Whether you’re retiring in your 40s or 70s, the biggest risk to your post-work wealth is what’s known as sequence risk.
It’s the threat that a recession or downturn will hit at the beginning of your retirement, instead of a few years in. Experiencing a downturn right as you begin to tap your portfolio for funds can deplete its ability to grow at the rate you need it to during your retirement.
Say you and your friends decide to go out to the bars. You know you plan to have a few drinks, mingle with your buddies and maybe meet some new people.
As you enter the bar, there’s the risk that one of your buddies started much earlier than you. There’s the risk that they’ve already drank too much, causing a disturbance, bothering people and getting sick. Right as you enter, they’ve already sabotaged your night. Instead of having a few drinks and laughs, you’re stuck babysitting your drunken friend. You go home, once you make sure he’s safe, annoyed and needing another night out.
That same scenario of the drunken friend can also play out differently. You enter the bar the same time as the friend. You have a few drinks, a few laughs, and a couple hours later you’ve met a few new friends, chatting and expanding your group. The friend goes home at the end of the night, still drunk. Maybe, even, still sick. But it happens in the comfort of their home. You end up with a great night out.
For those entering retirement, this sequence risk can be the difference between having a great night out and living your later years annoyed, angry and broke.
While you can’t control your drunken friend’s decisions, you can protect yourself from sequence risk by having at least a year – although more wouldn’t hurt – of expenses in cash, sitting in a high yield savings account.
That way, if your retirement starts out like a drunken buffoon, you can use the cash while your stocks have time to bounce back without you babysitting them.