Sequence of Returns Risk: Why Early Losses Matter in Retirement

In my recent blog post, How to Protect Your First 10 Years of Retirement, I touched on one critical concept — Sequence of Returns Risk.

After several long dinner-table discussions with my husband, we decided to dive deeper into what this means and why it’s so important for retirees, especially in those first crucial years of drawing from your nest egg.

What is Sequence of Returns Risk?

By definition, sequence of returns risk – (link to Schwab) is the danger that the order of investment returns — particularly early in retirement — can dramatically affect how long your savings last, even if your average return over time is identical.

Here’s why it matters: if you experience negative returns early on while also withdrawing money to live on, your portfolio may struggle to recover, potentially shortening its lifespan.

A Simple Example

Imagine two retirees — Harry and Larry — who each start retirement with the same portfolio value and average returns over 24 years. The only difference? Harry experiences market downturns early, while Larry experiences them later.

Assumptions: Both start with $1,000,000. Both take out 5% annually based on portfolio balance. Portfolio is a 60% S & P 500 and 40% Bloomberg AGG returns based on Slickcharts numbers.

As you can see – Harry took out less money (only $1,151,903) and also ended up with $647,389 less in his portfolio.

Why Sequence of Returns Matters

If your portfolio declines right as you begin taking withdrawals, you could end up selling assets at a loss, compounding the impact and leaving your portfolio less able to recover.

Here are four major risks tied to this problem:

1. Early Withdrawal Risk
   • Withdrawing from a declining portfolio forces selling assets at a loss, compounding the problem.
2. Longevity Risk
   • Poor early returns can accelerate depletion, leaving retirees vulnerable to running out of money before death.
3. Psychological Risk
   • Early losses may trigger panic selling or overly conservative behavior, potentially locking in losses.
4. Market Volatility Impact
   • Portfolios with high equity exposure are more vulnerable to sequence of returns risk, especially if markets are down during early retirement.

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Smart Strategies to Manage Sequence of Returns Risk

You can’t control market performance — but you can control your withdrawal strategy and portfolio design. Here are six proven approaches to help reduce the impact of sequence risk:

A. Asset Allocation and Diversification

• Keep a balanced portfolio (stocks + bonds + possibly alternative assets) to reduce volatility.
• Lower-volatility assets like bonds can provide stability and a cushion during down markets.

B. Withdrawal Rate Management

• Use a conservative initial withdrawal rate, typically 3–4% of the portfolio.
• Consider adjusting withdrawals depending on market conditions — withdrawing less in down years and slightly more in good ones.

C. Buckets Strategy

One of my favorites!
Think of your retirement money in three “buckets”:

• Short-Term (1–3 years): Cash or T-bills for immediate living expenses.
• Medium-Term (3–7 years): Bonds or conservative funds for near-future spending.
• Long-Term (8+ years): Equities for growth.

This setup lets you draw from safer assets during market downturns instead of selling stocks at a loss.

D. Partial Annuities or Guaranteed Income

• Purchasing an annuity can provide a steady baseline income for essentials, reducing pressure to sell investments in bad markets. Make sure you read all the details when purchasing any annuity plan.

E. Flexibility

• If markets dip, pause major spending, reduce withdrawals, or tap alternative income sources (like part-time work or rental income). Small adjustments can make a big difference over time.
• Being flexible with withdrawals can mitigate the effect of poor market sequences.

F. Hedging

• Some investors use inflation-protected bonds (TIPS), gold, or other assets as partial hedges against market and inflation risk.

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What We Know Now

When we began our retirement planning, we focused heavily on average returns and growth — not the timing of those returns. But after learning more about sequence risk, we’ve realized that how and when you earn those returns matters even more than the average.

Retirement isn’t just about saving — it’s about sustaining. And that takes strategy, awareness, and flexibility.

A thoughtful plan should include:

• Smart asset allocation and diversification
• Conservative, flexible withdrawals
• A bucket system for income stability
• Optional hedges or annuities for protection

If you’re nearing or in retirement, take a fresh look at your withdrawal plan. If you have a financial advisor, they should have the tools to help you with this analysis. It’s never too late to build a more resilient strategy for your next chapter.

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