Sunday, January 20, 2013

Sequencing Risks: Bad Luck With Bad Timing

Sequencing Risks: Bad Luck With Bad Timing

Been reading the papers and encountered a new financial phrase dubbed as 'sequencing risk'. So what is sequencing risk?

Basically it refers to the risk that you will experience annual returns in the wrong order. That a negative year or negative event closer to retirement is significantly more detrimental than a negative year or event occuring earlier on in your younger years. A negative financial event in your later years will impact on a larger balance than the balance you have in your younger years.

You may have heard the general idea that younger people have a longer time frame for their funds/savings/investments to recover and grow than older folks have.

The 'Woe Is I' and 'Poor Me' Attitude

Michael Drew, a professor of finance at Griffiths University commented on baby boomers and their bad luck and bad timing, "In their last decade of work, they experienced the bursting of the dotcom bubble, the subprime (mortgage) crisis, the GFC and they're now living through a sovereign debt crisis."

Those sequential financial events are nothing out of the ordinary if you analyse the global financial market going back to the 1930s. Does he think the last ten years are abnormal? If you look at the financial markets from the 1930s to the late 1990s, the business cycles have been marked with booms and slumps due to over gearing, too much loans, inflation and house prices escalating, Black Tuesdays, Asian financial currency crises and suicides.

2008 and the events thereafter impacting the financial markets are nothing new and I find it ridiculous that people behave like it was unexpected and a surprise. As markets rise, they eventually fall. If they don't drammatically fall, then they go sideways. Markets simply don't rise forever and ever in a straight line.

That's why retirement planning shouldn't always be about growth and particularly for those in their 50s. The reason why many baby boomers were caught with their pants down were because they hadn't saved enough in their younger years, and due to desperation to grow their retirement funds closer to their twilight years, they placed their money into growth funds when they should have been ideally moving their funds into more stable income funds or income investments (with a lower allocation in the riskier stock and property asset classes).

Close To Retirement?

Don't have all your funds invested into the stockmarket. If you've got ALL your savings and retirement funds saved in a superannuation fund(for Aussie readers) or a mutual fund (for US readers) then that is the WORST strategy you can ever devise for your money. Even if you have your money invested into two or three superannuation or mutual funds, you are NOT spreading your risk in the best way.

That is the worst investment strategy. Ever.  

The best strategy is to be diversified ACROSS asset classes (eg: property, stocks, cash, bonds, super/mutual funds) and to be diversified WITHIN the asset classes (eg for property- a mix of residential and commercial, for stocks- a mix of financial, resources, retail and for cash- in different banks and financial institution and for super/mutual funds- in different allocations such as property, domestic and international shares.)

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