By addressing sequence of returns risk head-on, financial advisors can help clients build resilient strategies that preserve both their assets and peace of mind.  Retirement is a time to enjoy the fruits of decades of hard work, not to worry about market fluctuations derailing carefully laid plans.

By setting up a Home Equity Conversion Mortgage (HECM) line of credit early in retirement, retirees can create a tax-free, liquid resource that grows over time. During market downturns, they can draw from the HECM instead of selling investments, preserving their portfolio for future recovery.

The Lurking Danger That Can Swamp Even a Solid Retirement Plan: Understanding and Mitigating Sequence Risk

When discussing retirement planning, sequence risk may not always be front and center, but it’s a critical concept that can have a profound impact on retirees’ financial security. As a financial advisor, understanding sequence risk—and educating your clients about it—can help safeguard their retirement plans against unexpected market downturns.

What Is Sequence Risk?

Sequence risk, also known as sequence of returns risk, refers to the danger that a market downturn early in retirement will erode a retiree’s savings more quickly than expected. Unlike general market volatility, sequence risk specifically concerns the timing of market returns in relation to withdrawals.

To illustrate, let’s assume a retiree needs $1,000 per month from their Roth IRA and has invested entirely in a balanced ETF priced at $50 per share. Initially, they would sell 20 shares monthly to meet their income needs. However, if the ETF’s value drops by 50%, they would need to sell 40 shares monthly to generate the same $1,000. This increased rate of withdrawal accelerates the depletion of retirement savings, leaving the individual vulnerable to running out of funds sooner than planned.

The adage “buy low, sell high” applies: selling assets during a market downturn locks in losses. Having alternative income sources can help retirees avoid withdrawing from investment accounts when markets are unfavorable.

Defending Against Sequence Risk

While market fluctuations are beyond anyone’s control, retirees can mitigate sequence risk by diversifying income sources. A robust plan includes:

• Cash reserves: Liquid savings can act as a buffer during market downturns.

• Real estate income: Rental income can provide steady cash flow.

• Home equity: Leveraging home equity through products like a Home Equity Conversion Mortgage (HECM) can create additional flexibility.

Using Home Equity to Address Sequence Risk

Home equity represents a significant, often underutilized, component of many retirees’ net worth. In periods of market decline, tapping into home equity can help retirees meet their income needs without depleting investment portfolios at unfavorable prices.

HELOCs: A Risky Option

Some retirees use home equity lines of credit (HELOCs) to access funds. While HELOCs can work well for short-term needs, they carry risks that make them less suitable for long-term retirement planning:

• Interest-only payments: Many HELOCs require interest-only payments during the draw period, which means the principal remains unpaid unless extra payments are made.

• Rising payments: Borrowing more increases monthly payments, which can strain budgets.

• Adjustable rates: Most HELOCs have variable interest rates, making future payments unpredictable.

• Revocation risk: HELOCs can be frozen or reduced during economic downturns, potentially leaving borrowers without access to funds when needed most.

• Recast shock: After the draw period (typically 10 years), HELOCs require full principal-and-interest payments, which can lead to a significant and unexpected increase in monthly obligations.

For these reasons, a HELOC is generally not an ideal tool for retirees seeking long-term financial stability.

The HECM Line of Credit: A Better Solution

A Home Equity Conversion Mortgage (HECM), often referred to as a reverse mortgage, offers a more secure way to tap home equity in retirement. Specifically, the HECM line of credit is a flexible and low-risk tool designed for retirees aged 62 or older. Key benefits include:

• No Required Payments: Borrowers are not required to make monthly payments as long as they meet basic loan obligations, such as paying property taxes and homeowners insurance.

• Growth of Available Credit: Unlike a HELOC, the unused portion of a HECM line of credit grows over time at a guaranteed rate. This growth is tied to prevailing interest rates, meaning the credit line can increase significantly, even outpacing the home’s value in some cases.

• Non-Recourse Protection: A HECM is a non-recourse loan, meaning the borrower or their heirs will never owe more than the home’s value when the loan comes due, regardless of the outstanding balance.

By setting up a HECM line of credit early in retirement, retirees can create a tax-free, liquid resource that grows over time. During market downturns, they can draw from the HECM instead of selling investments, preserving their portfolio for future recovery.

Building a Resilient Retirement Plan

Sequence risk underscores the importance of diversification in retirement income planning. Just as retirees diversify investments to manage market risk, they should also diversify income sources to ensure financial flexibility.

Incorporating a HECM line of credit into a retirement plan provides a powerful tool to combat sequence risk. When markets falter, retirees can temporarily rely on home equity to fund their lifestyle. Once markets recover, they can resume drawing from their investment accounts, extending the longevity of their assets.

Conclusion: Protecting Clients from Sequence Risk

Retirement is a time to enjoy the fruits of decades of hard work, not to worry about market fluctuations derailing carefully laid plans. By addressing sequence risk head-on, financial advisors can help clients build resilient strategies that preserve both their assets and peace of mind.

Adding a HECM line of credit to the financial toolkit can provide clients with the flexibility they need to navigate unpredictable markets, ensuring a more secure and enjoyable retirement. As always, it’s crucial to evaluate each client’s unique circumstances and goals to craft a plan that aligns with their needs and aspirations.