Financial AdviceMay 11, 2022by Rohit Kalta0The sequence of returns, the one risk everyone ignores

With inflation taking its toll on every major economy, finances must be planned properly. A huge market crash or bearish sentiment can eat into the returns obtained from your investments in no time. This becomes supercritical during the time of retirement as dwindling savings can toss your plans to take that long vacation where you can chill with your loved ones. The risk of the market dwindling at the early stages of retirement with consecutive withdrawals planned in the coming years can significantly impact the longevity and health of your investment portfolio. And compounded with high inflation, this can dent your wealth and propensity to spend. It becomes imperative to invest in mutual funds online to ensure that your portfolio can survive the sequence of returns and provide you with a shield against unexpected expenditures. Let’s understand in detail about sequence of returns, the one risk everyone ignores!

Once a person retires and starts withdrawing from his/her investment portfolio, annual market returns become important. A person during his lifetime can diversify his portfolio through equity/debt mutual funds, stocks, or bonds expecting a certain annual return. This average return may be completely different from what the market gives you. Things become quite volatile when you retire and try to withdraw a pie of that portfolio. Significant losses in the early years of retirement can significantly impact the health of the portfolio even if better than average market returns compensate for the losses. This is the critical risk posed by the sequence of returns. The risk from the sequence of returns runs in the opposite direction to that of contribution. During contribution to a portfolio which typically occurs when we have a steady flow of income, initial years of below-average market return followed by higher market return do not impact your portfolio in a major way. While the same logic when applied on withdrawal during which the risk posed by the sequence of return sets in proves to be extremely detrimental especially when the withdrawal ticket size is a considerable portion of your investment. Considering the risks and downsides already discussed, it becomes more so important to get in touch with the best mutual fund distributors in the market and look at some of the options to minimize the downside.

One such mitigating factor would be to plan your withdrawals systematically. Research has suggested that planning a max of 3.5-4.5% withdrawal from your portfolio, with adjustment for inflation would provide for almost 25-30 years of income. Even with considerable bearish sentiments, e.g., the market crash of 1929 and other financial downturns, this rule proved to be a boon. A retirement portfolio provided a shield for 25-30 years. But there are certain downsides to this rule. Firstly, it may leave you with unutilized assets at the end of your life. Secondly, it may be difficult to sustain 3-4% withdrawal rates from your portfolio at a later stage of your life. Hence, it becomes extremely important to start investing in SIPs early and increase your investments at a regular interval so that the magic of compounding works for you. Online investments in mutual funds considering their ease along with tax planning become pivotal in life to lead a hassle-free post-retirement phase.

The second most important rule to beat the sequence of return is product diversification. In other words, do not lay all your eggs in one basket. The basic objective of a mutual fund is to hedge your risk and distribute your portfolio over a combination of different industries, sectors, and business lines. This ensures that even if your banking portfolio goes down, the consumer goods sector is still flourishing and by the law of distributing your risk over multiple portfolios, you limit your downside and at the same time adjust your earnings as per inflation.

Dynamic spending rules also help you plan better when you retire. Withdrawing 4% of your portfolio in the initial years of retirement and then finetuning the amount going forward based on the inflation rates is a nice way to reduce the risk posed by the sequence of returns. When market returns are high and inflation is on the lower side in the initial years, investors can increase their withdrawal rates compared to times when the market rates are on the lower side and inflation is high. To safeguard against running out of money during retirement, withdrawals need to be capped at a certain percentage. On the other side for protection against too little spending, withdrawal should increase if it falls below a certain percentage. Such dynamic allocation and spending are the keys to amassing wealth during your retirement and it is the job of good mutual fund distributors to let you stay in peace concerning your portfolio allocation.

It is important to mitigate the risk arising from a sequence of returns by maintaining sound asset allocation strategies, product diversification, and an understanding of how to be nimble during dynamic market conditions. The worst-case scenario for retirees is when stagflation occurs. Stagflation is a combination of slow economic growth and high inflation. It impacts purchasing power and negative returns are the worst nightmare for retirees. 2022 may be shaping up as a potential year of stagflation or at least an indicator considering the discouraging numbers of the major economies be it on the growth or inflation front. During these testing times, it becomes even more important to get into in-depth consultation with mutual fund distributors who can suggest different types of online mutual funds. Online mutual fund investment and tax planning are services that can be availed. A trusted and sound mutual fund distributor can untangle a lot of critical issues about beating the phenomenon of the sequence of returns.

It is high time we do not ignore it any further considering the kind of macroeconomic activities at play be it the pandemic, war, trade sanctions, financial downturns, and the kind of challenges a dynamic market throws at you every year or quarter.

Simplifysors is a mutual fund distributor in India that ranks among the best. If you want to invest in mutual funds online and maintain a well-managed mutual fund portfolio, get in touch!

Rohit Kalta

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