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When you are approaching retirement big dips in the market can have an outsized impact on your investments because of a concept known as sequencing risk. Understanding how to manage sequencing risk can help you feel more confident about your future savings and income when markets are volatile.

It’s worth remembering that whilst you are a contributor, SASS is a hybrid scheme, which is a combination of accumulation and defined benefit. This means your Employer Financed Benefit and Basic benefit are not impacted by investment performance. Once you leave SASS you may decide to invest your money.

In this article we explain sequencing risk and discuss the things to keep in mind to help your savings last well into your retirement.

What we mean by sequencing risk

It’s the nature of investments that they will move up and down in value over time. And in the long term every investor should expect to experience both losses and gains. While periods when markets are falling can make you feel uncomfortable, experience shows us that markets generally recover. Looking at the examples below we can see that some recoveries can take a matter of months, but it can be years before markets return to their pre-crash or crisis levels.

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Event

Tech Bubble Crash

April 2000 - October 2002

Global Financial Crisis

October 2007 - March 2009

Coronavirus Pandemic February 2020 - March 2020

February 2020 - March 2020

Bear Market Duration 2.5 years 1.5 years 1 month
Asset Allocation 100% stocks 60% stocks / 40% bonds 100% stocks 60% stocks / 40% bonds 100% stocks 60% stocks / 40% bonds
% drop -49% -23% -56% -33% -34% -22%
Recovery 5 years 2 years 4 years 2 years 5 months 4 months

Source: https://www.troweprice.com/personal-investing/resources/insights/what-can-i-do-retire-confidently-during-market-uncertainty.html.

While many investors can wait for their investments to bounce back, as a pre-retiree or retiree you may not have time on your side. Protecting your investments from market volatility is even more important just before and during retirement.

Experiencing poor investment returns around retirement when your nest egg is largest has an outsized effect on your savings. This is particularly the case if you have no choice but to make withdrawals from your super savings when the market is at, or near, the bottom of a slump. Even if you’re able to leave your money in super for a time you’ll probably need access to those savings at some stage.

When the market does eventually rebound your super may not have enough time to recover. Once you’ve retired, you’re likely to have less money available to top up your super and ‘make up your losses’ because you are drawing down on your savings. This timing issue is known as sequencing risk.    

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Taking a mindful approach can help


While it’s impossible to time markets and avoid investment losses altogether, being aware of how biases impact our thinking can make a difference to the investment choices we make and outcomes we can expect.

While we might like to consider ourselves rational human beings, our inherent biases can lead to flawed decision making. And in the current environment – when we don’t really have a template for what might happen next – behavioural biases can play an even bigger role in our thought processes. These strongly ingrained behavioural biases serve us well in most of our daily lives but can derail us when it comes to investing.

Here are three of examples of biases that can influence our investment behaviour:

  1.  Loss aversion - research on “loss aversion theory” suggests that humans feel twice as much pain from a loss than we feel pleasure from the same amount of gain. When we look at this in the context of investing, it can mean missing out on opportunities for gains by settling for a lower rate of return. While this bias keeps us feeling safe in the short term, playing it too safe over the long term could see your investments fall short in delivering the income you need throughout retirement.
  2. Overconfidence - at the other end of the spectrum, some investors will have an increased sense of confidence in their ability to pick the top or bottom of the investment cycle. This overconfidence bias can lead to investors buying or selling to try and get a better outcome but actually missing out on returns as a result.
  3. Recency bias - recency bias can also come into play when we’re making decisions. When trying to understand what will happen in the future our minds naturally refer to what happened most recently. This is partly because our brains find it easier to recall recent events compared with things that took place further in the past. This tendency can result in us placing too much importance on recent events when we make investing choices.

Taking a mindful approach doesn’t mean trying to ignore your biases altogether. But being aware of the ‘spin’ you might be putting on things can help you think things through and make more informed decisions.

How to manage sequencing risk


While it would be great to be able to remove all risk from your retirement investments, this simply isn’t possible. Understanding how to manage these risks can give you peace of mind about how your money is invested and help you feel more confident about your finances in retirement.

Watch the video to find out more about managing sequencing risk.
 

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The information contained in this article is given in good faith and has been derived from sources believed to be reliable and accurate. No warranty as to the accuracy or completeness of this information is given and no responsibility is accepted by Aware Super Pty Ltd or its employees for any loss or damage arising from reliance on the information provided.

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