How The Sequence of Returns Risk Can Shape Your Retirement?

Retirement Planning

When you create a retirement plan, there are several factors you need to look at. This can include your financial goals, risk appetite, time horizon, age, income, liabilities, etc. Additionally, your plan can be affected by how fast you grow in your career, how consistent you are in your savings and investing routine, and how well you manage your money throughout life. Lastly, the success of your retirement plan also depends on how your money fairs in the market. Sometimes you can do everything right, and a sudden market downturn at the wrong time can render years of planning useless. Timing is of great essence in retirement planning. The market is dynamic and constantly moving in cycles of growth and decline. While you may not be able to control these events, you must know how the timing of poor investment returns can impact your retirement.  

financial advisor can help you understand the impact of the sequence of returns risk in retirement. This article will discuss sequence risk in retirement and how you can prepare for it to avoid any surprises in your golden years.

What is the sequence of returns risk?

The sequence of returns risk refers to the impact of market volatility on your investment returns in the years right before retirement or early in retirement. If you experience poor investment performance during these years, you can significantly suffer and affect the long-term sustainability of your retirement plan. The timing of positive or negative returns on your portfolio in the initial years of retirement or at the end of your career can have a compounding effect on the portfolio’s value over time.

Here is how this happens:

When you retire, you start withdrawing money from your investments. You do not earn new money at this stage as you are no longer working. Hence, you do not have any fresh capital to invest. All you have is your limited pool of investments and a lifetime to survive on it. If the market plummets at this time, your assets can suffer substantially. Since your investments will lose their value and you will not be investing new money, the value of your overall portfolio may likely never recover. On the other hand, if you retire at a time when the market is booming, your investments will continue to grow. Even with withdrawals, your retirement nest egg will not lose its value to a point where your future financial stability is in question.

How does the sequence of returns in retirement affect you?

While the fate of your investments is more or less dependent on your luck, it is still crucial to understand how the sequence of returns risk affects you:

1. If poor investment returns coincide with the early years of your retirement, your portfolio may be depleted. This can be particularly worrying if you make large withdrawals in the early years. Most people do this as they require lump sum funds to cater to immediate retirement expenses, such as moving to a new home, paying for a child’s college education, or other needs that may coincide with retirement, shifting cities, etc. When a significant portion of the portfolio is depleted, the potential for future growth is significantly reduced, thus, increasing the risk of running out of money later in retirement.

2. If a portfolio experiences significant losses early in retirement, it becomes more challenging for your investments to recover from those losses due to the reduced capital available to benefit from subsequent market upturns. As mentioned above, you will not have new money to invest in the market. Your portfolio will have limited and reduced capital. Even if the portfolio generates strong returns in later years, the initial losses can have a lasting impact on the portfolio’s overall value and sustainability, ultimately impacting your retirement financial security.

4 retirement risks faced by retirees

Unlike individuals who are still in the accumulation phase of their financial journey, retirees have limited time to recover from market downturns. This is why the sequence of returns risk can alter the course of your retirement in many ways, as explained below:

1. Your retirement nest egg can shrink, forcing you to adjust your lifestyle

The sequence of returns risk can result in a lower overall income in retirement. If your portfolio suffers in the initial years of retirement, you may be forced to alter your lifestyle. This can include cutting back on essentials, downsizing your house, and limiting or eliminating non-essential expenses. Your healthcare needs may be compromised. You would have to adjust your withdrawal rates and live frugally. Retirement can be a difficult transition as it is. If you add financial restraint to it, you may find it challenging to cope with your circumstances.

2. You may be forced to work again to make up for the shortfall

The only way to bridge the gap between your savings and your financial needs can be by earning more money and investing for your future use. If your portfolio experiences poor returns in the early years, you may have to go back to work or, at the very least, work part-time to compensate for the shortfall.

3. Your longevity risk increase, and you risk outliving your savings

The sequence of returns risk can intensify your longevity risk. Longevity risk is the risk of outliving your savings. If you encounter poor returns early in retirement, the potential for depleting your portfolio too soon increases. This can make it challenging to sustain your desired lifestyle throughout your retirement years. With fewer years ahead of you, it becomes more difficult to regain the lost portfolio value, especially with ongoing withdrawals. You may have to depend on your children or other family members for the later part of your retirement.

4. You may lose your peace of mind over preserving the longevity of your portfolio

The emotional impact of a shrinking retirement portfolio can be hard on most retirees. You may experience stress, anxiety, and uncertainty about your financial security. Not only do these hamper your peace of mind, but they can also negatively impact your investment decisions, leading to overly conservative choices which may not be in your best interest for long-term financial growth.

How can you preserve your investment portfolio from the sequence of returns risk in retirement?

You cannot control the market or your age. If you retire and the markets witness a lull, you will likely suffer from the consequences. But there are some investing strategies that can help you overcome the challenge and add some immunity to your portfolio. Here are some things to keep in mind:

1. Diversify your investment portfolio 

Maintaining a well-diversified investment portfolio at all stages of your life and career is essential. Diversification refers to spreading your money across multiple asset classes like stocks, bonds, real estate, and other investments. When you invest your money in diverse asset classes, you mitigate the impact of poor performance in any one area. For instance, stocks and bonds tend to have different characteristics and behaviors during market downturns. Stocks generally experience more significant price declines due to increased market volatility and pessimism from investors. On the other hand, bonds tend to be more stable and can act as a buffer against stock market volatility. Bonds may also provide income through regular interest payments, which can provide stability and continued cash flow. Real estate prices also move with inflation, making it a suitable investment to tackle the negativity of high prices.

Diversification is also essential across sectors and industries. So, if you invest in stocks, you can consider stocks from companies of varying market capitalizations, such as large, small, and mid. Additionally, you can focus on multiple sectors like technology, tourism, consumer goods, banking, etc.

Tax diversification is another essential yet often overlooked strategy. If all your withdrawals are taxed in retirement, the value of your portfolio will further drop. It can help to add some Roth retirement accounts to avoid this. Roth Individual Retirement Accounts (IRAs) and employer-sponsored Roth 401(k)s are not taxed in retirement. Since you cover all your tax liabilities during your contributing years, you can enjoy tax-free distributions in retirement. Moreover, Roth accounts do not have mandatory Required Minimum Distributions (RMDs). Hence, you are not obligated to withdraw your money when the market is down and can let the balance recoup when the market recovers.

It is essential to follow a customized strategy for diversification. You must assess the potential risks to your portfolio from all your investments that could impact your long-term financial security. Factors such as interest rates, inflation, energy prices, and government policies can influence investment returns. So, diversify your investments wisely to mitigate risks associated with market volatility from each asset.

2. Maintain a favorable asset allocation based on your age

Asset allocation refers to the desired proportion of assets in your portfolio. It can be decided based on your financial goals and risk appetite, which are directly proportional to your age to some extent. As you approach retirement, you must adjust your asset allocation to reduce exposure to high-risk investments and potentially provide more stability during market downturns. Before retirement, you may have a longer investment horizon and a higher tolerance for risk since you have time to recover from market downturns. Therefore, a higher allocation to growth-oriented assets like stocks is common during these years. This allows for the potential for higher returns over the long term and will enable you to create a sizable corpus for your retirement.

However, as you age and approach retirement, your time horizon narrows. This impacts your risk tolerance. Your focus should ideally shift from accumulation to preservation of capital and generating income to meet your living expenses. This may lead to a reduction in the allocation to growth-oriented assets and an increase in more conservative investments, such as bonds and cash. While some allocation to growth assets is still necessary to help offset the effects of inflation over the long term, keeping a relatively conservative portfolio can protect you from a sudden market downturn just as you retire.

It is important to start positioning your assets for retirement at least 2-3 years before your planned retirement date. Evaluate all potential sources of income available to you, such as Social Security, company pensions, and deferred compensation. This assessment will help determine how much you will need to generate from your savings.

It is also important to remember that asset allocation is not a one-size-fits-all approach. It should be personalized based on your individual circumstances and risk tolerance.

3. Maintain an emergency fundto tackle uncertainty

Establishing an emergency fund to cover unexpected expenses during retirement is vital. You may witness several unforeseen expenditures in retirement arising from market downturns, medical emergencies, debt, etc. An emergency fund prevents you from tapping into your investment portfolio when it is underperforming. With an emergency fund, you have the choice of not withdrawing your retirement savings at a time when your portfolio is already struggling to keep up. This can lower the impact of market volatility and offer your money the chance to grow in the future, ensuring you do not outlive your savings.

Having an emergency fund can also be a comforting factor as you have increased liquidity to cover your essentials even when times may seem uncertain.

4. Adopt a dynamic withdrawal strategy

It is important to consider implementing a dynamic withdrawal strategy that adjusts your withdrawal rate based on market conditions. This approach can help protect against depleting your portfolio prematurely. Make sure you understand the various income sources that can supplement your retirement needs. Evaluate contributions from pensions, Social Security claiming strategies and other sources of income that can support your cash flow requirements. For instance, delaying your Social Security benefits can help you enhance your check by a substantial amount. This can help you cover up the shortcomings in your portfolio at a later stage.

5. Be flexible and plan for the long-term 

It can help to keep an open mind and be willing to make adjustments over time to adapt to changing circumstances. This can include adjusting your spending habits, considering part-time work, or revisiting your investment strategies. You may also consider postponing retirement. Consider the increasing costs of retirement over time due to longer life expectancy, and regularly review your financial situation to ensure your retirement funds are sufficient to meet your evolving needs.

6. Seek advice from a financial advisor

You can reach out to a retirement specialist or financial advisor who can help you navigate the sequence of returns risk and develop a comprehensive retirement plan tailored to your specific needs. They can help you understand the relationship between risk and return on investment and adopt strategies that minimize the damaging effects of market volatility on your portfolio. You can also use other tools like the sequence of returns calculator to plan things better.

To conclude

Managing the sequence of returns risk requires careful planning, diversification, and flexibility. Preparing for the worst and understanding the challenges posed by the sequence of returns risk is important to make informed decisions and protect your financial well-being throughout retirement. You must employ retirement income strategies that consider potential market volatility, ensure a sustainable withdrawal rate, and provide a cushion for unexpected expenses. You can also work with a financial advisor to understand the challenges posed by the sequence of returns risk.

Use the free advisor match service to connect with a financial advisor who can tailor an asset allocation strategy that aligns with your specific needs and objectives before and after retirement. Answer some simple questions about your financial needs, and our matching tool will connect you with 1-3 advisors who can best fulfill your financial requirements.

For additional information on suitable retirement strategies for your financial requirements, visit Dash Investments or email me directly at


jonathan dash

Jonathan Dash
Founder and President