3 tips on how to manage sequencing risk in 2020
Written and accurate as at: Mar 24, 2020 Current Stats & Facts
Sequencing risk
On Sunday the Federal Government announced a 50% reduction to minimum yearly superannuation pension payments. The initiative addresses a significant and less considered retirement risk called Sequencing Risk. Sequencing risk is the effect that a market correction can have on your superannuation fund or personal investment market value if you are planning to retire or have recently retired. Your superannuation fund or personal investment market value may not recover as you are drawing down to fund your retirement lifestyle. The long-term impact is an increased likelihood of outliving your funds in retirement.
Below is an example of a $1million portfolio invested with the same overall return of 5% per year over ten years. Portfolio 1 incurs a negative performance in the first two years and Portfolio 2 in the last two years.
Year Portfolio 1 Returns Portfolio 2 Returns Withdrawals Difference
$1,000,000 $1,000,000
1 $850,000 -10% $1,010,000 6% $50,000 -$160,000
2 $757,500 -5% $1,162,000 20% $50,000 -$404,500
3 $783,250 10% $1,193,340 7% $50,000 -$410,090
4 $709,753 -3% $1,322,341 15% $50,000 -$612,589
5 $716,533 8% $1,312,011 3% $50,000 -$595,479
6 $688,029 3% $1,366,972 8% $50,000 -$678,943
7 $741,233 15% $1,275,963 -3% $50,000 -$534,730
8 $743,119 7% $1,353,559 10% $50,000 -$610,440
9 $841,743 20% $1,235,881 -5% $50,000 -$394,138
10 $842,248 6% $1,062,293 -10% $50,000 -$220,045
Suppose Portfolio 1 reflects your superannuation fund, including pension payments over the next ten years. Your fund would suffer a detrimental long-term outcome following a negative investment return in the early years of retirement. The results are compounded by yearly pension payments which erode the balance after the negative return and limit the fund recapturing value. Despite suffering these negative returns, there are many tactical decisions to consider which may reduce the long-term impact on your fund.
How to manage sequencing risk in 2020
Reducing the burn on your fund
The Federal Government announcement of GFC style measures to reduce the minimum pension rates for superannuation retirees is significant assistance in reducing sequencing risk. The measures assist in reducing withdrawals from super at a time when investments are at a loss. The proposal spanning FY2019-2020 and FY2020-2021 allows individuals to half their minimum yearly pension rates for Account-Based Pensions. The annual limits are based on age and proposed as follows:
Age at 1 July Current rates Proposed rates
Under 65 4% 2%
65 – 74 5% 2.5%
75 – 79 6% 3%
80 – 84 7% 3.5%
85 – 89 9% 4.5%
90 – 94 11% 5.5%
95 or older 14% 7%
The coronavirus pandemic is impacting everyday lifestyles. Social distancing and other measures such as travel bans will likely reduce your spending requirements for this year. To minimise the impact of withdrawals on your fund, you may consider reducing your pension payments in line with the new limits. Other more drastic considerations include turning off your pension altogether or subject to contribution rules, re-contributing pension drawdowns back to super.
Investment selection
It is important to minimise the sale of any growth investments which may be at a loss. If you have tailored your superannuation investments, consider drawing on cash or fixed interest assets to fund your lifestyle. The growth investments will have the chance to regain value. If you have a multi-asset class fund (for example a multi-asset class fund inside an industry fund) and must sell units to fund your drawdowns, then consider reallocating part of the fund to a high growth investment option. Keep in mind to consider your overall risk tolerance as increasing your growth investments will change the overall risk of your fund.
Long term view
Care and diligence should be taken with any financial decisions made in times like these. You should consider that any actions may impact your wealth in 10, 20 or 30 years from now. Speak with a professional adviser about your situation. A professional adviser will consider the implications of any of the above strategies on your long-term plans.