What Is Sequence-of-Returns Risk and How Can Retirees Manage It?

The Short Answer

Sequence-of-returns risk is the risk that weak investment returns occurring early in retirement, while you are withdrawing money, will permanently reduce how long your savings last. Two retirees can earn the same average return over 30 years yet end with very different outcomes, simply because the order of good and bad years differed. Strategies such as holding cash reserves, maintaining a diversified allocation, and using flexible withdrawal rules can help manage this risk.

Why Does the Order of Returns Matter?

While you are saving, the order of returns has relatively little effect on your ending balance, because you are not removing money. Once withdrawals begin, the dynamic changes. Selling investments after a decline to fund spending locks in losses, leaving fewer assets to participate in the recovery.

Consider two retirees who each begin with the same portfolio and withdraw the same amount each year. One experiences a significant market decline in the first two years of retirement, followed by strong returns. The other enjoys strong returns early and a decline later. Even with identical average returns, the first retiree’s portfolio is likely to be depleted sooner, because withdrawals during the downturn consumed a larger share of the portfolio.

When Is a Retiree Most Exposed?

Exposure tends to be greatest in the years just before and just after retirement, sometimes called the “retirement red zone.” During this period, portfolio balances are typically at their largest and withdrawals are beginning, so a major decline can have a lasting effect. Later in retirement, the effect of any single year diminishes because the remaining time horizon is shorter.

How Can Retirees Manage Sequence Risk?

No strategy eliminates market risk, but several approaches can reduce the likelihood that a poorly timed decline derails a plan.

Maintain a Cash or Short-Term Reserve

Holding one to two years of planned withdrawals in cash or short-term bonds allows you to fund spending during a downturn without selling equities at depressed prices. Our resource on how much cash a family should hold discusses balancing liquidity with long-term growth.

Use a Diversified Allocation

A portfolio that includes high-quality bonds and other diversifying assets can provide stability and a source of funds when equities decline. Newport’s article on asset allocation explains how the mix of assets shapes risk and return.

Adopt Flexible Withdrawal Rules

Dynamic or “guardrail” strategies reduce withdrawals modestly after poor market years and allow increases after strong years. Even small, temporary reductions in discretionary spending can meaningfully improve a portfolio’s longevity.

Rebalance Thoughtfully

Rebalancing allows you to draw withdrawals from asset classes that have performed well, rather than selling those that have declined.

Consider Reliable Income Sources

Delaying Social Security, using pension income, or, in some cases, purchasing an annuity can reduce how much a retiree depends on portfolio withdrawals, which lowers sequence risk.

Gradually Adjust Risk Around Retirement

Some retirees reduce equity exposure in the years leading up to retirement and then gradually rebuild it, an approach sometimes called a “rising equity glide path.” Whether this fits depends on your goals and risk tolerance.

How Does This Fit Into a Retirement Income Plan?

Sequence risk is one reason retirement income planning is not simply a matter of projecting an average return. Stress-testing a plan against different market paths, including early downturns, helps reveal how resilient it is and what adjustments might be needed. Newport’s article on market uncertainty offers perspective on staying disciplined during volatile periods.

The Takeaway

The years surrounding retirement are when the order of returns matters most. Planning ahead with reserves, diversification, flexible spending, and dependable income sources can help your plan withstand difficult markets. If you are approaching retirement and want to stress-test your income strategy, Newport’s private wealth team can help.

This article is provided for educational purposes only and is not individualized investment, tax, or legal advice. Please consult qualified professionals about your specific circumstances and review our disclosures.