as sequence of returns risk.
It’s one thing to claim that equity investments, on average, provide a certain return, but it’s an entirely different matter when the specific pattern of gains or losses cannot be predicted in advance. Consider a scenario with two retirees, A and B. Retiree A, upon retiring, invested 50% of their retirement corpus in an Index Fund tracking the S&P BSE Sensex in March 2003 when the Sensex was around 3,000.
This retiree witnessed a doubling of their equity investment in the first year and, by December 2007, grew their equity investment nearly 7 times the original amount. Upon observing this success, Retiree B decided to allocate 50% of their retirement corpus to equity. However, facing the downturn described at the start of the article, Retiree B fared worse.
Even after a significant downturn by October 2008, Retiree A’s equity investment remained more than double the original investment. The volatility of returns in equity always poses a risk, but this risk becomes more pronounced during retirement. In the accumulation stage, individuals continuously add to their corpus through regular monthly or annual contributions.
However, in the withdrawal stage of retirement, there isn’t the luxury of absorbing negative returns due to ongoing withdrawals for monthly or annual needs. This scenario translates notional losses into real losses. For instance,
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