For years, the prevailing wisdom, often championed by most registered investment advisors (RIA), has been to simply buy and hold passive index ETFs, rebalancing occasionally, and hoping for the best. But this approach overlooks a critical, but often unseen, risk: sequence of returns risk.
It’s not just about the overall market performance, but the order in which those returns occur. And for those who truly understand the market’s nuances, a passive approach can leave you vulnerable.
Imagine starting your retirement journey only to be immediately hit by a significant market downturn. If your portfolio is solely invested in broad, passive indexes, you’re forced to sell assets at depressed prices just to cover your living expenses.
This could potentially put your retirement plan at risk. And this is where the conventional playbook falls short. Savvy investors understand that a more proactive, engaged approach is not just beneficial, but essential.
Sequence of Returns Risk
Sequence of returns risk is the silent killer of many retirement plans. It highlights that the timing of market returns matters immensely, especially when you’re withdrawing from your portfolio. If you experience significant negative returns early in your retirement, or even just before it, your portfolio can be severely crippled.
Why? Because when you’re withdrawing from a declining portfolio, you’re forced to sell more shares to meet your income needs. This accelerates the depletion of your capital, leaving less to recover when the market eventually turns.
A passive, buy-and-hold strategy, which simply rebalances once or twice a year, offers little defense against this. It assumes a consistent market recovery, which isn’t always the reality, especially for those who need income from their investments.
This is why a different approach is needed. Instead of blindly following the herd into broad market indexes, investors should partner with an RIA firm that champions active risk management. This means moving beyond the typical asset allocation model that most firms employ, and instead, focusing on building a robust portfolio designed to withstand market volatility.
Active Management and Individual Stocks
Active management isn’t about chasing every hot stock or trying to time the market perfectly. Instead, it’s about a disciplined, proactive approach to custom portfolio management. It means working with a fiduciary advisor who doesn’t just allocate assets into a basket of ETFs, but who meticulously selects individual stocks for your portfolio. This allows for a level of control and responsiveness that passive strategies can’t offer.
Think about it: when you invest in a broad index ETF, you own a piece of everything, the good and the bad. You’re along for the ride, regardless of the underlying fundamentals of each company. With individual stocks, especially within a concentrated portfolio, your investment advisor can focus on high-conviction ideas, companies with strong balance sheets, competitive advantages, and robust growth prospects. This isn’t about diversification for diversification’s sake; it’s about intelligent concentration in quality assets.
Active risk management means continuously monitoring your holdings and making adjustments as market conditions evolve. Unlike the passive approach of buying and holding, an actively managed portfolio can adapt.
If a company’s fundamentals deteriorate, or if market conditions shift unfavorably, a fiduciary RIA using active management can make timely decisions to protect your capital. This dynamic approach is a big contrast to the set-it-and-forget-it mentality that leaves investors exposed when the market turns sour.
Here are some ways to manage sequence of returns risk:
- The 4% Rule, Reimagined: Forget rigid rules. With active management, your certified financial planner (CFP) or advisor can help you dynamically adjust withdrawals based on market conditions and your portfolio’s performance. This ensures your custom portfolio management adapts.
- Build a Liquidity Buffer: Create a strategic reserve of low-risk, liquid assets, enough to cover several years of expenses. This actively managed buffer protects your core portfolio of individual stocks from forced selling during downturns, ensuring your long-term growth engines remain intact. It’s a cornerstone of effective financial planning advice.
- Dynamic Spending for Active Income: Move beyond broad market adjustments. Your fiduciary advisor can help you implement a precise dynamic spending strategy, responsive to the health of your individual stocks and the market.
- The Concentrated Bucket Approach: Elevate the traditional bucket strategy with active management. Instead of just separating assets by time, actively manage each ‘bucket’ with carefully selected individual stocks. Your long-term growth bucket, for instance, becomes a curated selection of high-quality companies.
Proactive Wealth Management
Market downturns are inevitable, but your response doesn’t have to be passive. Many RIA firms still rely on the basic index ETF playbook, which may not fully protect against sequence of returns risk. Investors should seek an advisor that champions active management, building and managing concentrated portfolios of individual stocks.
Your retirement planning is a dynamic journey. This means working with a fiduciary advisor who practices genuine active risk management, making informed adjustments as markets evolve, rather than simply buying and holding.
Ready to move beyond the standard advisor playbook?
At Paraiba Wealth, our focus is on building actively managed portfolios—a strategy designed for greater control, tax efficiency, and tailored to you. If you’re ready to see what this looks like, book a no-obligation initial call today.