Most investors focus on average returns when they think about their portfolios. Over 30 or 40 years of saving, that makes sense: you are adding money regularly, and what matters most is the long‑term growth of your investments. Once you start withdrawing in retirement, however, a different risk becomes just as important: the sequence of returns. In other words, not just how much your portfolio earns over time, but the order in which gains and losses show up.
Sequence of returns risk is the risk that poor market returns in the early years of retirement, combined with ongoing withdrawals, can permanently damage a portfolio—even if long‑term average returns eventually look “normal.” Two retirees can experience the same average market performance over 25 or 30 years and end up in very different places depending on the path those returns took. Understanding this risk is critical if you want your money to last.
Why sequence matters once you start withdrawing
During your working years, you are typically contributing to your accounts. Down markets, while uncomfortable, can actually be helpful because you are buying more shares at lower prices. In retirement, the dynamic reverses. You are no longer adding money; you are taking it out. When markets fall and you continue withdrawing the same amount, you are forced to sell more shares at depressed prices, which leaves fewer shares to participate when markets recover.
If that happens for several years in a row early in retirement, the math becomes unforgiving. Even if markets bounce back later, the portfolio may never fully recover because too many shares were sold along the way. This is the essence of sequence of returns risk. It is not a new type of risk, but it shows up more sharply when withdrawals enter the picture.
An illustration without charts
Imagine two retirees, both starting with a $1 million portfolio and both withdrawing $40,000 per year, adjusted for inflation. They invest similarly and experience the same 25‑year average return. The difference is that Retiree A experiences strong markets in the first ten years and weaker markets later, while Retiree B experiences the opposite: poor markets in the first ten years and stronger markets later. On paper, their average returns look identical. In reality, Retiree B’s portfolio is much more likely to run into trouble because the early losses were compounded by withdrawals.
This simple example highlights why focusing only on long‑term averages can be misleading once you start drawing from your portfolio. The timing of returns can be just as important as the returns themselves.
How sequence risk interacts with your spending
Sequence of returns risk does not exist in a vacuum. It interacts directly with your spending strategy. A rigid, fixed withdrawal plan—such as taking the same inflation‑adjusted amount every year regardless of what markets are doing—may be more vulnerable to bad sequences than a flexible plan that allows for adjustments.
For instance, if you insist on taking the same dollar amount each year, even during a prolonged downturn, you will be selling a larger percentage of your portfolio at lower prices. A more flexible approach might use “guardrails” around your spending: you maintain a target withdrawal rate but agree to temporarily reduce discretionary spending if markets fall beyond certain thresholds, then increase again when conditions improve. This adaptability can significantly mitigate sequence risk without requiring you to watch markets every day.
The role of cash and short‑term reserves
One of the most practical ways to manage sequence of returns risk is to maintain an intentional buffer of safer assets—such as high‑quality bonds and cash—designed to cover several years of planned withdrawals. This does not mean abandoning growth assets; rather, it means having a portion of your portfolio specifically earmarked for near‑term spending so you are not forced to sell stocks at the worst possible times.
For a deeper look at how much cash to hold and how to structure it within your overall plan, see our post on how much cash to keep in retirement.
For example, some retirees maintain one to three years of baseline withdrawals in cash or short‑term bonds, plus an additional layer of high‑quality bonds behind that. When markets decline, withdrawals come from the safer bucket, allowing the equity portion time to recover. When markets are strong, portfolios can be rebalanced, effectively “refilling” the safer bucket from gains. This kind of structured approach can turn sequence risk from a vague concern into a manageable part of your plan.
Diversification and evidence‑based investing
Managing sequence of returns risk does not mean trying to predict or avoid every downturn. Markets are inherently unpredictable in the short term. What you can do is build a portfolio that is broadly diversified, grounded in evidence rather than speculation, and aligned with your time horizon and risk capacity.
That often includes a global mix of stocks, high‑quality bonds, and other assets that respond differently to economic conditions. While diversification cannot eliminate the possibility of negative periods, it can help reduce the severity of declines and provide multiple sources of return. Combined with a thoughtful withdrawal strategy and a cash buffer, diversification becomes one of the core tools for managing sequence risk over the life of your retirement.
Taxes, account types, and sequence risk
Sequence of returns risk also interacts with your tax strategy in ways that are easy to overlook. Which accounts you withdraw from—tax‑deferred, taxable, or Roth—affects how much you keep after taxes and how quickly certain balances decline. In some cases, drawing more heavily from one type of account during a downturn can help preserve flexibility and reduce future tax burdens.
A coordinated plan looks at withdrawals, tax brackets, and sequence risk together. For example, during a down market, it may make sense to temporarily adjust which account you draw from or consider tax‑efficient moves like harvesting capital losses in taxable accounts. The key is that these decisions are guided by your overall plan, not by panic or guesswork.
Keeping perspective during volatility
Perhaps the most dangerous aspect of sequence of returns risk is that it tends to show up during periods when emotions are already running high. Large, scary headlines often accompany market declines, and it is tempting to respond by abandoning your plan altogether. The challenge is that panic‑driven changes—such as moving entirely to cash—can lock in losses and undermine your ability to recover later.
Having a written, tested plan in place before volatility hits can make it easier to stay disciplined. That plan should outline where your withdrawals will come from, how much flexibility you have with spending, and what steps you will take if markets cross certain thresholds. In other words, you want to pre‑decide your response so you are not forced to improvise in the middle of a stressful period.
FAQ: How Do You Protect Against Sequence of Returns Risk?
The most effective strategies for managing sequence of returns risk work together rather than in isolation. Maintaining a short-term cash or bond reserve means you can cover spending without selling equities during downturns. Using a flexible, guardrails-based withdrawal strategy allows you to make small spending adjustments in bad markets rather than being locked into a rigid withdrawal amount. Broad diversification and an evidence-based portfolio structure reduce the severity of any single drawdown. And coordinating your withdrawal sequence with your tax strategy can preserve additional flexibility. None of these eliminates the risk entirely — but together they make your plan significantly more resilient to the timing of returns.
If you are within 10–15 years of retirement, or already retired, now is a good time to evaluate how exposed your plan is to sequence of returns risk. That includes reviewing your asset allocation, your spending strategy, and how much of your near‑term spending is backed by safer assets versus growth assets. A simple “what if” analysis—looking at how your plan holds up under unfavorable early‑retirement scenarios—can provide valuable insight.
Schedule a complimentary consultation with our office. We will stress-test your plan against different market sequences and help you design an income strategy that supports confidence today and resilience over the long run.
