Not all market downturns have the same impact in retirement. One of the most important but least understood concepts is sequence of returns risk.
This refers to the danger of experiencing poor investment returns early in retirement, when you are also beginning to withdraw money from your portfolio.
Even if average long-term returns are the same, the order of those returns matters. A market decline in the early years of retirement can reduce portfolio value faster, leaving less money invested to recover when markets eventually improve.
This becomes more challenging when withdrawals are being made at the same time. Selling investments during a downturn can lock in losses and reduce the long-term sustainability of a retirement plan.
Key factors that increase sequence of returns risk include:
- Higher withdrawal rates in early retirement
- Large market declines in the first several years of retirement
- Lack of cash reserves or income buffers
- Heavy reliance on a single investment strategy
There are ways to help manage this risk. Some retirees use a combination of cash reserves, bond allocations, and income planning strategies to reduce the need to sell investments during down markets.
Others coordinate withdrawals with tax planning strategies to help smooth income over time.
While market performance cannot be controlled, the timing of withdrawals and the structure of a retirement income plan can make a meaningful difference.
Understanding sequence of returns risk is an important step in building a retirement plan that is designed not just for growth, but for stability and income sustainability.