What is Sequencing Risk? (part 1).

In part 1 of this 2-part article about Sequencing Risk, I am going to introduce and address possibly the  greatest risk when investing your money for your future retirement, and explain how it can be managed and dealt with in such a way as to remove some of the fears that often come along with investing.

Grab a coffee or glass of wine, and give yourself some time and space to consider this 2-part article.

Sequencing risk is something that will affect investors all over the world. It is not unique to one country, investor type or culture. The sequence of investment returns (being good or bad performance of your investments) refers to the order in which you experience those good, bad or simply flat investment returns, throughout your investing life.

I’d like to summarise it this way: it’s the risk that your investments and retirement money will be hit by bad performance or a significant decrease in value, right when you need them the most.

It’s about reaping the benefits or returns of your investments, in the wrong order!

If you were 50 years old and wanted to retire at age 60, and someone told you that over the next 5 years your investments would do ‘pretty well’ and grow by 7% per year… you might be quite happy (especially in comparison to your recent returns). If we were then able to tell you that over the following 5 years (from age 55 to 60) there would be a severe market decline and your investments would halve by 50% how would you feel?

I am guessing you wouldn’t be feeling very well at all! You might say you have experienced a ‘poor sequence of returns’.

If instead you were 30 or 35 years of age when you experienced this 10 year sequence of returns, knowing, as your adviser has taught you, that markets fluctuate over time, and that the stockmarket (world bourses) has shown consistent returns of approximately 10% per year over 100 years, then you are likely to feel less troubled about this sequence of returns. Eventually you will ride out the ups and downs and be in a fine position by retirement age.

However in this example you are not 35 years old, you are 55 when the decline starts to affect your investments, and every time you review them over that 5 year period you may well be feeling quite stressed, disappointed and fearful, as your investments appear to be going backwards.

When our salary or business income is about to STOP.. we are all much more conscious of our retirement savings, of our need for a cashflow stream, and how that lump sum investment changes month-to-month or week-to-week.

That poor performance – at that time of life, hurts. It may affect your decision to retire.

Simply put, if your investments had continued to grow by 7% and not fall – you might be in position to retire comfortably. The fact you experience this poor return sequence could mean you have to keep on working or cutting some costs and changing your lifestyle. You may be stressed that your investments will even stay intact, let alone recover and grow again.

It’s important if this were to happen to you, that you are in contact with an adviser who knows your situation well, and who can listen when you explain the impact of such an event on your feelings, your potential plans and overall attitude to investing.

This is probably the most important time to be in contact with an adviser who has your interests at heart, who knows your situation well and who will listen when you explain the impact of such an event like this on your feelings, life plans, and your overall attitude to risk in investing. Many investors may have lost touch with their adviser or bank, the person who helped them invest years earlier. Bank staff may have simply changed, and a new relationship has not begun with your adviser.

Go to Part 2



All thoughts are my own. The information contained here is not personal financial advice tailored to individual needs.