Here’s a question most people have never been asked: does it matter when your portfolio has a bad year? While you’re still working and adding to your accounts, the honest answer is: not much. But once you start withdrawing from your portfolio in retirement, the order of your returns can matter almost as much as the returns themselves. This is called sequence of returns risk, and it’s one of the least understood risks in retirement planning.
Imagine two retirees, each starting retirement with the same amount saved and each withdrawing the same amount every year. Both earn the exact same average annual return over a 20-year retirement — say, 6% — but in a different order. One retiree happens to experience strong returns in the early years of retirement. The other experiences a market downturn right at the start.
Even though their average return is identical, the retiree who hits a downturn early can run out of money years sooner than the one who didn’t — because they’re forced to sell more shares at depressed prices to generate the same income, leaving fewer shares left to participate in the eventual recovery. The math of withdrawing income while values are down is fundamentally different from the math of withdrawing income while values are up, even if the long-term average looks the same on paper.
Sequence of returns risk is generally most dangerous in the five to ten years before and after you stop working — sometimes called the “retirement red zone.” A downturn during your accumulation years is usually recoverable because you’re still contributing and have time on your side. A downturn shortly after you start withdrawing income has far less time to recover from, and the withdrawals themselves compound the damage.
Hold a cash or short-term bond reserve. Keeping one to three years of planned withdrawals in more stable, liquid assets can mean you’re not forced to sell growth investments during a downturn — you simply draw from the reserve instead and let the rest of the portfolio recover.
Build a bucket or tiered income strategy. Segmenting assets by when they’ll be needed — near-term, mid-term, and long-term — can reduce how much of the portfolio is exposed to short-term market swings right when income is being drawn. This is a core part of how we build Retirement Income Strategies for clients.
Adjust withdrawal rates in down years. Some retirees benefit from a flexible withdrawal approach, taking slightly less in years following a market decline rather than a fixed amount regardless of performance.
Diversify across asset classes. A well-diversified portfolio won’t eliminate market risk, but it can reduce how severely a single downturn affects the whole plan. This is a central focus of our Investment Strategies and broader Wealth and Asset Management work.
Coordinate with guaranteed income sources. Pensions, annuities, and the timing of Social Security benefits can all reduce how much a portfolio needs to generate in any given year, which lowers exposure to a bad sequence. Learn more about how this fits into our Social Security planning.
Is sequence of returns risk the same as market volatility? Not exactly. Volatility describes how much returns fluctuate. Sequence of returns risk describes how the timing of those fluctuations — specifically, whether they happen while you’re withdrawing income — affects how long your money lasts.
Does sequence of returns risk affect people who are still working? Much less so. While you’re contributing to your accounts rather than withdrawing from them, a downturn actually allows you to buy more shares at lower prices. The risk becomes significant once withdrawals begin.
How many years before and after retirement should I be most concerned about this? Many planners focus on the five to ten years on either side of your retirement date — often called the retirement red zone — as the period when a poor sequence of returns can do the most lasting damage.
Can I eliminate sequence of returns risk entirely? Not entirely, since markets are inherently unpredictable. But it can be substantially managed through cash reserves, diversification, flexible withdrawal strategies, and coordinating with guaranteed income sources.
How do I know if my current portfolio is set up to manage this risk? It depends on your withdrawal timeline, asset allocation, and how much of your income relies on the portfolio versus other sources like Social Security or pensions. A full review of your Retirement Income Strategies is the best way to find out.
Crestview Wealth Management, LLC (CWM) is a Texas-registered investment advisor. CWM is a member of Ethos Financial Partnership, a Securities and Exchange Commission registered investment advisor. Content contained herein is not intended and should not be construed as personalized investment advice or an offer for the purchase or sale of any security, insurance, or other investment product. Investments involve the risk of loss, including possible loss of principal. Please consult with a qualified financial, tax, accounting, or legal professional before implementing any ideas or strategies discussed here. Content provided may be obtained from sources believed to be reliable but cannot be guaranteed as to its accuracy or completeness.