I’d like to continue our theme investing dangerously and risks that investors face.
Today we will discuss, The danger of sequence of returns risk: The concept of “sequence of returns risk,” or the risk of experiencing a string of unfavorable returns as you begin to draw down on your portfolio, is a very difficult scenario from which to recover. A good example of this was during the 2008-2009 Great Financial Crisis. Some soon-to-be retirees had their 401(k) invested much too aggressively or too concentrated in their own company stock. The market downturn and fragility of the financial system was devastating. Instead of retiring as planned, some of these people got wiped out by the market crash and were forced to remain working much longer than originally planned.
One way to manage sequence of returns risk is to set up a “bond tent.” The concept of a bond tent is to keep a few years’ worth of expense money in very short-term high-quality bonds or cash. The remaining assets can be invested, perhaps more aggressively, according to various other goals. Should the market have several years of subpar returns, the investor won’t have to liquidate their more volatile holdings at a steep loss. Rather, they will be able to use their cash cushion or high-quality bonds to meet their expenses as they wait for the market to recover.