What is Sequence Risk? Could it impact on my retirement plans?
Sequence risk, also called sequence-of-returns risk, is the risk of receiving lower or negative returns early in a period when withdrawals are made from an individual’s underlying investments.
The performance of your investment in the first couple of years of drawdown is vital. If your returns are good, your fund growth may exceed the income you take, leading to a net improvement to your fund value. Conversely, a low return may result in having to eat into your underlying fund. This early performance is more important than that of later years.
In 2008 the FTSE 100 fell 31%. If you had just started drawing on your pension fund and remained invested (Drawdown) your pension assets and their long term sustainability would have been severely damaged.
The economic uncertainty following the BREXIT vote decision could have a significant impact on retirement plans.
The new ‘Freedom & Choice’ pension legislation implemented in April 2015 has significantly increased the number of people drawing their pension benefits ‘flexibly’ and using Flexible Access Drawdown. This means that more people reliant on their pension income are at risk.
Can you do anything to mitigate this risk? Yes you can. You have a variety of options including the following:
- Use cash flow modelling to understand your situation
- Buy a form of guaranteed income to cover your minimum living costs, your essentials
- Hold cash deposits for emergencies
- Use alternative forms of investments as a reserve
- Explore safer types of Drawdown investment options to suit your needs
This list is not exhaustive but with careful planning you can see that it’s possible to plan for sequence risk and be a little more comfortable in the knowledge that you can sustain your pension fund and income over the longer term with timely advice.
If you are thinking about drawing your pension benefits, please seek independent financial advice. Contact us at People and Business, click here.
Steve Speed
23/08/2016