Protect Against Sequence of Returns Risk

The average rate of return on your retirement portfolio isn’t the only thing that you should consider when looking at your retirement income. Sequence of returns is also an important consideration. Let’s look at what sequence of returns risk is and how you can help mitigate against it.

What Is the Sequence of Returns Risk?

The sequence of returns risk refers to the danger that poor market performance early in retirement will reduce your portfolio faster than expected. Even if your average annual return looks reasonable over the long term, a string of bad years when you’ve just started withdrawing income can deplete your savings more quickly.

Imagine two retirees with the same portfolio value and the same long-term average return. If one experiences strong market gains in their first five years while the other faces losses, the outcomes can be dramatically different. The retiree hit with early losses may never fully recover, since withdrawals during down markets permanently shrink the nest egg.

Why This Matters for Retirees

• Retirees face unique challenges that make sequence of returns risk especially important to manage. 
• We are living longer on average, which means portfolios must stretch further. 
• Inflation adds pressure as the cost of living, especially for healthcare, rises over time. 
• Tax rules also play a role, as withdrawals from some retirement accounts are taxable, and minimum withdrawal requirements can increase as you age. If poor market returns line up with these rising obligations, savings can erode more quickly than expected.

Strategies to Manage the Risk

One of the most effective ways to protect yourself against the sequence of returns risk is to maintain a cash buffer or reserve of low-risk, high-liquidity investments, such as high-interest savings accounts or time deposits. This creates a pool of funds you can draw from in years when markets decline, so you’re not forced to sell equities at a loss. You may consider holding one to three years of essential expenses in such accounts.

Some investors take this further by using a “bucket strategy.” This involves dividing savings into segments based on time horizon: one for immediate expenses (cash or time deposits), another for medium-term needs (bonds or balanced funds), and a third for long-term growth (equities). This approach creates a natural order for withdrawals and allows long-term investments time to recover from market downturns.

Another key strategy is to remain flexible with withdrawals. If markets are struggling in the early years of retirement, temporarily reducing withdrawals or delaying large expenses can help preserve your capital until markets recover. Even small adjustments in the first few years of retirement can make a significant impact later on.

It’s also worth considering sources of guaranteed income. Deferring pensions, for example, can provide higher monthly payments later on, which means that you won’t have to rely on your investments as heavily in those early years of retirement. Some retirees also choose annuities as a way to secure a predictable income for life.

Finally, diversification is always essential. Spreading investments across asset classes can reduce the impact of a downturn in any single area. A well-balanced portfolio can’t eliminate sequence risk, but it can help manage it more effectively.

Sequence of returns risk may not be as widely discussed as average returns or fees, but it’s an important factor for retirees to understand. By planning for the possibility of early downturns through cash reserves, flexible withdrawal strategies, guaranteed income sources, and diversification, you can help ensure your savings last throughout retirement, regardless of what the market ultimately does.

Sources:

https://www.schwab.com/learn/story/timing-matters-understanding-sequence-returns-risk

https://www.woodgundy.cibc.com/en/reference/retirement-planning/rrif-minimum-withdrawal.html

https://www.canada.ca/en/financial-consumer-agency/services/rights-responsibilities/rights-investing/rights-guaranteed-investment-certificates.html

This material is intended for educational and informational purposes only. It is not intended to provide specific advice or recommendations for any individual. Additionally, you should consult with your Financial Advisor, Tax Advisor, or Attorney on your specific situation. The views expressed in the material are that of the author and do not necessarily reflect those of any market, regulatory body, State or Federal Agency, or Association. All efforts have been made to report or share true and accurate information. However, the information may become materially outdated or otherwise rendered incorrect due to subsequent new research or other changes, without notice. The author nor the firm are able to always verify the content from third-party sources. For additional information about the firm, please visit the MAS Website at https://www.mas.gov.sg/  and the SEC Website at www.adviserinfo.sec.gov. For a copy of the firm's ADV Part 2 Brochure, please contact us at info@avriowealth.com.