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Principles for a successful retirement: Choose your retirement investment strategy wisely
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You are now reading:
Principles for a successful retirement: Choose your retirement investment strategy wisely
When you are saving for retirement, your average return over time is important. When you retire, the sequence in which you experience the average becomes even more important.
A problem known as sequence-of-return risk can arise when you experience below-average or poor market returns at the beginning of retirement, as you begin to draw on your wealth to meet lifestyle needs.
These three individuals achieved the same average return over time but with very different outcomes because of the order in which they experienced their returns. This risk is a major consideration — both for timing your retirement and for evaluating whether diversification strategies or products that can provide downside protection against this risk may be appropriate for you.
Withdrawal is equal to 4% of initial portfolio value and then annually adjusted for inflation
The risks you experience as you plan your retirement journey will change over time. Therefore, your asset allocation strategy should be dynamic, to address the most essential risks at your current point in time. When you are far from retirement, you have the greatest capacity to invest for growth but also face the greatest risk of not saving consistently or being derailed by competing goals.
As you age, market-related and retirement-timing risks begin to emerge that you’ll want to address to protect your growing wealth. Once retirement is on the horizon, managing sequence-of-return risk is critical as you prepare your portfolio to provide current income while realising some long-term growth.
How you invest and how much you consistently spend in retirement are interdependent. Investing too conservatively puts a portfolio at risk of running out of money at a 4% initial withdrawal rate.
The 4% rule dictates that individuals withdraw 4% of their initial portfolio value in the first year of retirement and annually increase that amount by the inflation rate to maintain purchasing power. Withdrawing an initial 5% or 6% may not be sustainable especially if markets fall during early retirement years.
Instead of withdrawing a set amount each year or holding a static mix of investments, you may want to consider a more flexible approach that allows you to adjust as circumstances change. This can better reflect how your spending may shift as you age, factoring in the likelihood that you will tend to spend less during down markets and more when your investments recover and enable you to adjust your portfolio as markets and your time horizon evolve.
Years of sustainable withdrawals for a portfolio for typical markets
Projected nominal outcomes, 50th percentile*
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Sequence-of-return risk
Withdrawing assets in volatile markets early in retirement can ravage a portfolio, especially if you experience below-average returns early in retirement. Adjust your plan regularly, and you may want to evaluate investment solutions and diversification strategies that can provide downside protection.
Consider a dynamic approach
Adapting your investment objective for retirement over time to mitigate against evolving retirement risks, your level of wealth and your proximity to retirement can result in a better outcome.
One size does not fit all
Higher initial withdrawal rates or overly conservative portfolios can put your retirement at risk. However, setting your spending at retirement too low and not adjusting along the way may require unnecessary lifestyle sacrifices in retirement. You may want to consider a dynamic approach that adjusts over time to more effectively use your retirement savings.
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