When investors think about market timing, they often focus on trying to buy low and sell high during their working years. While timing matters during accumulation, it becomes far more critical in retirement due to a concept known as sequence of returns risk. Understanding this risk is essential for retirees who rely on their portfolios to generate income rather than simply grow.
What Is Sequence of Returns Risk
Sequence of returns risk refers to the danger of experiencing poor investment returns early in retirement while simultaneously withdrawing money from a portfolio. Unlike average returns, which may look identical over time, the order in which those returns occur can dramatically impact long term outcomes once withdrawals begin.
During accumulation, negative returns can often be offset by continued contributions and time. In retirement, however, withdrawals amplify losses because money taken out during down markets is no longer available to recover when markets rebound.
Why Timing Matters More in Retirement
Two investors may earn the same average annual return over twenty years, yet end up with vastly different portfolio values if the timing of returns differs. If strong returns occur early in retirement, the portfolio has a greater chance to sustain withdrawals. If major losses occur early instead, the portfolio may be permanently damaged even if markets recover later.
This is why timing matters more in retirement than during accumulation. Retirees are no longer adding capital. They are drawing from it. Market downturns combined with withdrawals can create a compounding negative effect that shortens the lifespan of a portfolio.
The Role of Withdrawals
Withdrawals are what turn ordinary market volatility into a serious retirement risk. Selling assets at depressed prices locks in losses and reduces the number of shares that can benefit from future growth. Over time, this can force retirees to either reduce spending or risk running out of money altogether.
The larger and more rigid the withdrawals, the greater the impact of sequence of returns risk. This makes withdrawal strategy just as important as investment strategy in retirement planning.
Strategies to Manage Sequence of Returns Risk
One effective approach is maintaining a diversified portfolio with a mix of growth and defensive assets. Bonds, cash equivalents, and other lower volatility investments can help fund withdrawals during market downturns, allowing growth assets time to recover.
Another strategy is flexible spending. Retirees who can reduce withdrawals during down markets often improve the sustainability of their portfolios. Even modest adjustments can significantly lower long term risk.
Bucket strategies are also commonly used. This involves separating assets into short term income needs, medium term stability assets, and long term growth investments. By drawing from safer buckets during market stress, retirees can avoid selling growth assets at the wrong time.
Planning Beyond Average Returns
Traditional projections often rely on average market returns, but retirement success depends far more on timing and behavior. Incorporating sequence of returns risk into retirement planning leads to more realistic expectations and stronger income strategies.
By understanding how market timing impacts withdrawals, retirees can make informed decisions that protect their lifestyle and financial security. Proper planning does not eliminate market risk, but it can significantly reduce the chance that early losses derail an otherwise well funded retirement.