Sequence of return risk focuses on the timing of market drops and how early losses in retirement can reshape your entire income picture. You can average the same annualized returns as another retiree and still end up with very different results simply because your bad years arrived at the wrong time. Retirees who have saved diligently worry they could still fall behind simply because they retired at the wrong moment. That fear lies at the heart of sequence risk, which is why understanding it is so important.
Imagine two retirees, each with a $1 million portfolio. They withdraw the same amount each year and earn the same average annual return over a 30-year retirement. The only difference is the order of their yearly returns. One experiences a few down years early, followed by strong growth later. The other experiences strong growth early and down years at the end. The retiree who hits turbulence in the first few years can run out of money far earlier, even though the long-term average returns are identical. This timing risk is the heart of the sequence problem.
Early withdrawals combined with early losses shrink the portfolio at a much faster pace. You are drawing income from a weakened base, which leaves less capital to recover and grow when markets bounce back. This is why two people with the same savings can face very different retirement outcomes. What seems like a small dip early on can have an outsized impact once withdrawals begin, which is why the early years deserve special attention.
Impact on Retirement Income
The first decade of retirement is often the most sensitive period because withdrawals begin just as the portfolio shifts from saving to sustaining. A few bad years early can lead to smaller withdrawals later, reduced spending flexibility, or the need to change your investment mix. Even if markets eventually recover, the withdrawals that happened during the downturn can permanently lower your future income.
For someone retiring at 65, a string of negative or low returns in the first 5 to 10 years can force adjustments. This might mean reducing a $60,000 annual income target to $50,000, delaying big purchases, or scaling back travel plans. These changes are not dramatic for everyone, but they can compound. Small shifts made under stress, like canceling a vacation or postponing home repairs, often reflect the underlying challenge of sequence risk rather than overall financial weakness. The worst-case scenario is running out of investable assets while still needing income, which is a problem no one wants.
On the other hand, strong early returns can create real advantages. Your portfolio grows while withdrawals are relatively small, leaving you with more flexibility. The order of returns becomes a tailwind instead of a hurdle. When good years show up early, retirees often find they have more room for discretionary spending or legacy planning later on, which shows how powerful the timing effect can be.
Ways to Protect Yourself
No strategy eliminates risk, but you can build guardrails that reduce the impact of early market swings. These strategies are valuable not only financially but also emotionally, because they give you space to stick with your plan during periods of volatility. They also help prevent short-term market anxiety from turning into long-term damage.
Hold a Cash or Short-Term Reserve
Many retirees keep one to three years of planned withdrawals in cash or very short-term bonds to create flexibility and breathing room. If markets fall, the income for the next year or two is already set aside, so you are not forced to sell investments at a loss. For example, if you need $70,000 a year from your portfolio, keeping $140,000 to $210,000 in stable assets acts as a shock absorber. The exact amount depends on your comfort level, income sources, and the level of volatility you are willing to tolerate. A reserve works best when it is coordinated with predictable income like Social Security or pensions, since that combination gives you even more room to ride out downturns without adjusting your lifestyle.
Balance Growth and Safety Assets
Retirement is not the moment to abandon growth, but it presents an opportunity to balance it. Stocks support long-term inflation protection and growth. Bonds and fixed income smooth out volatility. The mix often shifts gradually over time to reflect lower tolerance for early losses. A well-structured portfolio creates both resilience and recovery potential.
Some research suggests starting retirement with a slightly lower equity allocation and gradually increasing it over time. This approach reduces exposure to early volatility and relies more on growth later, after the sequence risk window has passed. For example, someone might begin with a 40% allocation to equities at age 65 and increase it toward 60% by age 75, allowing their portfolio to “earn back” growth potential once the early years are behind them. Without this balance, retirees can make reactive decisions such as moving too heavily into bonds during a downturn, which may feel safe in the moment but limits the portfolio’s ability to recover.
Use Flexible Withdrawal Rules
Rigid withdrawal plans can cause unnecessary damage. Instead of taking a fixed percentage regardless of circumstances, a flexible rule might reduce withdrawals slightly after a negative year and increase them after positive years. Even small adjustments help preserve the portfolio. For example, a retiree who cuts their withdrawal by 5% after a down year gives their investments room to rebound without draining the account too quickly. This could look like postponing a car replacement by one year or trimming discretionary travel. In other words, making changes that are manageable and temporary, not life-altering. These adjustments work because they match spending to the natural rhythm of the market rather than fighting against it.
Layer in Guaranteed Income
Some people use Social Security, pensions, or annuities to build a stable income floor. This can reduce pressure on the portfolio during market downturns while covering your essential expenses. When a portion of your income is predictable, you do not need to pull as much from volatile assets when markets misbehave. Guaranteed income also reduces emotional pressure, since the basics of daily life feel protected even during periods of market volatility. Even a modest level of guaranteed income can help retirees maintain confidence and patience during years when markets move unpredictably.
What This Means for Your Plan
Sequence of return risk is sneaky because it hides inside the timing of market swings rather than the averages. It can change the entire shape of your retirement income, even if your long-term returns look normal on paper. The good news is that thoughtful planning can keep this risk in its place.
By holding a stable reserve, setting a balanced investment mix, adding flexible withdrawal rules, and using guaranteed income where appropriate, you can create a retirement income strategy that protects your early years and strengthens your long-term plan. A strong plan does not need perfect markets. It only needs the right structure to carry you through the unpredictable moments without throwing your retirement off course.
Managing sequence of return risk is not about predicting markets. It is about having a strategy that lets you adjust when the unexpected happens. If you want to explore how to build that kind of flexibility into your plan, our Spending from an Investment Portfolio in Retirement workshop takes a closer look at how to structure withdrawals, balance growth with stability, and keep your plan on track even when markets feel uncertain.
Want to Learn More? Listen to Episode 208 of the Retire With Style Podcast.
