Sequence of returns risk refers to the risk to a retiree of retiring just before a crisis or negative returns. Should this occur, the retiree starts off retirement by regularly withdrawing money from their investment to provide their income and the money withdrawn can never recover when the market recovers.
Consider an investor who retired on 1 Jan 2008 just before the impending financial crisis. Say they invested in a high equity fund and withdrew what is considered a high income of 10% in the first year, growing this with inflation. We tested two different strategies to see if they would help. The first is reducing the proportion of growth assets to reduce volatility and the second is called the bucketing method.
Value 10 years into retirement of R1 million invested with an initial withdrawal of 10% with aim of income growing with inflation The most effective bucket system of the options considered was to place three years of income in a"cash" bucket and the balance in a"risk" bucket . Retirees withdraw income from the"cash" bucket and never top it up so when it runs out, they withdraw their income from the"risk" bucket.
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