When it comes to retirement planning, most people focus on how much they’ve saved. But just as important—if not more—is when you start withdrawing your money. This is where sequence of returns risk comes into play. It’s a lesser-known concept that can significantly impact your financial security in retirement, even if your average investment returns stay the same.
What Is Sequence of Returns Risk?
Sequence of returns risk refers to the danger that the order of investment returns—particularly poor returns early in retirement—can negatively affect how long your savings last. Unlike accumulation during your working years, where volatility is smoothed out over time, withdrawals during down markets in retirement can permanently erode your portfolio.
Let’s say two retirees have the same portfolio and earn the same average annual return over 30 years. One experiences market losses early on, the other later. The retiree who faces early losses while withdrawing funds may deplete their savings much faster, even if the market recovers later. This is because withdrawing money during a market downturn locks in losses, reducing the principal that could benefit from future gains.
Why Timing Matters
During retirement, you’re no longer contributing to your portfolio—instead, you’re drawing it down. If poor returns occur early, while withdrawals are high, your portfolio may not have enough time to recover before you need more funds. This compounding effect can jeopardize your ability to sustain income throughout retirement.
For example, during a market downturn like the 2008 financial crisis or the 2020 pandemic-related crash, retirees who were drawing from their portfolios at the time faced steeper challenges than those still working and contributing to their accounts.
Strategies to Mitigate Sequence of Returns Risk
1. Create a Cash Reserve:
Maintain 1–3 years of living expenses in cash or short-term instruments. This buffer allows you to avoid selling investments in a down market.
2. Use a Bucket Strategy:
Divide your assets into three buckets: short-term (cash), medium-term (bonds), and long-term (stocks). Draw from the safer buckets during downturns, allowing riskier investments time to recover.
3. Reduce Withdrawals During Market Declines:
Be flexible with your spending. If the market is down, reduce discretionary withdrawals to minimize impact.
4. Consider Annuities:
A portion of your retirement income can be guaranteed through annuities, which reduce reliance on portfolio performance.
5. Delay Social Security:
Delaying Social Security benefits until age 70 increases your guaranteed monthly income, reducing pressure on your portfolio early in retirement.
Final Thoughts
Sequence of returns risk is a critical yet often overlooked element of retirement planning. It’s not just how much you earn on your investments, but when you earn it—and when you withdraw—that determines whether your savings will last. By incorporating risk management strategies into your withdrawal plan, you can weather market fluctuations and safeguard your financial future.
Retirement should be about enjoying life—not worrying about running out of money. Understanding and planning for sequence of returns risk is one of the smartest moves you can make toward that goal.