Sequence of returns risk is the danger that a market decline in your first retirement years, while you are withdrawing income, leaves lasting damage to your portfolio even if long-term average returns look fine. Two retirees with identical average returns can end up hundreds of thousands apart, based on which years the losses landed in.
What is sequence of returns risk?
A portfolio in the accumulation phase can absorb a bad year without much consequence, since no one is pulling money out of it and time is on its side. A portfolio in the distribution phase does not have that luxury. Every withdrawal during a down year sells shares at a depressed price, and those shares leave the count that would have ridden the recovery when it comes. The math does not undo itself once the market turns, because the shares sold at the bottom are already gone from the account.
Why does the order of returns matter more than the average?
Consider two retirees, each starting with $1,000,000 and withdrawing $50,000 at the start of each year for three years. Both experience the same three annual returns: negative 20%, positive 5%, and positive 25%. Retiree A gets the bad year first. Retiree B gets it last.
| Year | Retiree A’s return | Retiree A balance | Retiree B’s return | Retiree B balance |
|---|---|---|---|---|
| Start | n/a | $1,000,000 | n/a | $1,000,000 |
| 1 | -20% | $760,000 | +25% | $1,187,500 |
| 2 | +5% | $745,500 | +5% | $1,194,375 |
| 3 | +25% | $869,375 | -20% | $915,500 |
Same three returns, same total withdrawn, same average return. Retiree B still finishes with $46,125 more than Retiree A after three years, 4.6% of the starting balance, from the order the returns arrived in. Stretch this pattern across a real 25- to 30-year retirement instead of three illustrative years, and a bad first year compounds for decades instead of three, widening the gap far beyond this example.
When is the risk highest?
The danger concentrates in a specific window: the five to ten years before your retirement date and the five to ten years after it. Your portfolio is at its largest relative size during that stretch, contributions have stopped or are about to, and withdrawals are just beginning. A downturn ten years into a comfortable retirement still hurts, but a smaller portfolio by then means a smaller dollar loss and more time already banked. A downturn in year one or two does the most damage, because it happens to the largest pool of money you will ever draw from.
How do you protect against it?
An income buffer of two to three years of spending, held in cash or short-term bonds, lets you skip selling equities during a down year. A bucketing structure extends the same idea across a longer horizon: near-term spending in cash and short bonds, mid-term money in a balanced mix, and long-term money still invested for growth since it will not be touched for a decade. Guardrail-based withdrawals adjust the spending rate itself, trimming it in a defined way after a bad year and allowing it to rise after strong ones, rather than holding a fixed dollar amount constant no matter what the market just did.
The detail most withdrawal sequencing plans miss is where the buffer’s cash comes from. Refilling it from a taxable account’s gains during a strong year, or from a tax-deferred withdrawal sized to a low bracket in a year the market cooperated, costs less in tax than refilling it with a rushed tax-deferred withdrawal during the down year itself. The buffer protects the portfolio. Funding it from the right account in the right year protects the tax bill too.
How does this interact with the rest of your plan?
RMDs begin at 73, or 75 if you were born in 1960 or later, and are set by the prior year-end balance, which means the withdrawal amount cannot flex downward the way a discretionary one can. A market drop the same year an RMD is due forces a sale at the worst possible price, with no buffer to lean on unless one was already built. A Social Security claiming strategy that delays the higher earner’s benefit to 70 grows that income at 8% a year, adding a larger, guaranteed floor right as the highest-risk window closes. The floor and the buffer, part of a full Retirement Income Roadmap, work toward the same goal from different directions.
What should you do next?
Size a cash or short-bond buffer to two or three years of spending before you retire, not after a downturn arrives. Decide in advance which account refills that buffer and in which kind of year, so the decision is not made under pressure. Model how an RMD due in a down market year would interact with the buffer, since that collision is where sequence risk shows up again even after the first ten years pass.
A buffer without a tax-aware refill plan solves half the problem. Schedule a consultation to build the other half.
Common questions
- Does sequence of returns risk go away after a few years of retirement?
- It fades once you move past the five to ten years surrounding your retirement date, since the portfolio is largest and most vulnerable during that stretch. It does not disappear once RMDs begin, because those withdrawals are fixed regardless of that year’s market.
- Can sequence risk affect someone who never sells in a panic?
- Yes. A fixed-dollar withdrawal still comes out of the account during a down year, selling shares at a depressed price, even when the decision is calm and planned rather than reactive.
- Do RMDs make sequence risk worse?
- In one specific way, yes. An RMD is set by the prior year-end balance, so it cannot scale down the way a discretionary withdrawal can. A market drop the same year the RMD is due forces a withdrawal at the worst possible price.
- Is a bond-heavy portfolio the answer to sequence risk?
- Not by itself. It reduces volatility but caps growth over a retirement that may last 30 years. A cash or bond buffer sized to a few years of spending, paired with continued equity exposure for the money you will not touch for a decade, is the more common structure.
- How far from retirement does sequence risk start to matter?
- Most retirement income research treats the five to ten years before and after your retirement date as the highest-risk window, since the portfolio is at its largest relative to future contributions right as withdrawals begin.
If the decisions on this page are ahead of you, the two of you can work through them with Robert Boeck before any of them becomes permanent.
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