Sequence of Returns Risk Reconsidered

Abstract

In the process of evaluating various retirement income strategies, it appears that, for investors not endowed with substantial wealth relative to consumption demands, sequence of returns risk is operative throughout retirement. We explore, in an asset-liability modeling context, the reasons why sequence risk exists throughout the planning horizon and why it can be particularly acute at the end of an investor’s life span. Given the nature of this risk, prudent asset management benefits from developing appropriate risk metrics, and from implementing credible monitoring, evaluation, and communication procedures. Two case studies focus on sequence of returns risk. They present risk metrics designed to answer the following questions: (1) is the investor’s retirement income strategy feasible; (2) if yes, is it sustainable; and (3) does it allow sufficient flexibility to provide security in the face of financial shocks? The risk metrics employ information derived from both investment simulation models and actuarial calculations.

Keywords: retirement income, retirement planning, sequence of returns risk

JEL Classification: G10, G11