Sequence of Returns Risk: Why the Timing of Market Drops Matters in Retirement

Two retirees can earn exactly the same average investment return over 30 years and still end up in very different places. One might have plenty of money left at the end, while the other runs out years early. The reason is the order in which those returns happen. This phenomenon is called sequence of returns risk, and understanding it is one of the keys to planning a secure retirement.

Why the order of returns matters

When you’re saving for retirement and regularly adding money to your investments, a market drop can actually be an opportunity. Your contributions buy more shares at lower prices, and when the market recovers, those shares grow in value. During the accumulation years, the order of returns matters relatively little to your final result, as long as you keep investing consistently.

When you’re withdrawing money in retirement, the situation reverses. If markets fall early in retirement, you may have to sell more shares at low prices to cover your living expenses. Those shares are gone and can’t participate in the recovery when the market rebounds. Your portfolio shrinks both from market losses and from withdrawals, which can permanently reduce how long your savings last.

When the risk is greatest

The years right before and right after you retire matter most. That window, sometimes described as the retirement red zone, is usually when your portfolio is largest and when withdrawals begin. A significant market decline during this period can have an outsized effect on your retirement because there’s less time to recover and you’re drawing down your savings at the same time.

Later in retirement, sequence risk generally becomes less critical because your remaining time horizon is shorter and your portfolio may be smaller relative to your lifetime spending.

Many people review their retirement plan and investment mix carefully during this window, making sure they’re not taking more risk than they can afford right as withdrawals begin.

Ways people manage sequence risk

While no strategy eliminates market risk entirely, several approaches can help reduce the impact of poor returns early in retirement.

Keep a cash buffer. Holding one to two years of spending in cash or short-term, low-risk investments means you don’t have to sell stocks during a downturn. You can draw from the cash buffer while waiting for markets to recover, then replenish it when markets are strong. Some retirees use a bucket strategy, dividing their savings into short-term, medium-term and long-term buckets with different investments.

Be flexible with your spending. Cutting back on discretionary expenses, such as travel or large purchases, in bad market years reduces how many shares you need to sell at low prices. Some retirees use guardrails, adjusting withdrawals up or down based on how their portfolio performs. Even modest flexibility can significantly improve the odds that savings last.

Hold a mix of stocks and bonds that matches your timeline and comfort with risk. Bonds and other less volatile investments can provide stability and a source of funds during stock market declines. Some people gradually increase their bond allocation as they approach retirement, then may gradually increase stocks again later in retirement, an approach sometimes called a rising equity glide path.

Consider some part-time income early in retirement. Even modest earnings during the first few years can reduce how much you need to withdraw from your portfolio, giving it time to recover from any early downturns.

Delay Social Security, if it fits your situation. Waiting to claim, up to age 70, results in a larger guaranteed, inflation-adjusted benefit later. While delaying means drawing more from savings in the early years, the larger lifetime benefit can reduce your reliance on your portfolio over the long run.

Guaranteed income sources, such as pensions or annuities, can also cover essential expenses regardless of market performance, reducing the pressure on your portfolio during downturns.

Don’t overcorrect

While sequence risk is real, being too conservative can create a different risk: outliving your money because your investments didn’t grow enough to keep pace with inflation over a retirement that could last 30 years or more. Balancing protection against early losses with the need for long-term growth is the central challenge of retirement investing.

Planning tools

Retirement planning software and financial planners often use simulations that test your plan against many possible sequences of market returns, including historical periods with poor early returns. These simulations can help you understand how your plan might hold up and what adjustments could improve its resilience.

Get personalized guidance

Managing sequence risk involves decisions about asset allocation, withdrawal rates, Social Security timing and spending flexibility that depend on your specific situation. A fee-only financial planner can help you build a retirement income strategy designed to withstand market ups and downs.

This article is for education only and isn’t personalized investment advice.