Not All Risks Are Obvious

When most people think about investment risks, they focus on the big, loud ones like market crashes, inflation, or interest rate hikes. But there’s a quieter, lesser-known risk that can have a huge impact on your retirement income if you are not prepared for it. It is called sequence of returns risk, and it catches many retirees by surprise.

This is one of those risks that doesn’t show up when you are just saving and growing your portfolio. It becomes a real threat once you start taking money out to fund your lifestyle in retirement.

If you are in or approaching retirement and plan to draw income from your investments, this is a conversation you need to have. Let me walk you through what this risk is, why it matters so much, and how to protect yourself from it.

What Is Sequence of Returns Risk?

Sequence of returns risk refers to the order in which your investment returns occur, especially in the first few years of retirement. The risk is that you will experience poor market returns early in retirement when you are starting to withdraw income.

Even if your portfolio averages strong long-term returns, the sequence of those returns can make or break your retirement income plan. That is because you are withdrawing money while your investments may be down, and you are locking in losses that your portfolio might never recover from.

Let me give you an example.

Two Investors, Same Average Return, Very Different Outcomes

Imagine two retirees with the exact same starting balance and the exact same average return over 25 years. One of them experiences good markets in the early years and poor markets later. The other experiences poor markets in the early years and good ones later.

Even though the average return is the same, the one who started retirement with early losses runs out of money years earlier. Why? Because they were withdrawing income during a downturn and never had a chance to recover.

This is the heart of sequence risk. It is not about how much your portfolio earns on average. It is about when those gains and losses happen in relation to when you are taking money out.

Why This Risk Matters More in Retirement

While you are still working and saving, market dips can be frustrating but they are often manageable. In fact, many long-term investors benefit from buying in during down markets. You are putting money in when prices are lower and riding the recovery up.

But once you retire, the game changes. You are no longer adding to your investments. You are now withdrawing from them to cover your living expenses. That means every dollar you pull from a shrinking portfolio hurts more, and it reduces the amount left to grow when the market eventually recovers.

This is why the first 5 to 10 years of retirement are sometimes called the “fragile decade.” What happens in those early years can affect your income security for the rest of your life.

How to Protect Yourself from Sequence Risk

The good news is that sequence of returns risk is manageable with the right strategy. Here are a few of the ways we help our clients build protection into their retirement plans:

1. Build a Cash Reserve

One of the simplest and most powerful strategies is to keep one to three years’ worth of expenses in cash or short-term investments. This gives you breathing room when the market dips. Instead of selling investments at a loss, you can draw from your cash reserve and wait for the market to recover.

2. Use a Bucket Strategy

We often use a bucket approach with clients, dividing retirement assets into different time horizons:

• Bucket 1: Short-term cash and bonds to cover the next few years
  
• Bucket 2: Moderate-risk investments for income in years 4 through 10
  
• Bucket 3: Growth investments for long-term needs 10 years or more down the road
  

This structure helps you ride out market volatility without needing to sell your most volatile investments when they are temporarily down.

3. Add Guaranteed Income Streams

Another way to reduce sequence risk is to layer in guaranteed income sources like annuities or pensions. These provide predictable income no matter what the market does and reduce your dependence on portfolio withdrawals.

Even using a partial annuity to cover core living expenses can help you protect the rest of your portfolio and sleep better at night.

4. Be Flexible With Withdrawals

One of the benefits of working with a financial advisor is learning how to be flexible with your withdrawals. That means adjusting your spending slightly in down years and being more aggressive in strong years.

You don’t have to live on a strict budget, but building in some flexibility can help preserve your wealth and keep your plan on track.

Don’t Let a Market Dip Derail Your Retirement

You’ve worked hard to build wealth. You’ve saved, invested, and prepared for a great retirement. But without protecting yourself from sequence of returns risk, even a few bad years in the market could force you to change your plans or reduce your lifestyle.

A smart retirement plan goes beyond average returns. It looks at timing, flexibility, and security. It gives you confidence that your money will last and that you can enjoy retirement no matter what the market throws your way.

If you want help reviewing your withdrawal strategy or want to run your own “stress test” for sequence risk, I would be honored to help. Let’s make sure your plan is built for real life, not just market averages.