TLDR: The ORDER in which your portfolio generates returns is much more important than the AMOUNT of those returns, especially in your later working years and early retirement years. There are ways to minimize or eliminate the risk of this happening, but you must first be aware of ‘sequence of returns risk’ and then take action accordingly. Solutions to consider are listed as a part of this article.
As you approach the glide slope to retirement (those critical 10 years leading up to retirement, with the final five demanding extra vigilance), one of the most insidious threats to your financial security isn’t market crashes or inflation alone.
It’s something called sequence of returns risk. This concept highlights how the timing of investment gains and losses can significantly impact the longevity of your portfolio, particularly when you’re drawing income from it.
This risk isn’t about the average returns over time; it’s about the order in which those returns occur. In this white paper, we’ll unpack what sequence of returns risk really means, why it’s particularly perilous during the transition to retirement, and provide practical strategies to mitigate it.
The goal isn’t to instill fear, but to foster a resilient mindset: viewing your portfolio not as a static pile of money, but as a dynamic resource that requires thoughtful stewardship to sustain your desired lifestyle throughout retirement.
What Is ‘Sequence of Returns’ Risk?
Many financial advisors misunderstand, or aren’t at all aware of, the importance of the sequence of returns, but it can matter at least as much as how your assets are allocated or protection strategies that you might deploy against market crashes.
The most effective way to illustrate how real, pervasive, and sneaky this risk is is to look at an example:
Imagine two retirees, both starting with identical $1 million portfolios invested in the same balanced mix of stocks and bonds. Both plan to withdraw 4% annually, adjusted for inflation, with the goal of a 30-year retirement.
To keep the math relatively simple, let’s dig into only the first ten years of their retirement. Over those ten years, their average annual return is the same as well.
So, how can two investors with the same portfolio and the same rate of return have two completely different experiences?
In each example, you are working with a $1,000,000 rollover IRA, from which you initially withdraw 4% ($40,000 in year 1), adjusted by 3% annually for inflation.1 Withdrawals happen at the start of each year, followed by the return applied to what’s left—simulating the real-world need to fund your lifestyle amid volatility.
In both scenarios, the average annual rate of return is 6%, which is not unreasonable for a conservative, balanced portfolio.
In Scenario A, we’ve weighted the sequence to have more positives in the early years, with some negatives sprinkled in for realism. In Scenario B, more negatives appear upfront, though positives provide occasional relief. The annual returns cited are actual historical returns extracted from the stock market timeline, but rearranged for this example.
Here’s the year-by-year breakdown:
After 10 years, Scenario A closes at approximately $1.1 million, having been hardly affected by the withdrawals.
Scenario B, by contrast, ends at roughly $730,000, about 33% lower, because the preponderance of early losses amplified the impact of withdrawals, leaving less to capitalize on later recoveries.
Total withdrawals? Identical in both cases, totaling exactly $453,000 for each portfolio (rising from $40,000 to about $53,700 by year 10 due to inflation adjustments).
The divergence stems purely from the order of the returns, not the magnitude.
In the context of a rollover IRA or similar investment account, this risk is further heightened because these vehicles are often the primary source of retirement income beyond Social Security or pensions.
While you’re on the retirement “glide slope” (the final 5 – 10 years before retirement), as you reduce contributions and prepare for withdrawals, your portfolio becomes more vulnerable to timing.
Research shows2 that the five years before and after retirement are the “retirement risk zone,” where sequence risk can erode up to 30-40% of potential income if unaddressed.
It’s not just about volatility; it’s about the unfortunate alignment of that volatility with your need for cash flow.
The Real-World Impact on Retirement Income
Why does this matter so much on the glide slope? As you near retirement, your human capital (your ability to earn from work) diminishes, leaving your financial capital to bear the full load. If sequence risk strikes, it can force unwanted lifestyle cuts: delaying travel dreams, skimping on healthcare, or even returning to work.
Studies analyzing historical data from 1926 onward reveal that retirees facing negative sequences in their first few years saw their safe withdrawal rates drop from 4% to as low as 2.5% to avoid depletion.
Consider the 2008 financial crisis. Those retiring in 2007-2009 experienced severe early losses, with the S&P 500 declining by over 50%. A $1 million portfolio withdrawing $40,000 annually (4%) might have shrunk to under $600,000 by 2010, even after accounting for inflation adjustments. Recovery took years, but the early sales meant less fuel for the rebound. In contrast, retirees from the mid-1990s bull market sailed through similar withdrawals with ease.
This risk isn’t hypothetical; it’s embedded in every market cycle. Inflation exacerbates it—if prices rise while your portfolio falls (like late 2021 through 2022), your withdrawals buy less, accelerating the drain. The key takeaway: Sequence risk doesn’t care about your long-term averages. It preys on the short-term realities of needing income now.
Besides Gnashing Our Teeth, What Can Be Done?
The good news is that sequence risk isn’t inevitable doom; it’s a challenge you can prepare for with deliberate planning. The solutions below focus on building flexibility and resilience into your portfolio and withdrawal strategy.
Remember, these aren’t one-size-fits-all. You should tailor them to your risk tolerance, health, and goals, but they provide a framework for self-reliance.
Firstly, as I coach all my clients, from a mindset perspective, recognizing this risk encourages a shift from an optimism bias that “Markets always go up in the long run” to proactive realism.3
Proactive Realism is the recognition that instead of “hoping for good markets,” replacing that with “planning for any market” will empower you to feel more in control of your finances in retirement.
Retirement isn’t a finish line; it’s the start of a new phase where your portfolio must work harder under different rules. Embracing this helps you avoid the emotional pitfalls of panic selling during downturns or overconfidence in bull markets.
1. Diversify Your Asset Allocation with a Bucket Approach
Shift from a single, growth-heavy portfolio to a segmented “bucket” strategy. Divide your assets into three buckets:
- Short-term (1-3 years): Hold cash or short-term bonds to cover immediate withdrawals. This avoids selling equities during downturns. Aim for 2-3 years’ worth of expenses here.
- Medium-term (4-10 years): Balanced investments like intermediate bonds or dividend stocks for moderate growth.
- Long-term (11+ years): Equities for higher returns, replenishing the other buckets over time.
This bucketing strategy minimizes forced sales in bad sequences, preserving growth potential. Historical backtesting shows this can extend portfolio longevity by 5-7 years in adverse scenarios. Mindset shift: Think of it as creating “time buffers” rather than locking away money.
💡For many clients, we typically advocate for an aggressive investment strategy within their Roth IRAs, provided it aligns with their risk tolerance. This approach is beneficial because Roth IRAs are generally the last retirement accounts accessed, and their withdrawals are tax-free, maximizing the impact of significant, long-term growth that has not been affected by sequence of returns risk.
2. Adopt Flexible Withdrawal Rules
Ditch rigid percentages, such as the 4% rule, for dynamic approaches. For instance:
- Guardrails Method: Set upper and lower bounds—e.g., withdraw 5% if your portfolio rises 20% above target, but cut to 3% if it falls 20% below. This adjusts to market realities.
- Percentage of Portfolio: Withdraw a fixed percentage annually based on current value, naturally reducing spending in down years.
- Floor and Ceiling: Guarantee essentials with fixed income securities and Social Security, then withdraw variably from the portfolio for discretionary spending.
Flexible rules can reduce failure rates from 20% to under 5% in poor sequences. Cultivate a mindset of adaptability: View withdrawals as responsive to life, rather than being locked in stone.
💡I have a saying that, “No one fails at retirement. We adapt”. I say this because we all go through life accepting that uncertainty is an inevitable part of life. Yet, as some retirees approach their own retirements, they are expecting something different, such as certainty and guarantees.
Of course, they will always find someone to sell them a guarantee (like an annuity or other special “products”), but it’s almost always at the expense of their long-term financial health. It’s reasonable to recognize that ALL of life is uncertain. Building systems to adapt to that uncertainty is far better than selling your financial soul for a modicum of certainty.
Generally speaking, I prefer the “Guardrails” method, and we use some pretty sophisticated software to build an ‘early warning system’ around these guardrails.
3. Incorporate Income Floors with CDs or Bonds
Use a portion of your rollover IRA to purchase bank certificates of deposit, corporate bonds, or treasury bonds, which provide guaranteed income that is immune to market volatility.
For example, allocating 20-30% to individual bonds covers basics, leaving the rest for growth. Bond ladders (staggered maturities) offer a decent level of predictability.
💡I like a version of this that is similar to a return-enhancing scenario called “Dollar Cost Averaging”.4 In my version, if the markets are starting to feel wonky, we might use the bucket approach, but load up the first bucket a bit more and tag that for periodic investments into higher-risk assets.
This strategy, called dollar-cost averaging, buys more of an asset when prices are down and less of an asset when prices are up, thereby acting as a ‘return enhancer’ while insulating your portfolio from extreme sequences of returns risk.
4. Delay Retirement or Phase It In
OK, I’m not a fan of this one, but it has to be a part of the conversation.
If markets turn sour on your glide slope, consider working part-time or delaying full retirement by 1-2 years. This reduces the likelihood of early withdrawals, allowing for a recovery period. Even modest earnings can offset sequence effects.
💡It might help to carry the mindset that this is extending your options, not a failure. Walmart will always need greeters, right? And as a bonus, you may also meet some rather fascinating people along the way.
5. Stress-Test Your Plan Regularly
This is paramount. You’ll have to stress test your portfolio in retirement, like it or not. The mindset to adopt here is that learning to stress-test and then doing it is still significantly less work than getting up and facing the commute every day.
Use free online tools or spreadsheets to simulate sequences based on historical data (e.g., Monte Carlo simulations). Review annually, adjusting as needed. This builds confidence and preparedness, turning uncertainty into managed risk.
💡This “sophisticated software” that I mentioned above is constantly stress-testing the value of your portfolio against your withdrawal rate and is sort of an early warning system to give us time to react to adverse events far in advance, making small, infrequent micro-adjustments the norm, rather than getting blindsided by an unexpected cut in your income.
Anything Can Happen… Even Good Things.
In weaving these strategies, prioritize a holistic view: Your retirement success hinges on your mindset as much as on the math. I think this is something that people don’t consider when thinking about who to look for to help them plan their retirement income; the math is pretty straightforward across the industry, and the differences between a positive and a not-so-positive outcome seems to consistently come down to you and your advisor’s mindset; having a positive attitude5, your advisor not being judgmental and the recognition that it’s your life, I’m just here to set you up for success.
By anticipating sequence risk, you’re not just protecting dollars; you’re safeguarding the freedom to live retirement on your terms.
As you implement these ideas, reflect on what truly matters: health, relationships, purpose. With thoughtful preparation, the glide slope becomes a smoother path to fulfilling your next chapter.
Of course, I’m always ready to help by showing you how we do things just a little bit differently, from how I can work with you to build a dynamic Retirement Income Plan, to how to arrange and manage your investments tactically to help avoid many of the risks associated with the potential of volatile returns.
If you have questions or need additional clarification on any of the information I’ve provided, please don’t hesitate to reach out. You can email me at jrsnell@jrscm.com, and I’ll be happy to help you in any reasonable way.
I’m not stuck on the idea that I won’t help someone who wants to do it themselves either… I understand. I expect that once we have the opportunity to chat and work together on some groundwork, you will likely be more than willing to collaborate over the long term. But I don’t require it.
I’m on a mission and I don’t have a ‘hard sell’ bone in my body, so you don’t have to be worried about feeling like you’re ‘just looking’ at a timeshare.
No one’s going to make you sit through a hard-sell presentation, so I don’t see the risk for you in scheduling a quick conversation if you’re looking for some early guidance.
You can call my office at 480-575-7688, email me, or schedule an appointment on my calendar, and I’ll return your call at a time that you determine.
Thanks for having a look and I hope that the information has been helpful.
Jeff
- This 4% annual withdrawal rate, updated annually by the inflation rate is a long-standing ‘rule of thumb’ in the industry. Here’s some background for those who wish to investigate further ↩︎
- https://research-repository.griffith.edu.au/server/api/core/bitstreams/f6927f96-8f27-447b-884e-2998bbfc4a8f/content ↩︎
- As a random aside, I am constantly surprised by how many people in their daily lives are more comfortable having things happen to them than they are by making things happen for them. ↩︎
- https://www.investopedia.com/investing/dollar-cost-averaging-pays/ ↩︎
- Another old saying, “Pessimists sound smart, but optimists make money.”
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