Risk

Question 1

What is sequencing risk and what are its effects on an investment portfolio (5)

Answer 1

• impact of volatility
• on the order
• and timing of withdrawals
• and the sustainability of future income
• the long term impact on capital value
• which is greater in the earlier years

Ie the impact of withdrawing money on the overall value of the investment

Question 2

Sequencing risk facts

Answer 2

• although a cash flow model incorporates an assumed investment return
• that can be adjusted depending on client objectives
• returns are never linear
• instead returns fluctuate
• when income / capital is taken during a market downturn
• funds are exhausted more rapidly
• because a greater proportion of the funds must be sold to achieve the same level of income
• and so funds have limited opportunity to benefit from market recovery
• this can quickly erode funds
• sequencing risk can be very damaging for clients with no alternative source of income
• that allows them to postpone withdrawal until markets recover
• clients approaching or in retirement face different risks than those with a long timeframe
• withdrawing funds in a falling market an have a significant impact on the sustainability of income levels
• because of reverse pound cost averaging

Question 3

Clients most affected by sequencing risk

Answer 3

• pre retirees late in accumulation phase
• post retirees early in drawdown phase

This part of cycle is know as ‘retirement risk zone’ (15 years pre retirement to 10 years post retirement)