Key Takeaways:
- Sequence of returns risk is the danger of experiencing market losses early in retirement while withdrawing income.
- The order of returns matters more than the average return once you stop working.
- Early market downturns can permanently reduce portfolio longevity.
- Traditional withdrawal strategies may not fully protect against this timing risk.
- A structured income approach like The Bucket Plan® can help protect near-term income and reduce the need to sell investments during downturns.
What Is Sequence of Returns Risk and Why Does It Matter?
Sequence of returns risk is the danger of experiencing poor market returns early in retirement while taking withdrawals.
When you are working, market declines are largely temporary on paper. You are not selling investments to fund your lifestyle. In retirement, that changes. Income must come from the portfolio.
Consider this example:
Two retirees each begin retirement with $1,000,000 and withdraw $50,000 per year. Over 20 years, both earn the same average return. However, one experiences a 20 percent decline in the first two years, while the other experiences that decline much later.
Even though their long-term averages are identical, the retiree who experiences losses early may see their portfolio depleted significantly sooner.
The reason is simple. Withdrawals during a downturn lock in losses. With fewer dollars remaining invested, the recovery has less capital to compound.
This risk is most significant during the first five to ten years of retirement, when:
- Withdrawals have just begun
- Portfolio balances are typically at their highest
- There is limited time to recover from early declines
Market volatility alone is not the issue. It is volatility combined with withdrawals.
That is why retirement income planning requires more than selecting investments. It requires coordinating withdrawal strategy, risk exposure, and time horizon so that early market declines do not permanently impair long-term sustainability.
Why a Portfolio Alone Is Not a Plan
Many retirees assume that if their portfolio is diversified and they withdraw a reasonable percentage each year, everything will work out.
Those are important principles. But they were designed primarily for building wealth, not distributing it.
Diversification spreads risk across different investments. It can reduce volatility, but it does not solve the problem of needing to sell investments for income during a market decline.
A fixed withdrawal rate, such as 4 percent, is based on historical averages. But retirement does not happen in “average” conditions. If losses occur early, that withdrawal rate can place added pressure on the portfolio.
To sum up: in retirement, the goal is no longer simply earning returns. The goal is to produce reliable income while managing the timing of market ups and downs, which goes beyond the scope of a diversified portfolio. It requires a plan for how and when money will be used.
A Structured Approach to Managing Sequence of Returns Risk
The key is separating money needed soon from money that can remain invested for long-term growth. When short-term income is protected, long-term assets have time to recover from normal market declines.
At The CP Welde Group, we use a retirement income strategy called The Bucket Plan® to put this principle into practice.
The concept is straightforward: organize assets based on when they will be needed.
Bucket 1: Short-Term Income
- Funds needed for the next one to two years
- Positioned conservatively to help avoid market volatility
Bucket 2: Intermediate-Term Needs
- Funds needed in the next several years
- Balanced between stability and moderate growth
Bucket 3: Long-Term Growth
- Assets not needed for many years
- Positioned for long-term appreciation
If markets decline, income is drawn from short-term reserves rather than long-term growth assets. This helps reduce the likelihood of selling equities at depressed prices.
Should I Evaluate My Retirement Income Strategy?
You may want to evaluate your plan if you:
- Plan to retire within five years
- Recently retired
- Rely on portfolio withdrawals for income
- Have $500,000 or more invested
- Want greater confidence during market downturns
Claim Your Complimentary Retirement Income Consultation
As a fiduciary retirement financial advisor serving Chadds Ford, Glen Mills, West Chester, Kennett Square, and surrounding communities, we focus on building structured income plans designed to last.
Book a complimentary consultation with us and let’s review your retirement income strategy so we can help you retire with confidence.
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Frequently Asked Questions About Sequence of Returns Risk
What is sequence of returns risk?
It is the risk that poor market returns early in retirement, combined with withdrawals, reduce how long a portfolio lasts.
Is sequence risk the same as market volatility?
No. Volatility occurs every year. Sequence risk refers specifically to the timing of losses during the withdrawal phase.
Can diversification eliminate sequence risk?
Diversification can help manage risk but does not eliminate the impact of early withdrawal timing.
How can The Bucket Plan® help reduce sequence risk?
It separates short-term income needs from long-term investments, reducing the need to sell growth assets during downturns.
When should I review my retirement income plan?
Ideally three to five years before retirement, and again during the early retirement years.