When planning for retirement, most people focus on average annual returns. But what often gets overlooked and can dramatically affect your nest egg is something called sequence of returns risk.
As a financial advisor, I see this mistake often. Two retirees might earn the same average return on their investments over time, but one could run out of money far sooner than the other, simply because of the order in which they received those returns.
What Is Sequence of Returns Risk?
Sequence of returns risk refers to the danger that poor investment returns in the early years of retirement, when you’re actively withdrawing from your portfolio, can permanently damage your long-term financial outlook.
Let’s say you retire into a down market. Your portfolio drops in value, but you still need to withdraw money for living expenses. Now you’re selling investments at a loss, leaving less capital to grow when the market rebounds. Even if returns average out over time, the damage from those early losses is already done.
Example: The Impact of Bad Timing
Imagine two retirees:
- Retiree A gets strong returns early in retirement, then weaker returns later.
- Retiree B gets the exact same returns, but in reverse order.
If both withdraw $50,000 per year, Retiree A may see their money last 30+ years while Retiree B could run out in 20… even though they both had the same average return.
It’s not just what you earn but when you earn it.
How to Reduce Sequence of Returns Risk
Here are some strategies I recommend to help you manage this risk:
1. Create a “Bucket” Strategy (this is my favorite strategy)
Divide your investments into short-, medium-, and long-term “buckets”:
- Bucket 1: Cash or stable bonds for 1–3 years of expenses
- Bucket 2: Conservative investments for years 3–7
- Bucket 3: Stocks for long-term growth
This structure can allow you to avoid selling stocks during downturns by tapping your safer buckets first.
2. Use a Dynamic Withdrawal Strategy
Instead of a fixed withdrawal rate, adjust based on market performance. For example:
- Cut back a bit in bad years
- Take more in strong years
This can help preserve your portfolio during volatile periods.
3. Delay Social Security or Pension Start Dates
Each year you wait typically increases your benefit, giving you more guaranteed income later and reducing pressure on your portfolio early on. But whether this is the right decision for you depends on your situation and personal factors such as other income sources, life expectancy, retirement date, etc. Often, delaying is not the right decision for someone.
4. Consider an Annuity for Guaranteed Income
For part of your portfolio, an annuity can provide predictable income, reducing the need to sell investments when the market is down. Not everyone needs one, but for some retirees, it can add more peace of mind.
5. Keep a Flexible Spending Plan
Build some flexibility into your retirement budget. Knowing which expenses are “needs” versus “wants” can help you make short-term adjustments without long-term consequences.
Conclusion
Sequence of returns risk is one of the biggest silent threats to retirement success but it’s also one you can plan around. The key is to be proactive: structure your withdrawals, protect against early market losses, and build flexibility into your plan.
If you’re within five years of retirement (or already retired), now is the time to review your strategy.
Together, we can work to keep you on-track toward your financial goals.
Request a consultation to learn more.
Read more articles by Ryan Johnson