'Sequence of returns’ risk can wreck your retirement planning: How to protect retirement corpus from it
Chances are that you did not account for the exact pattern of gains or losses, or the order in which your investment returns occur. This is what is referred to as ‘sequence of returns’ risk. It is the risk of negative returns occurring later in your working years and/or early in your retirement life. It particularly comes into play during the five years before and five years after retirement— the ‘fragile decade’. Investors in this phase of their lives are most vulnerable to sequence of returns risk.
Why is this risk a killer? Let us see with an example. Suppose two investors, A and B, start their retirement years with the same corpus of Rs.1 crore. They avoid withdrawals for the initial 10 years. Two different market scenarios play out for A and B, where the returns are identical, except that they occur in reverse order. A’s portfolio witnesses higher returns in the initial years, but lower returns than B’s portfolio in later years. In both scenarios, the Rs.1 crore initial pot would fetch the same amount of Rs.1.75 crore at the end of 10 years, with the market averaging 7.3% return annually. Both are on an even footing, despite a contrasting pattern of market returns.
Now, let us compare how the two scenarios would play out if both A and B make regular withdrawals during this period. If Rs.6 lakh is withdrawn at the start of each year, A’s pot will grow to Rs.1.15 crore at the end of 10 years. B, on the other hand, will be left with a sum of Rs.50 lakh. Despite fetching the same average market return, A has
