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Sequence of Returns Risk
Sequence of returns risk involves the order in which investment returns occur and the impact of those returns on people who are near retirement, transitioning into retirement, or recently retired. In a nutshell, a bear market or period of market losses can have a severely negative impact on the income generating potential of a portfolio belonging to a person who is transitioning into retirement. The reason is that people who are transitioning into retirement will—in the near-term—need to begin withdrawing portfolio funds to produce income. As a result, the ability of the portfolio to “catch-up” during subsequent years is greatly diminished, and the person’s longevity risk will likely increase significantly. Hedging or downside protection of one’s financial assets is critical and can help mitigate sequence of returns risk. Assume, for example, that a given 10 year period of market returns: a) is highly volatile; b) begins with a 2 year period of very negative returns (e.g. -40%), and; c) results in an average return at the end of the 10 year period that is 6%. This 6% average return is not necessarily a problem for a person who bought and held during the entire 10 year period. However, it has catastrophic implications for the income generating potential of the person who was set to retire 3 years into the 10 year period. The sequence of the returns or the fact that the losses occurred early in the 10 year period is critical for the person transitioning into retirement.
Low or No Surprises Supports the Case for Annuities in Retirement
In a basic sense, information theory measures the level of surprise in a message.
A highly informative message will come as a complete surprise and tell you something about which you had no previous knowledge.
Sounds pretty good, right—of what use is it to be told what you already know? Well, there are actually cases where information is not so welcome.
Financial Crisis Will be Seen Fundamentally as a Crisis for Retirees and Near Retirees
Professor James Galbraith provided a keynote address at a recent industry conference sponsored by NAVA—the Association for Insured Retirement Solutions.
Professor Galbraith comes from the Economics department at the LBJ School of Public Affairs at the University of Texas at Austin. A Keynesian and an author most recently of The Predator State, Professor Galbraith has been a consistently strong and vocal advocate of government stimulus and intervention in response to the financial crisis.