The Four Approaches to Managing Retirement Income Risk

Abstract

Sequence-of-returns risk amplifies the impacts of investment volatility when taking distributions from a volatile investment portfolio in retirement. There are four techniques for managing this sequence risk: reduce the spending rate, adjust spending to portfolio performance, reduce portfolio volatility in the early retirement years, and draw from a buffer asset outside the portfolio to support spending when the portfolio is underperforming. We examine the peculiarities of sequence risk using an example with U.S. market returns which leads to wealth depletion after a thirty-year retirement. We show how minor spending adjustments can lead to dramatically different outcomes for remaining investment wealth at the end of the thirty-year retirement period. We provide examples for how each of these risk management techniques can be implemented in practice by integrating a wider range of tools to create the potential for greater retirement efficiency in terms of supporting the retirement financial goals with the available asset base. Examples include delaying Social Security, using annuities with lifetime spending protections, employing a rising equity glidepath in retirement, using a time segmentation or bucketing strategy, and creating a “buffer asset” with a reverse mortgage or whole life insurance.