Real Wealth Education
Posted on March 29th, 2016 at 9:23 AM by David Orth
Here’s a risk you may have not even known existed- sequencing risk. Many investors will be familiar with the main types of risk surrounding superannuation investments; however, a lesser known risk is sequencing risk. So what is this risk and how can it affect your all-important nest egg?
Sequencing risk is the risk that the timing and order of your investments is unfavourable. This will result in less money for retirement and a smaller nest egg. Sequencing risk is particularly important when you are getting close to retirement. Early on the negative impact will only affect those few previous years. A negative impact closer to retirement affects each year of contributions over your entire working life resulting in a larger decrease to your overall balance.
Consider two individuals who have made the same net superannuation contributions of $10,000 per annum, over a 20 year period. Over that 20 year period they had the same average investment earning rate of 7% per annum. Let’s also assume that the two individuals had the same returns each year from years 2 to 19. Individual one had a -10% return in year one and a +10% return in year 20. Individual two had the opposite returns of +10% in year one and -10% in year 20. Due to individual two experiencing his negative result in year 20, his final nest egg was a huge $81,000 less than individual one. Individual one ended up with a nest egg of $483,636, individual two with a far less $402,634.
This example shows the huge impact that the timing and order of negative returns can have and how it can result in thousands being taken away from your nest egg.
There is good news however. This risk can be minimised by careful planning of your investments leading into retirement. Investing in less risky options when you are closer to retiring reduces the risk of a negative return. Another option is to diversifying your portfolio. This will result in a reduction in the volatility of returns and severity of a negative return. There are other ways to mitigate the risk but no perfect option.
If you would like to find out more about sequencing risk and how to manage it, either use the below contact form or give us a call on 1300 725 889.