Many individuals are often unsure of the proper time to retire. They may wonder when they will finally have enough saved to comfortably live on, or are uncertain of the lifestyle they intend to lead post-employment.

There are many points to consider when determining a retirement date. First, you must understand the risk to retirement date. What this means is if the market declines within the first seven years after you retire, it will be difficult to recapture the value of your portfolio in order to last through 25 years of retirement.

After you have assessed your risk to retirement date, you must look at your retirement glide path, which is the sequence risk you can expect to experience in retirement. The sequence risk, also known as sequence-of-returns risk, is the risk that an individual will receive lower returns early when withdrawals are made from one of their accounts.

Good vs. Bad Sequence of Returns

In a scenario where the sequence of returns is “good”, a person may be able to reach his or her desired retirement amount earlier than anticipated. Conversely, under a “bad” sequence of returns, a person may fall short by as much as 34% of their targeted goal. The difference between a “good” and “bad” sequence of returns for two individuals saving the same amount can mean a delayed retirement of more than eight years.

In the event of receiving an unfavorable sequence of returns, it is best to encounter it either early in one’s accumulation phase or later in the distribution phase. A poor sequence of returns just before or after retirement is detrimental to the success of an individual’s portfolio.

The sequence of returns helps to determine one’s retirement timeline, and can dramatically impact an individual’s anticipated quality of life in the post-employment period. Any adverse correction in the stock market can cause an individual’s actual retirement date to be materially different than the initial goal.

Retirees who take distributions or remove cash flows out of their portfolio introduce a sequence of return risk, as the removal of money from a portfolio not receiving contributions, along with a decline in the market can leave a portfolio exposed to the threat of money loss.

Preparing For Retirement

For retirees looking to increase their spending ability in retirement, there are some potential compromises that can be made. Working individuals may decide to wait until the market improves before establishing a retirement date. Others may choose to ramp-up savings or reduce stock market exposure in order to reduce portfolio decline.

For those looking to boost the amount in their retirement fund, increasing savings by 40% in the 10 years leading up to retirement can galvanize a portfolio from market decline in retirement. The overall best strategy is to reduce retirement risk in the seven years leading up to retirement and the first seven years of active retirement. After that, retirees may want to take on more stock market risk in order to keep up with inflation.

There are a number of ways to manage retirement date risk for individuals looking to secure financial stability in retirement. Proactively managing portfolio volatility can be a meaningful way to manage retirement date risk. Put simply, the larger the portfolio, the less contributions matter and the more emphasis is put on the increase/decrease in the value of the portfolio. This heightened significance is due to the compounding of returns to the portfolio over a period of time. A volatile portfolio that produces poor results can end up forcing the accumulator to work longer as the portfolio recovers. Therefore, continuing to work until the retirement accumulation goal is achieved is typically the favored method. 

What Happens if I am Forced to Retire Early?

While the most preferred approach to a successful retirement is to continue working until your savings goal has been met or exceeded, many individuals may be forced to retire earlier than anticipated. This necessitates having to reduce the amount being spent throughout retirement.

Declines in the value of a portfolio can cause retirement date risk, as the portfolio value determines the amount of monthly cash flow a retiree has to spend. In addition, a lower portfolio value reduces the amount one can withdraw from the account.

If markets average out to eventual long-term returns, or if early returns are too low for too long, ongoing withdrawals can deplete the portfolio before the “good” returns.

finally arrive. The greater the volatility of the portfolio and reliance on growth, the greater the retirement date risk that accompanies it.

Based on the situations mentioned above, you may be wondering what a prospective retiree is to do. In the final years leading up to retirement, accumulators may wish to proactively manage risk and reduce the volatility of the portfolio, specifically as a means to lower the retirement date risk they face. In order to do so, individuals may have to save more leading up to retirement or work longer in order to receive the amount necessary to provide the desired monthly income.