Protecting Against "Sequence of Returns" Risk

Andrew Prentice |

With the summer season ending, children going back to school and days getting shorter it is impossible not to feel the change. As the variables around us change we need to change as well, and adapt with them in order to survive. With valuations of stocks at elevated levels and bond yields depressed at historical lows, your traditional stock/bond only portfolio may not suit the average investor in the future. The diversification benefits that we have seen in the past with a traditional portfolio may not evolve with the types of changes occurring in the financial markets. Particularly if an individual or couple is close to retirement and will need to turn their savings into income, they have what is known as “sequence of return risk”. This is the risk that having poor returns in the beginning years of your retirement dramatically reduces the probability of a successful plan.

The good news is that there are ways to adapt your portfolio and mitigate this risk, and one of those ways is by using an annuity. Now, I know that annuities have a bad rap and sometimes rightly so. However, if the correct annuity is chosen for the correct situation, they can be an appropriate solution that helps improve the probability of a successful financial plan. The two ways that could be opportunistic to use an annuity in our current climate are 1) by taking a portion of your bond exposure and allocating it to a fixed index annuity. This will allow for the safety that bonds typically provide with principle protection, but also still give the opportunity for upside gains, and 2) using an annuity with a living benefit. This way, if returns dip right before you start taking income from your portfolio you still get to take a locked-in income base that isn’t affected by poor market returns.

Finding ideas to adapt and prepare your portfolio for the ever-changing financial climate can be tricky. These are just a couple ways that annuities can fit into a successful plan but always remember to do your due diligence. As with any other investment, annuities vary by structure and cost so finding one that is appropriate for your situation is important.